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Home / Market / Mark-to-market /  The AT-1 time-bomb in bank capital

There is enough anxiety over the fast eroding capital of public sector banks, especially that of loss-making lenders. As the rising pile of toxic assets eat away their capital, banks are struggling to do business.

What could make the mess messier?

Banks are mandated to keep 9% of minimum capital adequacy ratio, out of which Basel-III rules mandate a Tier-I capital ratio of 7%. A part of this Tier-I capital of lenders consists of additional Tier-1 bonds. Called AT-1 bonds in market parlance, these are innovative debt instruments that have equity-like perpetuity but pay fixed coupon like any other bond. The coupon payments are not cumulative, that is, lenders have to pay every year. The interest payment can be through distributable reserves or from the credit balance of the profit and loss account, according to the rules of the Reserve Bank of India (RBI).

And here is the trouble. Given the massive losses that public sector lenders have piled up in 2015-16 with some making losses even in the first quarter of 2016-17, banks are fast running out of distributable reserves to service these regular coupon payments on their AT-1 bonds. Karthik Srinivasan, analyst at ratings agency ICRA, points to this emerging risk. “The risk of servicing the coupon on some of these bonds has increased, should the profits of the current year be inadequate, as the accumulated distributable reserves have depleted significantly over FY2016 and Q1 FY2017," wrote Srinivasan in a note dated 22 August.

According to the rating agency, five out of the 21 public sector lenders it tracked have negative or very low distributable reserves as of 31 March.

On a cumulative basis, public sector banks have issued about 17,000 crore worth of AT-1 bonds since 2007 when the RBI first allowed such issuances. IDBI Bank raised 1,500 crore through these bonds on Tuesday. The coupon payments are dearer as these bonds were raised at over 10% yield. Investors should recall that Dhanlaxmi Bank deferred the interest payment of its Upper Tier-II bonds and was downgraded to junk earlier this month. Will there be a similar moment in the public sector space?

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