PSBs using AT1 bonds to shore up capital base

State-owned banks with weak profile take up costly long-term interest commitment

Many public sector banks (PSBs) are using additional tier I (AT1) bonds — a hybrid instrument — to shore up capital base. This is coming at a cost in the form of high coupon or interest rate, as investors factor in risks from a huge pile of bad loans on their books.

Mumbai-based lender IDBI Bank agreed to a hefty 11.06 per cent coupon rate, while Union Bank of India struck a deal for 9.5 per cent. In fact, State Bank of India (SBI) placed its AT1 bonds at a lower rate of nine per cent on Tuesday.

Analysts at rating agencies and arrangers to offering said the high interest on coupon suggests this is seen as a risky instrument, since issuing banks have the option to not pay coupon or principal when finances are weak. It also points to the huge pool of non-performing loans and the liquidity of these instruments in markets.

SBI placed the entire offering with YES Bank, so it was bilateral deal. This may not indicate a market trend, despite SBI’s much better financial profile, an analyst with a rating agency said.

Union Bank is one of the few PSBs which reported a net profit in the last five quarters despite the Reserve Bank of India’s asset quality review (AQR).

A senior merchant banker said there was appetite for paper rated at “AA” and above. Banks having a rating below the AA level had a tough task at hand to place the AT1 bond issue.

PSBs’ interest income has been under pressure due to lacklustre growth in credit and also due to the fact that there is part reversal of interest income booked on assets which turn bad. Their credit costs — amounts to be set aside for stressed loans — would remain high in the medium term. The combined effect is limited accretion of revenues, creating a challenge for future interest and principal payments on bonds.

According to RBI data, stressed assets in the Indian banking system rose to 12 per cent in June 2016 from 11.4 per cent at the end of March 2016, reflecting pressure on PSBs.

Rating agency ICRA has flagged risks over the capability of PSBs to service coupon (interest) payments. The huge losses reported by many PSBs in 2015-16 and weak balance sheets and depleting revenue reserves of banks are the reasons behind the agency’s pessimism.

There is pressure on the net distributable reserves and credit balance of some PSBs due to losses and tidy amounts set aside as provision for bad loans.