In March 2021, the capital market regulator, the Securities and Exchange Board of India (SEBI), had issued a circular revising the norms for investments by debt mutual funds in the Basel III debt instruments issued by banks. The circular also revised the norms for the valuation of perpetual bonds issued by various classes of issuers (banks, non-banking financial companies (NBFCs) and corporates).
As mutual funds were a large investor segment in these bonds, these changes were expected to impact the demand for these instruments issued by the banks. As per ICRA’s estimates, Rs. 20,505 crore of Additional Tier I (AT-I) bonds of public sector banks (PSBs) and Rs. 7,925-crore bonds of private sector banks (PVBs) are due for the exercise of call option (after five years from issuance) in FY2022 with majority of Rs. 19,750 crore in H2FY2022.
Given the impact of the Covid-19 pandemic and the perceived weakness in the financials of public banks compared to their private counterparts, the large upcoming rollovers and the revised regulations were expected to pose challenges to the rollover of these debt instruments, especially for public banks, thereby impacting their Tier I capital ratios. Moreover, the appetite of foreign investors in the AT-I bonds could also have been uncertain given their weak standalone credit profile and features of the instruments, thereby creating ambiguity on their ability to raise AT-I from overseas markets. However, all PSBs have largely raised fresh AT-I bonds nearly equivalent to the call options due in FY2022, which is likely to preserve their capital ratios.
Given the impact of SEBI’s regulations and the uncertainty regarding the appetite of domestic investors, some of the private banks, like HDFC Bank and Axis Bank, also raised AT-I bonds in the overseas markets. Further, some banks like ICICI Bank is yet to raise AT-I in the current fiscal, however with strong capital position, it may decide, not to do so.
As per ICRA’s estimates, the demand from mutual fund investors remained muted and the AT-I bonds of PSBs were subscribed by other PVBs (which, in turn, sell down to other investors), pension funds and corporate treasuries. The coupon for the bonds issued by the banks largely remains similar or lower than the bonds for which the call option is scheduled to be exercised this year.
Apart from the relatively better coupon on these AT-I bonds of PSBs, other factors that supported the AT-I issuances of PSBs in domestic markets include their improved ability to service the coupon on these bonds. In FY2021 and FY2022, almost all PSBs wrote off their accumulated losses against their share premium after receiving approval from the Government of India (GoI) and the Reserve Bank of India (RBI).
The coupon on these bonds is payable from the profits generated by the bank during the year and accumulated profits from the past. As the PSBs wrote off their accumulated losses, their ability to service these AT-I bonds improved. This also led to credit rating upgrades on these AT-I bonds, which, coupled with the improved outlook on the earnings of PSBs, supported the issuance of these bonds.
It must be noted that PSBs must take prior approval from the GoI for issuing AT-I bonds as per a circular issued in February 2018 as weak financials of these banks significantly increased the risk of coupon skip and many PSBs exercised an early call option on their AT-I bonds to prevent coupon skip in FY2018 and FY2019. Most PSBs received this approval from the GoI in Q3 FY2022, which resulted in higher issuances in Q3 FY2022.
Commenting on the developments, Mr. Anil Gupta, Vice President – Financial Sector Ratings, ICRA Ratings says: “The rollover of the AT-I bonds by public banks at competitive rates compared to their earlier issuances is a positive for the capital ratios and also reduces the recapitalisation burden of the GoI. While we still await the bank wise allocation of the budgeted capital infusion of Rs 20,000 crore into PSBs in FY2022, with the improved profitability and equity capital raise from markets, the near-term capital requirements remain negligible for most public banks for regulatory as well as growth requirements.”
