Mumbai: India’s banks will ramp up sales of bonds that act as capital buffers in 2015 as lackluster earnings and rising soured loans make share sales tough, Fitch Ratings Ltd says.

State-owned lenders in India issued 12,250 crore of Basel III notes in 2014, a fraction of the more than $85 billion in similar securities sold by banks in China, according to data compiled by Bloomberg. Bad debts as a proportion of Indian banks’ total advances are at least the highest in eight years and capital sales of as much as 84,000 crore may be required next fiscal year to shore up balance sheets, according to Icra Ltd, the local unit of Moody’s Investors Service.

Demand for such bonds is “seen as low because of the risky features of these securities and bad loans add to the problem," said Arun Srinivasan, a Mumbai-based senior vice president for investments at ICICI Prudential Life Insurance Co., which manages assets equivalent to $15 billion. “Bad debt won’t fix itself overnight and investors will price in this risk by demanding higher interest."

With economic growth only just starting to pick up from near the lowest in a decade, investors are treating Basel III notes, which offer higher payments to compensate for the risk regulators will declare a borrower non-viable in the event of a banking crisis, with caution. State-owned banks had a stressed asset to total loans ratio of about 12.9% as of 30 September, compared with 4.4% for private banks and 10.7% for the banking system as a whole, Reserve Bank of India (RBI) data released 29 December show.

Higher coupons

IDBI Bank Ltd paid a 10.75% coupon when it sold 2,500 crore of perpetual Tier 1 notes in October. Its dollar-denominated bonds due 2020 sold that same month have a 4.125% coupon while the weighted average fixed coupon of all its rupee debt is 9.33%.

Bengaluru-based Canara Bank Ltd issued 10-year subordinated notes with a 9.7% coupon in March, according to data compiled by Bloomberg. That compares with a weighted averaged fixed coupon for all its debt of 7.17%.

While state-owned banks are generally considered safer than private banks because of their implicit government backing, Basel III notes are considered risky because of the writedown or conversion features they contain that are triggered by a certain event or at the point of non-viability. Sold by a bank with an already high bad debt problem, that risk is compounded, Srinivasan said.

Rules tweaked

To make such notes more palatable to India’s investing public, the central bank tweaked Basel III capital regulations twice last year. In September, it eased rules to allow individual investors to buy the securities, and said lenders could pay interest out of past reserves as well as current year profits. It also shortened the minimum maturity of Tier 2 debt to five years from 10 originally.

In March last year, the RBI extended the transition period banks have to comply with the more stringent capital norms by one year to 31 March 2019, because of their deteriorating asset quality.

Stressed assets at Indian banks will probably peak in March, according to Fitch Rating’s Mumbai-based director Saswata Guha. He said state banks suffer from lower capitalization and weak earnings.

Sales pipeline

“Many state banks have announced plans to raise core equity but their weak valuations mean that additional Tier 1 capital is likely to bridge the near-term gap," Guha wrote in a 17 December report. “Private banks appear less vulnerable given their stronger intrinsic financial strength."

Bank of Baroda, India’s third-largest lender by assets, plans to borrow as much as 1,500 crore selling Basel III perpetual securities, people familiar with the matter said 23 December, while state-owned Indian Overseas Bank sought government approval 15 December to raise as much as 2,600 crore via notes with no fixed maturity.

Other lenders in the pipeline to sell Basel III bonds include Bank of Maharashtra and Allahabad Bank. State Bank of Mysore and Andhra Bank raised a combined 1,000 crore via Basel III securities last month.

Fitch expects Indian banks will require more than $200 billion in capital, with almost half, or about $92 billion, of that coming from additional Tier 1 notes.

‘More cost effective’

“The profitability of state-owned banks is low right now because of asset quality issues, which in turn is slowing internal capital generation," Vibha Batra, the New Delhi-based group head of financial-industry ratings at Icra, said in a 31 December phone interview. “Banks will prefer to sell additional Tier 1 instruments in 2015 because it’s more cost effective than raising core equity."

The S&P BSE Bankex, an equity gauge of 12 Indian lenders, five of them state owned, trades at 14 times estimated earnings over the coming 12 months. India’s benchmark Sensex trades at 15.2 times. State Bank of India, the country’s largest lender, trades at 11 times, while Bank of Baroda trades at 7.7 times.

“State-owned banks are expected to rely more on debt markets this year as weak earnings and a jump in non-performing assets make equity fundraising tough," Srinivasan said. Investor demand for so-called bank infrastructure bonds, as well as plain vanilla corporate debt, may further limit Basel III bond appetite, he said.

ICRA estimates that for fiscal year 2016, or the 12 months to 31 March 2016, banks in India require 8,000-10,000 crore of common equity, 30,000 to 37,000 crore of additional Tier 1 capital and 39,000-47,000 crore of Tier 2 debt.

“The appetite for additional Tier 1 instruments is low in India because these are complex instruments," Batra said. “But I expect demand to rise gradually." Bloomberg

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