Perpetual bond yields nosedive after PSB capital infusion plan

Following the recapitalisation announcement by the government, the yields on the perpetual bonds issued by public sector banks (PSBs) have dropped drastically. Taking advantage of that, some banks have started raising money at a low cost and investors, such as mutual bonds, can’t seem to get enough. 

The fall in yields is as much as 150 basis points in some cases, as the banks are seen well-capitalised for the next few years and don’t need to depend on markets for their capital. As yields fall, prices of bonds rise. 

The key worry for bondholders is that banks can potentially skip the coupon payment. Banks are expected to make the coupon payments to their bondholders from their profits or revenue reserves. In case the banks are not profitable, they can pay the coupon from accumulated or statutory reserves.

Perpetual bonds are called so because there is no set time period for maturity of these bonds, but the issuer has the ‘call’ option, that is, these bonds can be redeemed anytime an issuer wants to. Banks use these bonds to shore up their core equity as additional Tier-1 capital. These are all Basel-III compliant bonds with a unique clause of a ‘haircut’ for the investor, or foregoing interest earnings on the fixed company if the bank is in stress. Naturally, the coupon offered is a little higher than other banks to compensate for the potential haircut. 

Bank of India raised Rs 500 crore on Friday at 8.79 per cent. The bank’s perpetual bond yield was at 10.9 per cent before bank recapitalisation happened, according to market sources. 

Similarly, Andhra Bank raised Rs 500 crore on Thursday at 9.20 per cent, whereas its earlier bonds were trading at a yield of 11.25 per cent before the recapitalisation exercise. Similarly, Union Bank of India’s bonds were yielding 8.65 per cent, against 9.75 per cent earlier. Punjab National Bank’s bonds were trading at 8.60 per cent, against 9.60 per cent earlier. 

Earlier, these bonds fetched a higher yield of 9-12 per cent. In comparison, five-seven year AAA-rated debt papers issued by PSBs are fetching anywhere between seven per cent and eight per cent.

Bond dealers say perpetual bonds at the earlier high yields were a very good buy and therefore, lot of high networth individuals were attracted to these bonds. And when the recapitalisation plan was announced, investors picked up the bonds aggressively considering the chances of default on these bonds have been minimised. 

Mutual funds are also heavily invested in these bonds and they are still bullish. 

“Despite the yields coming off, these bonds remain attractive considering that the balance sheets of public sector banks are likely to get repaired. The fresh lease of capital will shore up capital adequacy ratios and reduce the risk of coupon repayment for bondholders,” said Dwijendra Srivastava, chief investment officer – fixed income, Sundaram MF.