London/Mumbai: For all the hurdles faced by Indian lenders, there are bank bonds out there that investors can’t get enough of.
State Bank of India’s perpetual notes—so called because they lack a fixed maturity date—are being hoarded and hunted by traders betting the nation’s biggest lender will buy them back within the next 10 weeks as it puts its capital structure in line with Basel regulations.
That’s created a trading opportunity for investors like Carl Wong of Nexus Investment Advisors Ltd and Raj Kothari of Jay Capital Ltd, who say SBI’s perpetual bonds are the only notes that have yet to be redeemed as part of the revamp.
Lenders around the world have been scrabbling to redeem bonds issued before the financial crisis that will lose their status as contributors to core, Tier-1 capital as the Basel III norms come into effect. But Indian banks have an extra incentive to call the debt: they’re flush with cash after households poured money into deposits following the government’s decision in November to pull high-value banknotes from circulation to combat tax evasion and graft.
“This is a very low-beta, low-risk, high-return trade," Wong said in a London interview. “If I can put more money into it, I would. At yields of about 6%, they can be a good shock absorber in a portfolio as global rates go up."
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SBI’s $400 million bond, which pays a coupon of 6.439%, traded at a bid yield to next call of 6.21% on Wednesday. Its call date falls on 15 May. The lender’s $225 million bond, which pays a coupon of 7.14%, traded at 7.25% and has its call date on 27 June. If they aren’t bought back, the notes will no longer count toward meeting capital-adequacy ratios and must be relegated to senior debt under the new banking regulations.
“It’s not easy to source these papers in size," Wong said. “However, if you are patient enough, you can buy in clips."
While SBI declined to comment on whether it would call back the bonds, it denied that India’s cash ban might play a role in the decision.
“We would not comment on market speculation," Ritesh Mehta, assistant vice president for corporate communication at the lender, said by email. The bonds “were issued in US dollars and the funds were utilized in the overseas market. Hence, demonetization has no relevance in this matter," he said.
Flooded with cash
Investors who own the bonds say the banknote ban boosts the chances of a buyback.
“There is a high chance that the bonds will be called back because Indian banks are flooded with cash," said Kothari, head of trading at Jay Capital in London. “These lenders can refinance at lower rates and retire a debt that doesn’t even qualify as capital any longer."
Indian banks may have the worst bad-asset ratio globally, but with an economy growing at a pace of 7% in the fourth quarter, that isn’t enough to put investors off the debt, according to Wong.
“The average non-performing loans are quite severe," he said. “The good thing is they are transparent. As long as the growth is in place, it will help banks to eventually resolve this problem."
While the high coupon and the loss of capital status are supportive of a buyback, there’s no guarantee banks will choose the option. In Europe, investors took a hit when Standard Chartered Plc and Commerzbank AG decided not to call back their legacy notes in November.
Still, bondholders are relying on the market convention that banks typically redeem such notes in order to maintain a good relationship with investors. Other Indian banks including ICICI Bank Ltd have already called theirs. “It hampers reputation if they don’t exercise the option," Kothari said. Bloomberg