ICRA believes that the risk of servicing the coupon payments on Basel 3-compliant Additional Tier 1 (AT1) bonds has increased considerably, especially for the weaker public sector banks (PSBs), following the large losses reported in the last few quarters during FY2016 and also in Q1 FY2017, resulting in significant depletion of revenue reserves. Cumulatively, PSBs have issued close to Rs 170 billion of Basel 3-compliant Additional Tier 1 (AT1) bonds. The volume of AT1 issuance has so far remained much lower than the PSBs capital requirements under Basel 3 norms, on account of weak investor appetite.
While the Government of India (GoI) continues to support PSBs, including the weaker ones with significant capital infusion in the past as well as in the current fiscal to enable them to maintain regulatory minimum capital requirement, it may not help in timely servicing of coupon on AT1 instruments as capital infusion does not increase the distributable reserves. Out of the 21 PSBs in India, five reported negative or very low distributable reserves as on March 31, 2016 (refer table 1 for bank wise details).
Karthik Srinivasan, Senior Vice President and Co Head-Financial Sector Ratings, ICRA Limited, said: “The risk of servicing the coupon on some of these bonds has increased, should the profits of the current year be inadequate, as the accumulated distributable reserves have depleted significantly over FY2016 and Q1 FY2017. However, capital infusion by the GoI does reduce the risk of principal loss to investors as it enables banks to maintain regulatory minimum capital requirement, thus lowering the risk of write-down or conversion of these bonds into equity.”
The features of hybrid debt capital instruments make them riskier than senior bonds or Lower Tier 2 bonds issued by banks. For the first time in the history of the Indian banking sector, a small private sector bank could not service the coupon on its Upper Tier 2 instrument in the current fiscal, following its inability to maintain the regulatory minimum capital requirement, thereby reiterating the riskiness inherent in hybrid debt capital instruments.
In ICRA’s estimate, PSBs will need to raise Tier 1 capital of Rs 1.7-2.1 trillion during FY2017-FY2019 to meet the higher regulatory minimum capital requirements as well as to fund growth. Of this requirement, around 40% can be made through raising of AT1 instruments; however, given the elevated risk for existing instruments and the weak investor appetite, it is unlikely that PSBs will be able to raise the required AT1 capital. Hence, their dependence on equity raising to meet minimum Tier 1 capital requirements remains very high. Further, a large part of the PSB equity requirements would need to be from the GoI as the possibility of substantial capital raising from non-government sources remains limited. In the current fiscal, GoI has so far announced a capital infusion of Rs 229 billion into PSBs.
ICRA expects and factors in timely capital infusion by the GoI to enable PSBs to maintain capital levels above the regulatory minimum requirements. Accordingly, while the capital infusion by GoI does not reduce the risk of missed coupon payment on AT1 instruments, it does provide a cushion to PSBs to service the coupon on Upper Tier 2 / IPDI Instruments, issued under Basel 2 norms, as it enables them to maintain regulatory minimum capital requirement, a condition for making coupon payment on these instruments. In the current year also, the GoI has announced capital infusion of Rs 229 billion into PSBs to enable them to maintain regulatory minimum capital requirements in addition to supporting credit growth.
Table 1: Bank-wise distributable reserves
Source: Banks, ICRA research; Amounts in Rs billion
Some of the salient features of AT1 instruments regarding coupon payment include:
– Bank has full discretion at all times to cancel distribution/payments and cancellation of discretionary payments shall not be an event of default.
– Coupon is not cumulative
– Coupon on AT1 instruments must be paid out of distributable items i.e. current year profits or in case of loss in a year from revenue reserves or credit balance in profit & loss account.
– Payment of coupons on AT1 from the revenue reserves is subject to the issuing bank meeting minimum regulatory requirements for CET1, Tier 1 and Total Capital ratios at all times and subject to the requirements of capital buffer frameworks (i.e. capital conservation buffer, countercyclical capital buffer and Domestic Systemically Important Banks).
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