Indian banks keep their capital bonds in the family
* Bank of India Tier 2 first publicly sold Basel III bond
* Over half the deal ends up with bank retirement funds
* Cozy relationship raises questions about systemic risk
By Manju Dalal
SINGAPORE, Oct 4 (IFR) - Bank of India sold a second tranche of Basel III-compliant Tier 2 bonds to 15 investors this week, making it the first widely distributed capital-eligible deal in the local market since the new regulatory regime was adopted in India.
The biggest buyers of the transaction, however, were the provident funds of other state-owned banks, raising questions over whether or not such purchases doubly expose bank employees - who depend on these funds for their retirement - to the risk of losses in India's banking system.
While their participation boosted demand for an asset class that is expected to grow rapidly, it also left some in the market wondering if there was any net benefit to the sector at all, given the funds are simply buying one another's banks' deals.
Basel III rules require Tier 1 and Tier 2 securities to be written down or converted to equity if a bank is determined to be no longer viable. That provision allows eligible securities to count towards a bank's capital adequacy ratios, but the additional risk has dampened investor appetite for the new-style deals.
"This is a new trick to create demand," said a banker about the Bank of India trade. "If a bank's [provident fund] invests in its own bonds, then the invested amount has to be deducted from the bank's capital," he said.
"And, if a bank's PF invests in the bonds of other banks and vice-versa, the common amount is struck off from the capital of both banks. So, the situation remains the same, but a temporary solution [of meeting Basel III requirements] has been met."
Bank of India's Basel III-compliant Tier 2 offering, which raised Rs5bn (US$80.3m) last week, was priced to yield 9.80%. The first Rs10bn tranche of the deal, sold in September, was priced at the same level, but was placed with only one buyer, Life Insurance Corp of India.
Buyers of the new tranche included the provident funds of four nationalised lenders: Allahabad Bank, Indian Overseas Bank, Union Bank of India and Vijaya Bank, according to people aware of the transaction.
ICICI Bank and Axis Bank, two of deal's arrangers, also took a portion of the deal on their proprietary books, and other bonds were sold to postal funds managed by State Bank of India and the UTI Mutual Funds, sources said. AK Capital, Centrum Finance, IDFC, IDBI Gilts and Trust Capital arranged the deal.
Sources said nearly Rs3bn, or 60%, of the deal was sold to the four nationalised banks' funds.
Such a high allocation suggests Indian banks are still struggling to attract demand from other institutional investors - at least at their target pricing levels.
In overseas markets, new-style Basel III-compliant bonds are priced at a higher yield because of their loss-absorption features.
The situation is different in India, where analysts believe the government is unlikely to allow any state-owned bank to fail. As a result, issuers have insisted on pricing new Tier 2 securities in line with notes issued under old rules, which did not include loss-absorption clauses.
The recent developments have also led to concerns that managers of employee retirement funds are not making independent investment decisions when they buy the bonds of their peers.
"Treasury heads (of nationalised banks) are part of the investment committees of their banks' [provident funds]," said a treasury department official of a nationalised bank. "The fund more or less follows whatever the treasury head says."
The treasury official agreed the Bank of India deal had double-exposed the bank's provident fund investors, and that, sooner or later, the central bank is likely stop the practice.
However, he argued that provident fund managers had few attractive investment alternatives.
"Bank [provident funds] don't have many venues to invest for safe returns as so many corporations are going in for debt restructuring and, in no way, do the provident funds want any haircuts on their returns," he said. "Bank bonds are the best bet."
Provident fund managers will have plenty more bank bonds to consider. According to the regulator, Reserve Bank of India, banks will need to issue Rs5trn of additional capital over the next six years ending March 2018. Common equity is expected to make up about Rs1.75trn of this, with debt accounting for the remaining Rs3.25trn. That includes about Rs1.9trn of Tier 1 and Rs1.35trn of Tier 2 bonds.
Central Bank of India, Canara Bank, IDBI Bank, Dena Bank, Syndicate Bank, State Bank of India, Union Bank of India and Vijaya Bank were already considering Tier 2 Basel III-compliant bond sales in the coming months, sources said. Bank of India might also come back to the market, but not before the March quarter, they added. (Reporting By Manju Dalal, editing by Abby Schultz, Julian Baker)
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