In 2 weeks, bank tier-2 bond sales soar past AT-1 issues for whole year

Analysts cite credit growth surge, better risk profile of tier-2 bonds behind the rush

Over the past few months, banks have increasingly turned to the debt markets and raised funds, in order to finance the burgeoning demand for loans amid slower growth in deposits. In the past two weeks, however, a new favourite has emerged when it comes to banks’ debt instruments -- tier-2 bonds.

Data provided by debt market officials showed the quantum of funds raised by banks through tier-2 bonds since November 28 has far outstripped the entire amount issued through additional tier-1 bonds, so far, in the financial year.

Since November 28, banks have issued Rs 35,048 crore worth of tier-2 bonds, taking the amount raised through such instruments for the year, so far, to Rs 41,048 crore, the data showed.

In the current financial year, banks have raised a total of Rs 22,534 crore through the issuance of AT-1 bonds. Though that number may go up in the coming days because of the likely issuance of Rs 1,000 crore worth of AT-1 bonds by Bank of Maharashtra, the overall figure pales in comparison with what has been raised through tier-2 bonds.

The primary driver of the recent spurt in tier-2 bond issuances is the relentlessly wide gap between credit growth and deposit growth which has spurred banks to raise capital. The latest RBI data showed that as on November 18, credit growth was 17.2 per cent year-on-year, while deposit growth was 9.6 per cent.

According to a Macquarie Research Report, the gap between loan and deposit growth for the fortnight ended November 4 was at a 12-year high of 875 basis points. The firm said that the incremental loan-to-deposit ratio year-to-date was 114 per cent, which was a “key concern”.

The credit-deposit ratio refers to the portion of deposits raised by a bank that has been deployed as loans.

“It’s a good time for banks to approach the capital markets. It’s also a good signal because the reason they are raising it is so that they have a better lending capability,” said Bank of Baroda’s Chief Economist Madan Sabnavis.

“We have seen that credit-deposit ratios, especially if you look at private sector banks, have all been above 85-90 per cent. Banks need to create buffers by having enough capital,” he said.

What may have also prompted banks to rush towards the capital markets is a fall in bond yields which makes it cheaper to raise new debt.

Since October 31, yields on 5-year and 10-year bonds -- which are considered to be benchmarks in the corporate bond market -- have declined around 12-17 basis points in the secondary market. The data showed the bulk of tier-2 bond issuances since November 28 have seen bonds being priced around the 7.85 per cent mark. With the 10-year government bond yield hovering around 7.30 per cent, a cut-off of around 7.85 per cent is considered to be a relatively good deal for banks, treasury officials said.

A key point raised by analysts regarding the recent flurry of tier-2 bond sales was the issuance pattern of state-owned banks and questions surrounding the inherent risk in AT-1 bonds.

Unlike their usual trend of accelerating bond sales in the second half of the year when credit growth usually picks up, state-owned banks have sold a significant quantum of AT-1 bonds in April-September this year. This was due to the unusually strong credit growth and the expectation of the debt markets becoming costlier due to the RBI’s rate hikes.

For lenders other than state-owned banks and larger private sector lenders, AT-1 bonds come with the baggage of the YES Bank fiasco of 2020 which saw the private sector lender’s AT-1 bonds being written down, causing huge losses for investors.

“AT-1 bonds are a risky instrument. We saw the write-down in YES Bank’s bonds. In the pecking order, tier-1 bonds are written down earlier than tier-2 bonds in case the bank faces problems,” said Anil Gupta, vice-president, Financial Sector Ratings at ICRA.

“So, the issuance of tier-1 bonds is relatively limited to very strong banks. Not all banks can issue tier-1 bonds, except for maybe large public sector banks and maybe three or four of the large private banks,” he said.