Listing of zero-interest bonds at fair value could affect beneficiary banks' tier 1 capital by 50-175bp: Ind-Ra

24 Feb 2022 , 10:15 AM

India Ratings and Research (Ind-Ra) opines that fair valuing of the equity infused by government of India (GoI) in five public sector banks (PSBs) in 1HFY21 through non-interest-bearing bonds could lower the banks’ effective Tier 1 capital levels in the range of 50-175bp than reported. Ind-Ra understands that the five recipient PSBs may need to value zero-interest bonds (recapitalization bonds) at fair value instead of par value.

Ind-Ra had highlighted the same in its press release titled ‘Capital Infusion through Zero-Interest Bonds in PSBs May Help Regulatory Capital, But not Tangible Equity as Much’. Ind-Ra believes the intrinsic net worth of these instruments could be lower by almost 50% at end-FY22 at the outset than similar maturity government papers in the market, given they do not carry any interest.

The illiquid, non-trading nature of these securities could add to the discount. The agency opines that these banks have moderate competitiveness (albeit better than last year) to raise equity and would need to offer materially higher yields to raise Additional Tier 1 (AT1) from the markets. Valuing these zero-interest bonds at a fair level could coerce these banks to raise either equity or AT1 in the near term solely on account of this factor.

The GoI had cumulatively infused capital amounting to Rs200 billion across Central Bank of India (CBOI; IND AA-/Stable; Rs48 billion), UCO Bank (UCO; IND AA-/Stable; Rs26 billion), Bank of India (BoI; IND AA/Stable; Rs30 billion), Indian Overseas Bank (IOB; IND AA-/Negative; Rs41 billion) and Punjab and Sindh Bank (P&SB; Rs55 billion) in H2FY21, from the budgetary allocation for FY21 through the issue of non-interest bearing (non-transferable) special GoI securities with maturities ranging from 2031 to 2036.

The quantum of capital infusion varied between 11%-44% of the Tier I capital of the respective PSBs as of 3QFY21. Equity levels is an important factor in a bank’s ability to service Basel III AT 1 and Tier 2 bonds. In Ind-Ra’s estimates, while the impact on P&SB could be substantially high (as high as 5% on CET1 at end-9MFY22), it could be manageable for most other banks that are carrying CET1 in the range of 12%-13% (effective CET1 could be lower by 0.5%-1.75%).

With time the discounting factor will decrease, and zero-interest bonds’ fair value will tend to be the par value and affect the banks’ CET1. In addition, the aforementioned PSBs are in a better shape in terms of capital, provision cover, profitability and net NPA than a year ago. Ind-Ra revised the Outlook from Negative to Stable on IOB, UCO and CBOI in 3QFY22. Furthermore, these banks have sizable deferred tax assets, the utilization of which could also release CET1 for these banks over the next few quarters. Also, the GoI’s planned INR150 billion equity infusion for the year FY22 is yet to be allocated. However, the contours of the infusion of this amount is not clear.