14 October 2016 Current Affairs: Four public sector banks (PSBs) may struggle to make coupon payments on their additional tier 1 (AT1) bond as they have reported heavy losses due to a surge in bad loans.
In this case coupon payment is an annual interest paid on the face value of a bond. It is expressed as a percentage. AT1 bond is issued under Basel III capital regulations.
The main reasons that may affect ability of PSBs to pay coupon on AT1 bonds are decline in profitability and increasing losses that may wipe out their revenue reserves.
Union Government has committed capital support to these PSBs on the coupon on AT1 bonds. However, this support can only be serviced through PSBs current year’s profit or from revenue reserves. Thus, any capital infusion by the government alone cannot help the banks to service coupon on these bonds.
AT1 bonds are the hybrid bonds that combine debt and equity elements. They are also called as contingent convertible capital instruments (CoCos). AT1 or Cocos bonds have their roots in financial crisis when governments were forced to bail out banks. They are the riskiest debt issued by banks and do not have any set maturity date.
The defining characteristic of AT1 or Cocos bond is that it may be converted into shares when certain conditions are met. For example, when a company runs into trouble, the owners lose their stake and the debt becomes equity, lenders turns into owners.
But in case of banks such negotiations are not possible. The coco bonds are designed to anticipate that process and transform automatically from debt to equity.
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