Additional Tier-1 bond issuances by banks likely to decline in FY24

Mutual funds stays away after Sebi valuation norm change

Additional Tier-1 (AT1) bond issuances by banks may see a substantial decline in the current financial year (FY24) as well as in the next financial year as not many such papers previously issued are maturing, coupled with banks’ dependence on such instruments have come down following improving profitability.

Banks had issued Rs 34,394 crore AT1 bonds in FY23, compared to Rs 29,984 crore in FY22.

This year only, bonds worth Rs 15,000 crore are coming up for maturity. Banks issue AT1 bonds to boost common equity tier-I capital (CET1). They have to maintain a minimum of 8 per cent CET1.

“In FY24 & FY25, the volume of AT1 bonds maturing or the call options falling due for these instruments for both private and public-sector banks is not very large compared to the previous few years,” said Aashay Choksey, vice-president and financial sector head at ICRA.

In the next financial year, Rs 13,000 crore to Rs 14,000 worth of such bonds are falling due.

Choksey said private banks were now very strong on core capital and their profitability was also very healthy, particularly for the large issuers. “They [large private banks] have also not replaced AT1 bonds with fresh instruments. They have actually allowed these to mature,” he said.

The call options that are falling due for private banks is around Rs 8,000 crore in FY24 and for public sector banks it is Rs 7,000 crore, which is mainly State Bank of India.

SBI was the only issuer of AT1 bonds in this financial year so far, which raised Rs 3,010 crore at a coupon of 8.1 per cent.

The base issue size for AT1 bonds was Rs 3,000 crore with a green shoe of Rs 7,000 crore. The amount that was raised was just above the base size though SBI got bids worth Rs 5,900 crore.

Investors were asking for higher levels of yields, which prompted SBI to raise only Rs 3,010 crore. Interestingly, SBI decided to have a 10-year call option, though typically these bonds have a five-year call option.

Canara Bank and Punjab National Bank were some of the other banks that had taken approval from their boards for raising capital by issuing AT1 bonds. PNB Managing Director and Chief Executive Officer Atul Kumar Goel on Wednesday said there was no immediate requirement for capital since the capital adequacy ratio of the bank is 11.5 per cent. A senior official from Canara Bank said fundraising via AT1 bonds would depend on market conditions.

“The lower appetite [for SBI AT1 bonds] could also be a result of a 10-year call option, because these bonds typically have a five-year call option. If you want mutual funds to subscribe you would call back the instrument in five years,” said Karan Gupta, head & director, Financial Institutions, India Ratings.

He said there could be pricing issues as well for SBI not going for the green shoe option, given the way interest rates have moved. Gupta agreed that this year AT1 bond issuances could come down as compared to the previous years as not many bonds are maturing.

Mutual funds, which was a subscriber of such bonds in the previous years, has stayed away from subscribing after there is change in norms.

“Mutual Funds are subject to Sebi regulations where gradually the maturity of AT1 bonds is moving towards 100 years. Also the spread is not very attractive keeping in mind the risk similar to equity,” said Marzban Irani, chief investment officer, Fixed Income, LIC Mutual Fund. Banks have the option to skip the coupon payment if their profitability is impacted.

Sandeep Bagla, CEO at Trust Mutual Funds, agreed that changes in regulations had made it difficult for fund managers to take incremental exposure in AT1 bonds.

“Mutual funds used to invest in select AT1 bonds of high-quality issuers, but have stopped investing in such bonds since the last few quarters,” Bagla said.

“In 2018, Sebi introduced scheme categorisation, in which fixed income schemes were classified into different categories as per their duration profile. For example, schemes in the short-term bond fund category would have to maintain portfolio duration between 1 and 3 years. As there is no maturity specified in the perpetual AT1 bonds, mutual funds used to take the period till call date as the maturity of the bond and for calculation of the portfolio duration. In 2021, Sebi mandated that the maturity of the AT1 bonds be gradually increased to 100 years. In our short-term bond fund example cited earlier, a 10 per cent exposure to AT1 bonds would increase the portfolio duration by almost one-full year, under the new changes in guidelines,” Bagla said.