Weaker PSBs could skip interest payment on additional Tier-I bonds: ICRA

Analytics in PSB ICRA

Amid intermittent breaches of regulatory capital ratios by some public sector banks, last minute capital support and changes in regulations, credit rating agency ICRA has cautioned investors to be prudent to factor in the distinct possibility of a coupon skip on Additional Tier-I (AT-I) bonds.

The agency said the first quarter results indicate that six public sector banks (PSBs) are short of the regulatory CET (common equity tier-I) requirements for FY18. In addition, five more banks are short of regulatory Tier-I requirement for FY18.

“If the AT-I bonds are not allowed to absorb losses, it would be prudent to not accord Tier-I status to them…Past may not be a fair predictor of the future, in this instance,” Karthik Srinivasan, Group Head, Financial Sector Ratings, said.

In the backdrop of relaxation in regulatory framework and lowering of risk associated with AT-I instruments and the inability of many PSBs to raise core equity given their low equity valuation multiples, AT-I issuances surged over the past two years.

According to ICRA, Indian banks have till date raised ₹84,100 crore (including a $300 million offshore issuance by State Bank of India), supported largely by the higher coupon offered on the instruments, which triggered investor appetite in the declining interest rate regime. PSBs accounted for over 70 per cent of the amount raised. The mobilisation of AT-I capital also allowed banks to defer equity-raising plans.

Wider base

The AT-I investor base has widened over the past two years, to include high net worth individuals and corporate treasuries in addition to traditional institutional investors like mutual funds, banks, pension funds, traders and players in high-yield assets.

“The capital infusion by the government into a PSB in August 2017 reiterates the government’s intent to ensure that PSBs do not default on the debt instruments. At the same time, the capital infusion also indicates limited likelihood of further relaxations or regulatory forbearance for AT-I bonds going forward,” ICRA said in a statement. Assuming that the regulator does not dilute the loss-absorbing capacity of these instruments any further, at the current juncture, the rating agency believes that the government needs to shore up the capitalisation levels of PSBs during the next two years.

Otherwise, the PSBs will have to shrink their balance sheets to reduce their risk-weighted assets and cede market share to private banks.

Further, in the case of weaker PSBs that have fully eroded or are close to fully eroding their reserves (which could be used to service the AT-I coupon in a year of loss), the management would need to focus on divesting the non-core assets as even capital infusion will not be able to avert a default on the AT-I bonds.

PSBs that are significantly lower placed on distributable reserves include Indian Overseas Bank, IDBI Bank, UCO Bank, Bank of Maharashtra, Dena Bank, United Bank of India, Bank of India and Syndicate Bank. Distributable reserves are created through appropriation of net profits, including statutory reserves, and excluding share premium, revaluation reserve, foreign currency translation reserve, investment reserve and reserves created on amalgamation. The accumulated losses and deferred revenue expenditure, if any, shall be netted off to arrive at the distributable reserves.

“However, ICRA notes that the AT-I regulations are still open to interpretations and notwithstanding the past relaxations, the coupon servicing by weaker PSBs continues to be characterised by high risk.

“Also, the inclusion in AT-I bonds in the overall capital of a bank creates an illusion of comfortable capitalisation, which is misleading if these instruments are being bailed out,” said Srinivasan

Source: hindubusinessline.com

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