On 12 July, Punjab National Bank (PNB), India’s largest nationalized bank, raised Rs500 crore in the debt market by selling bonds bearing an interest rate of 10.40%. The bonds had an AAA rating from domestic credit rating agencies. A triple-A rating signifies the highest degree of safety. Eight days later, Vijaya Bank, a relatively smaller bank, raised Rs200 crore by selling bonds bearing an interest rate of 9.50%, despite having a lower rating of AA+.
Both sets of bonds are long-term—they have raised money for 10 years and beyond.
The fact that bonds with a higher rating carried a higher interest rate than those with a lower rating means PNB raised more expensive money than Vijaya Bank.
Debt market experts say that ratings are losing their significance as there is no “free market” for such bonds. Typically, they claim, bonds issued by one bank are subscribed to by other banks. However, this is not done directly but through provident funds of the concerned banks.
“Even though the provident funds are run by independent trusts, there is tacit understanding among banks to help each other,” says a debt market dealer who did not want to be identified.
“In such a scenario, ratings assigned to these bonds lose their significance as the banks have their own risk perception of such papers. There is also a vested interest at work as once a bank participates in a peer’s bond issue, it can expect a similar treatment from the peer when it enters the market,” he adds.
Public sector banks have raised close to Rs6,000 crore in the debt market between April and June through high-risk hybrid instruments and perpetual bonds. These are papers with a maturity of 10-15 years or more and are considered to be riskier because banks can defer interest payment to the investors if they don’t make a profit in a particular year. Banks can also defer interest payment if their capital adequacy ratio falls below the minimum prescribed 9%. The postponement of interest payment can, however, be exercized only with the approval of the banking regulator. Banks are rushing to raise capital to meet new global banking standards, or Basel II norms, that require them to set aside more capital set aside for risk management.
In such a situation, a reciprocal arrangement with other banks can come in useful. As do favourable ratings from credit rating agencies (bond issuers are allowed to choose their own rating agencies).
“Banks want the highest rating for all debt issuances. The issuer of bonds prefers a rating agency which assigns similar ratings for both high-risk and low-risk instruments to an agency that assigns lower rating to relatively riskier paper. The ratings don’t always reflect the true risk profile of the bonds,” saysR. Jayakumar, senior director and chief operating officer of Fitch Ratings (India) Ltd.
The treasury head of a large public sector bank that has raised money in the debt market in recent times agrees. “It’s mostly market leaders among banks who demand highest ratings from credit rating agencies for all their debt issuances. They do tend to dictate terms to rating agencies to make their issue successful at times,” adds the treasury head who does not wish to be identified.
Not everyone is convinced that ratings do not matter. And one expert says that the ability of a company with a lower rating to raise money at a lower rate than a company with a higher rating may just be because of the way the debt market works. “Debt markets have seen large fluctuations in recent times,” adds the expert, who is the corporate and government ratings head at a large Indian rating firm.
“Volatility in the market has been such that even a day’s difference has given a 0.2-0.3% advantage to banks who had come in later,” he says.
Anil Ladha, head, debt capital market at ICICI Securities, a financial services firm, says recent entrants in the bond market are reaping the benefits as there has been a rally in the market over the past two weeks. “Yields on bonds have been moving southwards and the spread between the benchmark 10-year government bond and the AAA-rated corporate papers is narrowing. This is an indication that the market feels that the interest rates are going to be lower henceforth,” he adds.
Ladha says that different rating agencies have different risk perception of debt issues. The corporate and government ratings head at the rating firm says that his company “has stringent norms” for bonds and repeats that the recent phenomenon is a case where “banks that raised money earlier are paying higher interest rates than those that have come in more recently.”
Apart from banks, other investors buy bank bonds too. Banks have an exposure limit to debt of other banks, and once this is reached, they cannot buy any more bonds issued by them. “It is possible that non-regular investors are demanding higher” interest rates, says Rajesh Mokashi, executive director of rating agency Credit Analysis and Research.
Since 11 April, several public sector banks have raised long-term bonds. State Bank of India tops the list, having raised Rs2,523.50 crore, followed by PNB and United Bank of India, which raised Rs500 crore each, and Bank of India, which raised Rs400 crore.