Call options and credit growth drive the AT-1 bond market

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Public sector banks raised a total of 4,000 crore through additional Tier 1 bonds (AT-1 bonds) this fiscal year, and expected to rise significantly more as they aim to fund credit growth and replace bonds maturing this year .

The Punjab National Bank was the first to enter the market, raising 2,000 crore via AT-1 bonds at 8.75% this month. Canara Bank also raised 2,000 crores, but at a lower interest rate of 8.24%.

AT-1 bonds, also called perpetual bonds, have no maturity date, but have an option to buy after five years. These are issued by banks to increase their core capital base, and thus comply with Basel III standards.

According to data compiled by rating agency ICRA Ltd, banks have raised a total of 42,000 crore via AT-1 bonds in the last financial year. out of that, 28,500 crore was raised by public sector banks, and 12,000 crores by private sector banks HDFC Bank and Axis Bank in the overseas market.

Market participants expect AT-1 bond issuances from Union Bank and State Bank of India in the coming months. According to the ICRA, public sector banks are likely to issue 14,000 to 16,000 crore in AT-1 bonds this fiscal year.

Bankers say they are looking to raise capital via AT-1 bonds in anticipation of strong credit growth this year. Banking system credit growth is expected to top 12-13% in FY23, according to a Monday report from Bank of America Merrill Lynch. The fortnight ending July 1 saw strong credit growth of 14.4%. %, compared to 6.1% during the corresponding period last year.

The second reason is that call options are due on bonds issued by many banks this year, and banks may consider replacing these bonds with AT-1 bonds. According to ICRA, PSU banks have call options due to 7,300 crore this fiscal vs. 20,500 crores last fiscal year. Private sector banks, on the other hand, have 18,000 crore call options due this year.

“Assuming that (public sector) banks were to maintain the same level of AT-1 capital on increasing RWAs (risk-weighted assets) by the end of FY23, they would have to increase 70-80 billion ( 7,000 to 8,000 crores) of growth capital and 8,000 crore replacement AT-1 bonds. As a result, overall AT1 issuance by the public sector bank is estimated at 140-160 billion ( 14,000 to 16,000 crores) in FY23,” ICRA said in its report.

“SBI itself has 2,500 crore call options expiring this year. We will however seek to raise more capital as credit growth will occur,” an SBI official said on condition of anonymity.

Investors like these bonds because they offer better yields compared to government securities. For example, Canara Bank’s AT-1 bonds pay investors an annual coupon of 8.24%, while 10-year government bond yields are 7.44%.

India’s AT-1 bond market took a hit in March 2020, when Yes Bank’s AT-1 bonds of almost 8,400 crore was written off as part of a bailout led by SBI. Soon after, the Securities and Exchange Board of India (Sebi) tightened the rules, only allowing private placement of these bonds to institutional investors with a minimum lot size of 1 crore. All of this has led to a slowdown in investor appetite for these bonds.

“Risk premiums should be higher because the end investor needs to be warned. The issuer gets prices comparable to 10-year government development loans. Investors value these bonds as five-year instruments instead of treating them like long-term bonds with a five-year call option,” said Venkatakrishnan Srinivasan, founder of Rockfort Fincap. “That said, AT-1 bonds are the best option available to banks. PSU to raise capital in this market,” he added.

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