Covered Bonds vs Perpetual Bonds vs AT1 Bonds: What’s the Difference?

Debt isn’t “boring” anymore. It used to be simple. A company borrows money, you lend it, you get interest, you get principal back on maturity. Done.

But markets hate simplicity. So debt products evolved. Some reduce interim cash outflows for issuers. Some track changing rates. Some stretch duration to ride rate cycles. Some add credit protection. Some can even convert into equity.

In this blog, we’ll focus on three instruments that show how “plain vanilla” debt can quietly turn into something else: Covered Bonds, Perpetual Bonds, and AT1 Bonds, with an Indian context.

Now let’s unpack each.

Debt isn’t one-size-fits-all anymore

Even before these three, debt already had “variants”:

• Zero-coupon or deep discount bonds help issuers reduce interim cash outflows.
• Floating rate bonds adjust coupons as market rates move.
• Long duration bonds can benefit if interest rates fall (price goes up).
• Secured vs unsecured bonds differ by safety structure.
• Credit quality bands range from government bonds to higher credit risk bonds.
• Convertible bonds can convert partly or fully into equity later.

Covered bonds, perpetual bonds, and AT1 bonds sit on top of this landscape. They exist because issuers want cheaper or more flexible funding and investors want yield, structure, or both.

1) Covered Bonds: Better risk structure, more moving parts

What is a covered bond in plain English?

A covered bond is a bond where repayments are “covered” by a ring-fenced pool of loans that generate regular cash flows.

Example:
An NBFC has a high-quality car loan pool with strong repayment history. The NBFC itself may be rated AA, but that car loan pool may be even stronger in quality and predictability. So the NBFC issues a bond backed by that pool’s cash flows.

The idea is simple: better collateral and better cash-flow visibility can support better pricing.

How it works (step-by-step)

1. The issuer (bank/NBFC) identifies a high-quality loan pool (like car loans).
2. It issues bonds linked to that pool’s interest and principal inflows.
3. Bond investors receive repayments sourced from the pool, and also have a claim on the issuer if needed.
4. Because the structure reduces risk, the issuer may be able to raise funds at better terms.

“Dual recourse” explained like you’re busy

Covered bonds are often called dual recourse bonds because investors have two claims:

• First recourse: cash flows from the cover pool (the car loan repayments).
• Second recourse: the issuer’s other assets if the pool is not enough.

That dual layer is what makes them feel “safer” than a plain unsecured corporate bond, though “safer” does not mean “risk-free.”

Why issuers like covered bonds

• They can raise funds at a lower interest rate if the covered structure supports a stronger rating or better demand.
• They can leverage their existing loan book more efficiently.
• It can diversify funding sources beyond normal borrowing.

Why investors like covered bonds

• They get a bond that is supported by a specific high-quality pool plus the issuer’s broader balance sheet.
• It may suit investors looking for a yield-with-structure rather than pure unsecured credit exposure.

Risks and why it’s not for everyone

Covered bonds are complex. Key risks include:

• Structure risk: you need to understand how the cover pool is maintained and what happens if it deteriorates.
• Asset quality risk: if the loan pool underperforms, cash flows weaken.
• Issuer risk still exists: the issuer’s health still matters, even with dual recourse.
• Liquidity and pricing: these instruments can be less straightforward to buy/sell versus simpler bonds.

Covered bonds are not “magic.” They are just a smarter packaging of risk, with paperwork and rules doing the heavy lifting.

2) Perpetual Bonds: Interest payouts with no end date

The core idea

A perpetual bond has no maturity date. Unlike a 5-year bond, there is no fixed promise that the principal will be repaid at a specific time.

So what do you get?
You typically get a coupon payment that can continue indefinitely.

That’s why these instruments are often described as “equity-like,” not because they behave exactly like shares, but because the principal is not scheduled to come back on a defined date.

The call option changes the story

Most perpetual bonds come with a call option. This means the issuer can choose to redeem the bond after a certain period like 5 years or 10 years.

Why does this matter?
Because the issuer will usually call the bond if it becomes expensive for them.

Example:
- You buy a perpetual bond paying 11%.
- After 5 years, market yields are 7%.
- You, as the holder, love it because you’re earning 4% more than market.
- The issuer hates it because they’re paying above-market costs, so they may call the bond, repay principal, and issue fresh bonds at lower rates.

So while “no maturity” sounds like certainty, the call feature introduces real-world uncertainty.

Key risks in perpetual bonds

• Interest rate risk: prices can swing sharply when rates move because there’s no fixed maturity anchor.
• Call risk: if rates fall, the issuer may redeem, and you may have to reinvest at lower rates.
• Reinvestment risk: you might not find a similar yield when the bond is called.
• Issuer longevity risk: holding a company’s bond “forever” is a big assumption, so these are typically issued by established names with scale.

How are perpetual bonds valued?

Normal bonds are often priced using yield-to-maturity (YTM) because maturity exists.

Perpetuals don’t mature. So a common simplified pricing approach is:

Value of a perpetual bond = Annual Rupee Interest / Required Rate of Return

Example from the concept:
- Annual interest (coupon in rupees) = ₹1,000
- Required return = 4% (0.04)
- Value = ₹1,000 / 0.04 = ₹25,000

Now see what rates do:
- If required return falls to 3%, value rises to ₹1,000 / 0.03 = ₹33,333 (approx).
- If required return rises, value falls.

