Credit Suisse failure unlikely to spook AT-1 bond investors in India

PNB likely to issue AT-1 bonds worth Rs 2,000 cr this week; yields not seen surging

The write-down of $17 billion worth of contingent convertible bonds of Credit Suisse has brought to the fore risks surrounding Indian additional tier-1 (AT-1) bonds, which are instruments of a similar nature.

Analysts said following regulatory changes taken after the YES Bank fiasco in 2020, the domestic landscape for AT-1 bonds has significantly improved. As such, the latest episode surrounding Credit Suisse is unlikely to have a substantial impact on domestic AT-1 bond issuances by banks.

In the first such bond sale following the Credit Suisse episode, state-owned lender Punjab National Bank is set to issue AT-1 bonds worth Rs 2,000 crore on Friday, sources said.

Treasury officials expect the coupon for PNB’s bonds to be set around 8.50 per cent, not much above the 8.25 per cent set for SBI’s last AT-1 bond sale on March 8. Considering the fragile sentiment currently prevailing in the global banking sector, the expected rate of interest for PNB’s AT-1 upcoming issuance suggests that domestic investors for these securities are not too concerned.
 

“The Credit Suisse episode is a negative; in India, we’ve seen the YES Bank AT-1 bonds already being written down. So, it’s not as if it’s new to us. Nothing changes from that perspective. It is just that the characteristics and the features of the instrument just get reinforced –--it is a loss-absorbing instrument. If investors are still looking to invest in it, they will ask to be compensated accordingly,” said Karan Gupta, director of financial institutions, India Ratings and Research.

After the Reserve Bank of India (RBI) took control of then-beleaguered YES Bank in early 2020, Rs 8,415 crore worth of the private lender’s AT-1 bonds had been written off, leading to substantial losses for investors. In January 2022, the Bombay High Court ruled there were procedural lapses in the decision to write down the bonds. However, this month, the Supreme Court stayed the Bombay High Court ruling.

AT-1 bonds, which can be used by banks to augment equity, offer high yields or returns. The risk for investors stems from the fact that when it comes to the possibility of a collapse, banks can cease interest payments or write off such debt.

In 2021, Sebi said that mutual funds have to value AT-1 bonds as 100-year bonds. The move caused a sharp reduction in the exposure of mutual funds to these instruments as the valuation norms imply a large hit on net asset value.

On the other hand, insurance companies were permitted to subscribe to bonds of companies that had not paid dividends in the past three years. Consequently, insurers showed firm demand for AT-1 bonds in the current year. So far, in the current financial year, banks have issued AT-1 bonds worth a total of Rs 33,420 crore, against Rs 42,800 crore in FY22.

“The move for mutual funds to value the bonds for 100 years has already resulted in reduced fund size and exposure over a period. So, the portfolios of mutual funds are not under pain,” a treasury official said.

“Yields have not increased in the secondary market in response to the latest crisis. There is a consolidation of banks. The set of papers that are available is limited as well. You can have one or two banks that are weaker names. Otherwise, you have mostly large banks which are okay,” he said.

Outlook

Analysts, however, said fund-raising through AT-1 bonds is likely to become more expensive, in line with higher bond yields across the board.

With inflation remaining elevated, the possibility of more rate hikes by the RBI cannot be ruled out. The sovereign bond market is set to see a record-high supply of bonds, starting April. Consequently, the bias for bond yields is likely to be on the higher side, analysts said. 

Government bonds are the benchmarks for pricing corporate debt. The yield on the 10-year benchmark bond had climbed as much as 14 basis points, so far, in 2023 before softening over the last couple of weeks.

“Recently, you saw UCO Bank selling AT-1 bonds at 9.50 per cent. If someone is willing to borrow at 9.50 per cent, the investor is also willing to take that risk,” Gupta said.

“SBI recently issued (AT-1 bonds) at 8.25 per cent, so yields have moved up for everyone from last year. I don’t think anything materially changes from an issuance perspective. It is the same issuers who understand the risks of the instrument,” he said. In September 2022, SBI had issued AT-1 bonds at 7.75 per cent.

Analysts said that high net-worth individuals could also demand higher yields from banks’ AT-1 bonds going ahead as yields on papers issued by large NBFCs were currently much higher. Moreover, with bank credit growth expected to slow in the next fiscal year, the need for banks to issue AT-1 bonds could reduce.