Perpetual bonds fail to woo investors

Arrangers still stuck with 50% of the issuances

Placing perpetual bonds issued by banks to shore up Tier-I capital with investors has turned out to be a bitter experience for arrangers in FY15. Arrangers, merchant bankers registered with the Securities and Exchange Board of India and involved in issue management and mobilisation of funds, have not been able to sell forward these Basel III-compliant bonds to investors due to the risks involved in these instruments. Key investors such as insurance companies have stayed away from these bonds, due to which arrangers are still saddled with almost 50 per cent of these bonds in their kitty.

The task of hawking these instruments could be challenging in FY16, as investors have ample options to choose from. These bonds come with tough covenants (rules) for distributing the dividends, which investors often find unattractive. Perpetual bonds have no maturity date and these are treated more like equity instruments than debt. These bonds are referred to as additional Tier-I capital (AT-I) under the Basel-III requirements of banks.

Vibha Batra, senior vice-president and financial sector rating head at ICRA, said the requirement for AT-I capital for banks is huge (estimated at above Rs 30,000 crore) in 2015-16. For investors, there is going to be a lot of choice in the market, with infrastructure bonds and debentures from strong companies. Public sector banks (PSBs) that have stressed balance sheets are going to find it tough to place AT-I bonds with investors, Batra said.

According to arrangers, they are still sitting partly on perpetual bonds issued by banks such as Dena Bank, Indian Overseas Bank, Bank of Maharashtra, Corporation Bank, Oriental Bank of Commerce and IDBI Bank. “The issue with perpetual bonds is that they are rated two notch lower than the Tier-II bonds issued by banks due to higher risks involved. Banks may have raised about Rs 4,000 crore through perpetual bonds in March and we are still stuck with about 50 per cent of these bonds as we could not sell them further,” said an arranger.

Tier-II capital includes subordinated bonds, hybrid bonds, undisclosed and revaluation reserves, among others. Tier-II bonds of these banks had seen good demand in the past among investors despite the coupon rate being lower than the one, which was offered by perpetual bonds.

“When the insurance regulator had allowed investments in Basel-III bonds they had not given any clarification on Tier-I bonds (perpetual bonds). The regulator has given category code for Tier-II bonds; since no category code was given for Tier-I bonds, it is deemed there is no approval for investment in these bonds. Hence, most insurance companies have stayed away from these bonds,” said the head of fixed income of an insurance company. Bank of India, first to issue these bonds, paid 11 per cent coupon. Later when Reserve Bank of India relaxed rules, the expectations about returns softened. Still, insurers expected higher interest rates, than bonds for comparable tenure (5-10 years). In March, banks offered coupon rates between 9.48 per cent and 10.75 per cent.

“These bonds are treated more like equity type of instrument than debt but somehow that did not get reflected in the pricing of these bonds. The risks are not getting factored in well in these instruments due to which the demand is muted,” said another arranger.

After the bitter experience of arrangers, banks might be forced to tap other avenues like pure equity rather than issuing these bonds. A treasury official with large PSB said not many banks have come out with Basel-III compliant bond offerings. Institutional investors are not strongly positive about these instruments. They would like to get higher rate of returns to compensate for strict rules on dividend payments (forgoing). Banks are not ready to shell out more (more attractive coupon).

WHAT IS A PERPETUAL BOND?
A perpetual bond is a financial instrument with no maturity date

The bonds are not redeemable but pay a steady stream of interest forever

The price of a perpetual bond is, therefore, the fixed interest payment, coupon amount, divided by a constant discount rate, which represents the speed at which money loses value over time (partly because of inflation)