Mumbai, February 28, 2018

Capital infused by government can be used to replace existing AT-1 bonds

ICRA on Tuesday said that despite the recent recapitalisation by the Government of India (GoI), if banks, which are currently under the prompt corrective action (PCA) framework were to recall their AT (Additional Tier)-I bonds, some of them may not be able to meet the Tier-I regulatory requirements as on March 31, 2018.

In this regard, the credit rating agency pointed out that two public sector banks – Bank of Maharashtra and Oriental Bank of Commerce – have already issued notices to their AT-I bondholders, intimating them about an exercise of early call option on their AT-I bonds.

According to ICRA, as per the terms of the AT-I bonds, banks have a right to exercise an early call option on their AT-I bonds upon occurrence of a regulatory event, among others, provided these are replaced with similar or better quality capital.

This, coupled with the confirmation by RBI that capital infused under the recent recapitalisation programme can be utilised to replace the existing AT-I bonds and subsequent instructions from the government to recall their AT-I bonds, have triggered early calls by banks, it added.

Anil Gupta, Vice-President, Financial Sector Ratings, ICRA, said: “As on December 31, 2017, public sector banks had AT-1 bonds outstanding of Rs.60,385 crore. Out of the banks that are currently under the PCA or are likely to come under PCA, about 60 per cent of AT-I bonds totalling Rs.37,600 crore can be prematurely recalled.”
High-net NPAs

According to Gupta’s assessment, with capital infusion of Rs.80,562 crore during Q4 (January-March) FY2018, the effective recapitalisation will stand reduced for many PSBs. Accordingly, despite recapitalisation, some banks can potentially be lower than the regulatory Tier-I capital requirements level (including capital conservation buffer) for March 31, 2018.

Eleven PSBs have been put on PCA by RBI due to high-net non-performing assets (NPAs) and negative return on assets (ROA) for two consequent years.

The banks that have been put on PCA include Indian Overseas Bank, Dena Bank, Corporation Bank, Central Bank of India, IDBI Bank, UCO Bank, United Bank of India, Bank of Maharashtra, Oriental Bank of Commerce and Bank of India.

The RBI has already invoked the PCA on 11 out of 21 PSBs (of which 10 banks have issued AT-I), and based on the PCA framework, according to ICRA’s estimates, five more PSBs can be included under the PCA framework.

“Earlier in January 2018, the government had instructed PSBs not to issue AT-I bonds without prior approval. Accordingly, the weak banks would be required to raise equity capital to meet their overall Tier-I requirements, which otherwise could have been met through the AT-I bonds,” said ICRA. Gupta explained that though the Tier I capital ratios are likely to weaken in relation to regulatory requirements upon the early recall of these AT-I bonds by PSBs, the risk of coupon skip by weaker PSBs on their AT-I bonds will significantly reduce.

“Some of the investors who could have bought these bonds from the secondary market at a premium [higher than face value], may stand to lose as the early redemption by banks is likely to be done at face value.

“However, with riskier features like a “write-down” clause in these bonds, it may be a positive for investors of AT-I bonds issued by the weaker PSBs,” he added.

[The Hindu Business Line]