This is why perpetual bond prices can be very sensitive to rate moves.

3) AT1 Bonds: Higher yield, but the risk is built-in

What are AT1 bonds?

AT1 bonds (Additional Tier 1) are issued by banks to strengthen their capital base. They became widely discussed after the 2008 global financial crisis, when regulators globally pushed banks to carry more shock-absorbing capital.

Think of AT1 as a tool for banks to meet capital adequacy needs, but the “capital-like” nature comes with tougher terms for investors.

Why do AT1 bonds pay higher interest?

Because they are riskier than traditional bonds.

AT1 bonds are often structured as perpetual instruments, and while issuers may redeem them later (commonly seen around 8–10 years in practice), there is no guarantee.

The most important feature: conversion or write-down in stress

This is the part many people miss.

In a distress situation, AT1 bonds can:

• be converted into equity, or
• be written down, even fully written down to zero.

This is not theoretical. Similar outcomes have occurred in distressed banks in India and globally, depending on the resolution and regulatory triggers.

A typical trigger logic is:

• If the bank’s capital levels fall below a threshold, conversion/write-down can be used to reduce the bank’s debt burden and protect depositors and overall stability.

Who usually participates and why it needs sophistication

AT1 bonds often attract:

• HNIs
• family offices
• institutions

Mostly because yields can look attractive.

But the risks are not just “default risk.” You also face:

• conversion risk (your bond becomes equity when you least want it),
• write-down risk (value can be reduced),
• call risk (issuer redemption decisions),
• pricing complexity (rates and bank health both matter).

AT1 is not “just another high-yield bond.” Its rulebook is different.

Comparison Table

Common misunderstandings

• “Covered bonds are risk-free because they are backed by loans.” No. The pool can underperform and structures vary.
• “Perpetual means I’ll surely keep getting interest forever.” Not automatically. Issuer health and terms matter, and call features change outcomes.
• “AT1 is like a normal bank FD with extra yield.” No. AT1 can be converted or written down in stress.
• “If a bond is called, it’s always good news.” It can create reinvestment problems, especially when rates are lower.
• “Higher yield always means better value.” Higher yield often means higher embedded risk, sometimes in non-obvious ways.

Key takeaways

• Covered bonds use a loan pool + issuer backing, so the structure can improve risk management, but it adds complexity.
• Perpetual bonds remove maturity, so interest rate risk and call risk become central.
• AT1 bonds are built to absorb losses, so conversion/write-down risk is the headline feature.
• “Higher yield” often signals “different rules,” not just “better deal.”
• If you can’t explain the triggers and exit path, you don’t understand the product yet.
• Always read the offer document terms because these instruments are term-driven.

FAQs

1. Are covered bonds the same as securitisation?

They are often described as securitised-style structures because repayments are linked to a loan pool. But a key idea in covered bonds is dual recourse: you have a claim on the pool and also on the issuer, depending on structure.

2. Why can covered bonds get better pricing than normal bonds?

Because a high-quality cover pool can make repayment support stronger and more predictable. If investors trust the pool and structure, the issuer may raise funds at better terms than an unsecured borrowing.

3. What is the biggest risk in covered bonds?

Complexity. You need clarity on how the pool is maintained, what happens if the pool quality drops, and what legal protections exist. It’s not just “credit rating,” it’s also “structure rules.”

4. If perpetual bonds have no maturity, how do people exit?

Usually through secondary market selling, or if the issuer exercises the call option and redeems the bond. Without a call and without a liquid market, exit can be difficult.

5. Why do perpetual bond prices move a lot when interest rates change?

Because the cash flows can extend indefinitely. When rates rise, the present value of long cash flows falls more sharply. When rates fall, the present value rises. That sensitivity is the main driver.

6. How does the call option affect perpetual bond holders?

If rates fall, the issuer is more likely to call the bond and refinance cheaper. That means holders lose a high coupon stream and must reinvest at lower yields. So the call option shifts upside away from the holder.

7. Are AT1 bonds always redeemed in 8–10 years?

Not guaranteed. Even if past behaviour shows many issuers eventually redeem, the instrument is perpetual by design. The decision depends on issuer choice, market conditions, and regulatory considerations.

8. What does “write-down” mean in AT1 bonds?

Write-down means the bond’s principal value can be reduced, potentially even to zero, under stress triggers or resolution actions. This is a built-in loss-absorbing feature to protect the bank’s stability.

9. Can AT1 bonds convert into equity?

Yes. Conversion to equity is a common mechanism in AT1 structures when capital falls below a threshold. That reduces debt and increases equity, helping the bank’s capital position.

10. Who should be extra careful with AT1 bonds?

Anyone who treats it like a normal bond. AT1 requires understanding of bank capital triggers, resolution mechanics, and loss absorption terms. It suits investors who can evaluate these risks properly.

Disclaimer: This article is for educational information only. It is not a recommendation to buy or sell any security. Terms and risk features vary by issuer and issue documents, so readers should evaluate suitability and read the relevant offer documents carefully.