PSB recap bonds fair valuing to dent Tier-1 capital up to 1.75%: Ind-Ra

The rating agency said it understands that the five recipient PSBs may need to value zero-interest bonds at fair value instead of par value

The fair valuation of the equity infused in five public sector banks (PSBs) through zero coupon bonds could lower the Tier-1 capital levels by 50-175 basis points than reported, according to India Ratings and Research.

The rating agency said it understands that the five recipient PSBs may need to value zero-interest bonds (recapitalisation bonds) at fair value instead of par value. The government of India had infused capital in them by issuing bonds in the first half of previous financial year (H1FY21).

The intrinsic net worth of these instruments could be lower at FY22-end at the outset than similar maturity government papers in the market, given they do not carry any interest.

The illiquid, non-trading nature of these securities could add to the discount. These banks have moderate competitiveness (albeit better than last year) to raise equity. They would need to offer materially higher yields to raise Additional Tier 1 (AT1) from the markets. Valuing these zero-interest bonds at a fair level could coerce these banks to raise either equity or AT1 in the near term solely on account of this factor.

The GoI had infused capital amounting to Rs 20,000 crore in five banks - Central Bank of India (Rs 4,800 crore), UCO Bank (Rs 2,600 crore), Bank of India (Rs 3,000 crore), Indian Overseas Bank (Rs 4,100 crore) and Punjab and Sind Bank (Rs 5,500 crore). It issued non-interest bearing (non-transferable) special GoI securities with maturities ranging from 2031 to 2036.

The quantum of capital infusion varied between 11 to 44 per cent of the Tier I capital of the respective PSBs as of 3QFY21. Equity levels is an important factor in a bank’s ability to service Basel III AT 1 and Tier 2 bonds.

With time the discounting factor will decrease, and zero-interest bonds’ fair value will tend to be the par value and affect the banks’ CET1. In addition, these PSBs are in a better shape in terms of capital, provision cover, profitability and net NPA than a year ago.

Furthermore, these banks have sizable deferred tax assets, the utilisation of which could also release CET1 for these banks over the next few quarters.

Also, the government's planned Rs 15,000-crore equity infusion for the year FY22 is yet to be allocated. However, the contours of the infusion of this amount is not clear.