A clutch of top-rated state-run banks, including State Bank of India (SBI) and Union Bank of India, are likely to issue additional tier-1 (AT1) bonds soon, money market experts told Moneycontrol on July 18.
AT1 bonds are a type of perpetual debt instrument that banks use to augment their core equity base and thus comply with Basel III norms. These bonds were introduced by the Basel accord after the global financial crisis to protect depositors. These bonds do not have a maturity date. Banks have a call option that permits them to redeem these bonds after a certain period.
These banks are likely to take cues from strong demand witnessed for recent AT1 bonds issues from Canara Bank and Punjab National Bank, sources said.
On July 15, Canara Bank saw aggressive bidding for its AT1 bonds from investors and raised Rs 2,000 crore at 8.24 percent coupon via the issue, according to people aware of the matter. Prior to that, on July 6, Punjab National Bank also raised Rs 2,000 crore through the sale of AT1 bonds at a coupon of 8.75 percent, which was fully subscribed.
“Union Bank’s AT1 bond issue can be announced any time now,” said a person familiar with the development. “SBI is still deciding on the timing of the AT1 issue. The bank will most likely come up with a green perpetual bond issue soon.”
Experts said that investors are favouring PSU banks’ AT1 bonds of late, and that has to do with how these lenders have managed to clean up non-performing assets (NPAs) on their balance sheets and made sufficient provision for bad assets. As at the end of FY22, the gross NPA ratio of state-run banks stood at 7.6 percent compared with 9.5 percent at the end of FY21, according to data from the Reserve Bank of India (RBI).
“As banks’ credit offtake grows, banks will need tier-1 capital to strengthen their balance sheets further, and fundraising via AT1 bonds will be the preferred route for top-rated PSU banks,” said Raju Sharma, chief investment officer, debt, at IDBI Mutual Fund.
Lessons from the Yes Bank debacle
AT1 bonds carry a higher risk as well and are subordinate to all other debt and senior only to equity. If the capital ratios of the issuer or bank fall below a certain percentage or in case of an institutional failure, the rules allow the issuer to stop paying interest or even write down these bonds. If a bank reaches the point of non-viability, AT1 bonds are typically the first part of debt that is written down.
The market for AT1 bonds took a hit after the Yes Bank AT1 bond write-off, as part of the SBI -led bailout in March 2020. Yes Bank’s restructuring involved a write-off worth over Rs 8,400 crore worth of AT1 bonds, rendering them worthless. Investors had begun to look at these instruments with caution since then.
However, the situation is different this time. Top-rated banks have cleaned up their balance sheets well and are recovering from the COVID-19 pandemic due to timely capital raising. The government’s credit guarantee schemes as well as the RBI’s one-time restructuring scheme and tighter regulations have helped banks weather the crisis far better.
“Post the Yes Bank debacle, institutional investors have started investing again only in top-notch public sector banks as of now with the assumption and going by their past experience that the government will always infuse capital, if required,” said Venkatakrishnan Srinivasan, founder and managing partner at Rockfort Fincap, a Mumbai-based debt advisory firm.
With the reduction in banks’ NPA levels over the years, and an increase in profitability, investors are now treating AT1 bonds as a five-year paper, added Srinivasan.
Attractive returns
Another reason why AT1 bonds are catching investor interest is the attractive yield spread vis-à-vis government securities. For example, the AT1 bond of Canara Bank fetched investors an annual coupon of 8.24 percent, while the 10-year government bond yields 7.44 percent. The difference between the two rates is called the spread. The higher the spread, the riskier the investment.
“The spread on the AT1 bond is still attractive for investors, even though it has shrunk a bit,” said a treasury official at a state-run bank, requesting anonymity. “Banks, on the other hand, will prefer tapping the AT1 route rather than going for an equity capital raise at the moment, looking at the global risk off.”
IDBI Mutual Fund’s Sharma concurred with the banker’s view. “There is a view among institutional investors that there is not going to be a situation like what happened in Yes Bank this time,” Sharma said. “So, in a situation like this, if the issue is providing decent returns and is considered relatively risk-free, why will investors shy away from investing here?”
According to Rahul Singh, Senior Fund Manager – Fixed Income at LIC Mutual Fund Asset Management, there is a "big chunk" of investors in the wealth and alternate investment fund (AIF) segments that are regular investors in the perpetual debt market. They keep the demand thriving in this segment, he added.
Further, Rockfort Fincap’s Srinivasan said that regular, top-rated PSU issuers like Power Finance Corp, Rural Electrification Corp, Power Grid Corp and IRFC have not been actively issuing long-term bonds since April, which is why investors are finding AT1 bonds attractive of late.
However, all may not be hunky-dory for lower-rated banks looking to come up with AT1 bond issuances, said experts. Lower-rated banks may still see high borrowing costs, they added.
“The concern is now for lower-rated issuers who will go for AT1 bonds because demand there is yet to pick up,” said Yogesh Kalinge, vice-president at AK Capital. “Post the Yes Bank debacle, investors are still wary about investing in such issues, but top-rated banks like SBI, Bank of Baroda, Union Bank, etc, will look to capitalise on investor demand.”
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
