Mumbai: Indian banks have raised at least Rs28,700 crore from the domestic bond market in the six months since the collapse of Wall Street icon Lehman Brothers Holdings Inc. in September led to a gut-wrenching credit squeeze the world over. This money will help banks maintain the capital they need to maintain strong loan growth.
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The banks have raised these funds primarily through hybrid bonds that have characteristics of both equity and debt.
Insurance companies and pension funds have been the main buyers of the hybrids sold by Indian banks.
The State Bank of India group is the largest issuer of such bonds in the country, raising at least Rs6,750 crore from hybrid bonds of a total of Rs9,250 crore that it raised through various instruments.
Among other big issuers, Punjab National Bank has raised Rs3,000 crore; HDFC Bank Ltd Rs2,875 crore; Bank of Baroda Rs1,700 crore and Corporation Bank Rs1,650 crore.
Most of the issues that hit the market between October 2008 and March 2009 carried greenshoe options and raised more money than the size of the issues. To that extent, the actual money raised in the second half of fiscal 2009 could be around Rs35,000 crore or even more, according to rating agency executives.
Globally, the issue of hybrid bonds peaked between December 2006 and December 2007.
The Indian central bank allowed banks to tap the market with such issues as April 2006 to help them maintain higher capital as required under international banking norms.
In the first half of fiscal 2009, there were a few such bond issues but the move gathered momentum after a global risk aversion set in following the collapse of Lehman Brothers, forcing Indian banks to hit the domestic market for funds through such bonds.
While the fact that banks managed to raise such a massive debt by itself is a major achievement, what stands out, according to rating agencies, is the use of new instruments. At least Rs18,455 crore of the funds were raised through hybrid bonds, according to Fitch Ratings India Pvt. Ltd.
Appetite will grow
Banks’ appetite for such bonds will only grow as they will find it difficult to raise equity in a market that is not out of the bear grip as yet. After losing some 52% in calendar 2008, Sensex, India’s bellwether equity index, has risen about 9% so far in calendar 2009. Besides, state-run banks that account for 73% of banking assets in India do not have much scope for entering the market as, under the law, government stake cannot go down below 51% in these banks. In many of them, the government stake is close to the minimum permissible limit.
Even though bank credit growth has dropped to around 18% in the first 11 months of fiscal 2009, bankers are expecting a pickup in loan demand with the fledgling signs of economic recovery visible in certain industrial pockets and they will need hybrid capital to be able to meet such demand.
“The need for capital will continue in the coming years. Till such time equity market opens up, demand for such hybrid instruments will continue,” said Ananda Bhoumik, senior director of Fitch Ratings.
The spike in bond issuances in the last quarter of fiscal 2009 can also be attributed to declining interest rates.
“Earlier, banks were not issuing hybrid instruments much because the rate of interest was very high at about 10.5-12.5% and the capital requirement was also not much. Now, with softening interest rate, banks are finding it cheap to raise such capital at a time when requirement of capital is slowly increasing,” said Tarun Bhatia, head of ratings at Crisil Ltd, the India arm of Standard and Poor’s.
The Indian central bank has cut its policy rate from 9% to 3.5% between October and March to drive down the interest rates and make money cheap.
The risk factors
Ratings agencies are, however, not very comfortable with the development and, according to some of them, hybrid bonds are risky as they include an equity component.
According to Vibha Batra, co-head, financial sector ratings, Icra Ltd, the riskiness of these hybrid bonds can be gauged from the fact that the senior debt of US mortgage lenders Freddie Mac and Fannie Mae’s have AAA ratings whereas the hybrid issued by them is rated as “junk” or below investment grade.
Indian banks have been raising the so-called perpetual bonds that have no maturity date and are, therefore, treated as equity. The coupon on such bonds is paid perpetually and the instrument has a call option after 10 years that can only be exercised with the prior approval of the Indian central bank. The call option gives the issuer the right to recall the bond and clear their liabilities before the bond matures.
The interest on this instrument is not payable if the capital adequacy ratio, or CAR, is below the regulatory minimum. CAR is the ratio of a bank’s capital to its risk-weighted assets.
Yet another hybrid instrument, the upper tier II capital bond, has a minimum maturity of 15 years, with a call option after 10 years that can be exercised if the bank is not making losses or has met the regulatory minimum capital.
However, coupons on these bonds are cumulative. This means that coupons due can be paid later when the sick bank becomes healthy again.
Preference shares—or senior stock, whose holders get paid first when a dividend is declared—haven’t been as popular in India as in developed economies. These bonds have a high coupon rate. The coupon, depending on the financial health of banks, range between 9.5% and 11%, or at least 2% more than the rate on a government paper of similar maturity.
Fitch Ratings estimates that with a return on assets of 0.6% and credit growth of 20%, tier I capital of banks, or the core capital of the bank, will fall below the regulatory minimum by 2012. In such a scenario, banks will again be forced to approach the domestic market to shore up their capital base with hybrid bond issues.
Graphics by Ahmed Raza Khan / Mint