The Rs 1-trillion additional tier-1 (AT-1) bond market — also called perpetual bonds — is likely to see a heavy loss of investor appetite after Reserve Bank of India proposed writing-down the AT-1 bonds of YES Bank. Forcing bondholders to take a 100 per cent haircut on the bank’s AT-1 bonds would lead to losses to the tune of Rs 10,800 crore, estimates Acuité Ratings. It says such a move can drive away investors from such bond issues in the future.
According to the rating agency, the bulk of the exposure to YES Bank’s AT-1 bonds is to mutual funds (MFs) and banks’ treasuries. Several MF schemes have already marked down their exposure to zero, which would impact investments of unit holders unless the regulatory stance on the bonds changes.
“The scheme is still in the draft stage but, if implemented, it would indicate a shift in regulatory thinking on these bonds. This will have an impact on appetite for these bond issues. In 2017-18, some of public sector banks with weak financial health and equity erosion were put under prompt corrective action of the RBI, but AT-1 obligations were still paid out fully,” said R Sivakumar, fund manager at Axis MF. “In the current scenario, we are seeing a different treatment for these bonds.” Fund managers and fixed income experts say the regulator’s treatment to AT-1 bonds is a source of worry, as it can be harbinger of how such bonds will get treated in the future, if the need for regulatory intervention arises.
Fixed income experts say these bonds have been an important avenue of raising funds for banks, especially for those unable to tap the equity markets due to beaten down equity value. “Most public sector banks already can’t access equity capital markets. Such a move will make it difficult for them to access debt markets as well. This is a retrograde step,” a debt fund manager said.
“For the first time, AT-1 bonds are being written off ahead of equity. Equity shareholders will still own 51 per cent of the restructured bank, but AT-1 bondholders will suffer full loss. This could put brakes on fundraising in the AT-1 market,” the fund manager said.
Sivakumar of Axis MF said: “There are instances where regulations say that AT-1 bonds will be senior to equity, whereas, in the current scenario, we are seeing these bonds being treated as junior to equity.” Under Basel III Capital Regulations, outlined by the RBI in its master circular, an AT-1 bond is superior to equity. Meanwhile, information memorandums of such bonds highlight the risk of write-down or conversion to equity if a bank’s financial health is in trouble.
According to sources, banks are reconsidering fundraising plans through AT-1 bonds. On Saturday, IndusInd Bank decided not to consider issuing bonds for fundraising. The bank said Monday’s board meeting, which was to consider issuances of AT-1 bonds and/or tier-2 bonds, was being put on the back-burner.
Fixed income experts say regulatory intervention on AT-1 bonds can further widen risk premium on such bonds, especially for smaller banks.
“Going forward, appetite for such an instrument in the market shall be muted or be available only at higher spread for risk-free names,” said a person heading the institutional fixed income business of a non-banking financial company (NBFC).
Further, financial advisors say AT-1 bonds were also sold to retail investors, citing the 250-300 basis point higher yield than bank fixed deposits, without disclosing the inherent risks of write-down or losses.
So far, AT-1 bond market has been tapped by both large and small-sized banks. According to data from Bloomberg, State Bank of India raised Rs 8,169 crore from AT-1 bonds in 2019. Among other banks that accessed the AT-1 bond market last year were IndusInd Bank (raised Rs 1,489 crore) and Bank of Baroda (raised Rs 3,397 crore). Other banks that raised capital through AT-1 bonds include Punjab National Bank, Canara Bank, Union Bank of India, Andhra Bank, ICICI Bank, and HDFC Bank, among others. Some NBFCs have also used AT-1 bonds for capital requirements.