Moody’s Rating Upgrade may help small Government Banks

India’s latest rating upgrade in more than a decade by Moody’s Investor Services may come as a shot in the arm for smalland mid-sized state-owned banks, which are reeling under mounting bad loans.

These banks, helped by the government’s massive fund injection weeks ago, have experienced at least 75-basis-point reduction in borrowing costs, and may now be able to sell perpetual bonds at even softer rates – by another quarter per cent. Lower borrowing costs are likely to help lenders improve their profit margins that were bleeding under the huge burden of sticky loans.

“Small to mid-sized public sector banks have gained substantially from lower borrowing costs,” said Ashish Agarwal, executive director at AK Capital.

“Post the announcement of recapitalisation of banks, pricing of their perpetual bonds dipped by approximately 75 basis points even while yield on benchmark sovereign bonds was rising. Sovereign rating upgrade is likely to lift investor confidence in state-owned banks,” he said.

Beginning November, five state-owned banks including Bank of India, Oriental Bank of Commerce, Corporation Bank, Allahabad Bank and United Bank of India have collectively raised about Rs 3,400 crore.

Dealers attributed their gains to lower borrowing costs. For instance, Allahabad Bank sold Rs 600 crore worth of perpetual bonds during the second week of November by paying 9.34 per cent, which is about 250 basis points lower than what it had paid in September to sell such securities.

“Bank recapitalisation, along with the latest sovereign upgrade, has boosted investor appetite,” said Ajay Manglunia, senior executive vice president at Edelweiss Finance. “The bottom line is that these banks are now expected to grow by shrugging off their bad loan burden – if not today, but in the coming quarters. The risk premium may fall further with more investors showing interest in such high-yielding securities. We have already received investor queries on such papers,” he said.

The benchmark bond yield was at 6.61 per cent on September 25, the day the Kolkata-based lender sold those risky papers.

But, the index jumped to 6.94 per cent on the day the lender tapped the market again in November. Perpetual bonds are priced in sync with the government bond gauge. Going by this, Allahabad Bank should have paid higher cost instead of offering low rate. There are similar examples with Bank of India, OBC and Corporation Bank.

“It needs to be seen whether banks will continue to reap the benefits of low borrowing costs in the wake of hardening of interest rates,” Agarwal said. Perpetual bonds, known as additional tier-1 (AT1) in market parlance, are quasi-equity instruments under Basel-III requirement. If an issuing bank incurs losses in a financial year, it cannot make coupon payment to its bondholders even if it has enough cash.

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