Mumbai: Rating agencies are increasingly getting worried about a spate of hybrid bond issues by Indian banks, against a backdrop of rising bad debt and with policymakers prodding lenders to step up loans.
So far in 2009, India’s largest banks, State Bank of India and ICICI Bank, have raised at least Rs12 billion each via hybrids, while the government has also been using these instruments to infuse capital in certain state-run banks.
But rating agencies say hybrid instruments are riskier than garden variety bonds due to their longer tenor and as buyers, mainly pension funds and insurers, may have to forego coupon receipts at times of stress.
As a result, ICRA and Fitch Ratings rate hybrids lower than plain debt and Moody’s Investors Service is considering following them.
“The rating differential reflects the loss absorbing nature of hybrid debt capital in its role as protecting senior creditors, including depositors. From our perspective, less the proportion of hybrids, the stronger is the quality of capital,” said Ananda Bhoumik, senior director at Fitch Ratings India.
The flexible nature and acceptability of hybrids as capital, coupled with a relatively small premium prevalent in Indian markets, has made such instruments popular with Indian banks who are struggling to ramp up their base to meet the central bank’s capital adequacy rules.
For instance, coupon and capital payments on hybrid instruments -- such as perpetual bonds, upper Tier-II bonds and preference shares -- could be postponed or even cancelled when the bank makes losses or is inadequately capitalised.
“Firstly, in markets like this when interest rates are low, people get long-term borrowing at low yields. Secondly, equity continues to be the most expensive form of capital... Thirdly, RBI allows significant portion of the capital to be in the form of these instruments and currently banks have sufficient headroom to issue hybrids,” said Tarun Bhatia, head of Crisil Ratings.
Fitch rates Axis Bank’s lower Tier-II debt as ‘AAA´, but has an ‘AA-plus’ rating on the bank’s upper Tier-II and perpetual debt. Crisil has an ‘AAA´ rating on ICICI Bank’s debt, but the outlook on its hybrid debt is negative.
Deborah Schuler, senior vice-president at Moody’s, said though there was no immediate risk to banks from Moody’s proposed rating methodology change, downgrades on hybrid instruments could raise the cost for subsequent issuances and make investors wary of buying them.
“Outstanding hybrid instruments would have to be re-rated accordingly, possibly into the non-investment grade range, which could force some institutional investors to sell their holdings.” she added.
According to Fitch data, Indian banks have raised Rs212.6 billion through hybrid debt since September 2008, compared with about Rs140 billion via lower Tier-II or senior debt.
Although liquidation is not a risk in India as most banks are government-supported, risk for investors remains high if a bank comes under pressure as sovereign support may be focused more on deposit or senior debt holders, at the expense of hybrid investors, said Vibha Batra, co-head, financial ratings at ICRA.
That’s not yet a worry as hybrid debt for banks comprises just about 5% of the total debt, said Fitch’s Bhoumik.
“I think the issue would have to be faced somewhere around 3-4 years time, when you have hit 15%, and that’s when banks would have to seriously look at equity capital,” he said.