Role reversal: India Inc “lends” to banks via AT-1 bonds

A role reversal appears to be happening in Indian financial markets, with India Inc lending to banks instead of borrowing from them.

The high returns on investments in Tier I (AT) Supplementary Bonds issued by public sector banks are proving attractive to large corporations, even though the bank credit available to them has declined.

This development takes place in the midst of mutual funds avoiding AT-1 bonds (perpetual debt instruments) due to SEBI restrictions.

As companies have deleveraged significantly in recent years and remain on the fence when it comes to new capital spending, they are funneling their excess funds parked with banks and mutual funds into bonds. AT-1, according to a fund manager with an MF.

Bank credit to major industries contracted 1% in September 2021 compared to a 0.2% contraction a year ago, according to the latest data from the RBI.

Opportunistic investment

Corporate investment in PSB AT-1 bonds is opportunistic. Banks offer relatively higher interest rates on these bonds to attract investors after SEBI’s March 2021 circular on “investing in instruments with special characteristics and valuing perpetual bonds” discouraged MFs to invest in it.

The Union Bank of India recently raised ₹ 2,000 crore via AT-1 bonds at a coupon rate of 8.70%. The PSB had previously recovered resources through AT-1 bonds on two occasions – 1,000 crore (coupon: 8.64%) at the start of January 2021 and 205 crore (8.73%) at the end of the same month.

Although AT-1 bonds are perpetual in nature, banks typically exercise the call option after five years from the date of issue. So a company can earn higher returns by investing in these bonds than by securing a five-year term deposit that pays around 5.50 percent.

PSBs mobilize resources through AT-1 bonds, as they have call options due during the current fiscal year and the next on the bonds they had issued earlier. Bank of Baroda, Canara Bank and Punjab National Bank are among the PSBs that are considering mobilizing resources via the AT-1 road.

MFs shrink

One of the reasons why mutual funds stay away from these bonds is that their maturity is considered 100 years from their issue date for valuation purposes, unlike the current practice of valuing them. depending on the time remaining for the next purchase option date.

Thus, MMFs fear mark-to-market losses due to this change in valuation standard, because if interest rates rise, the price of longer-term bonds will depreciate much more than short and medium instruments. term.

According to ICRA estimates based on industry data, MFs held 30 percent of outstanding Level I bonds and 14 percent of outstanding Level II bonds as of February 2021.

The credit rating agency estimated that the holding of AT-I and Tier-II instruments compliant with Basel III is estimated at 8% of the assets under management of investment funds holding these instruments, thus limiting the investment margin. additional.

The ICRA, in its outlook for the banking sector for fiscal year 22, estimated the Level I capital requirements for PSBs at 43,000 crore, of which 23,000 crore was due to call options expiring on AT-I bonds, while the balance is estimated as equity.

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