The Securities and Exchange Board of India (SEBI) announced a significant change, stating that the valuation of additional tier-1 (AT-1) bonds by mutual funds will now be based on yield to call. This move, aligning with a long-standing market request, is expected to increase demand for these instruments and enable more banks to raise funds through perpetual bonds.
Increased demand and fundraising
The new valuation methodology is set to pave the way for a surge in AT-1 bond issues by banks, helping them to strengthen their core equity capital. With the yield to call basis for valuation, mutual funds are likely to find these bonds more attractive, leading to greater investment and reduced volatility in net asset values (NAVs).
Previous challenges
The change comes after a turbulent period following the YES Bank crisis in early 2020, when the Reserve Bank of India (RBI) had to supersede the bank’s board, leading to a write-off of its AT-1 bonds. This incident caused significant losses for investors, including mutual funds. Consequently, SEBI had implemented a phased timeline for mutual funds to value AT-1 bonds as 100-year instruments from April 1, 2023, which had previously been valued according to their call options, typically ranging from 5 to 10 years.
Market impact
Prior to the new regulation, the long-duration valuation had led to substantial fluctuations in bond prices and mutual fund NAVs due to the inverse relationship between bond prices and yields. This volatility discouraged mutual funds from investing in AT-1 bonds, causing their investment value to plummet from Rs 25,057 crore in January 2020 to Rs 5,382 crore in April 2023. The share of AT-1 bonds in mutual funds’ assets dropped from 2.53% to 0.45% over the same period.
Positive outlook for banks
With the SEBI’s shift to yield to call valuation, banks are expected to find it less expensive to raise capital through AT-1 bonds. The reduced volatility in mutual fund NAVs will likely make these instruments more attractive to investors, potentially reversing the trend of declining investments.
