Yes Bank finds new investor base for capital instruments

Fri Jan 10, 2014 3:13am EST

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* Bankers fear Reserve Bank of India could stop future deals

By Manju Dalal

SINGAPORE, Jan 10 (IFR) - Private-sector lender Yes Bank has found a creative, albeit controversial, solution to India's struggle to attract investors to subordinated bank capital securities.

On December 31, the issuer privately placed India's first Basel III-compliant Tier 1 bond with a single investor, Indiabulls Financial Services,one of the country's biggest non-bank lenders. Indiabulls bought the Rs2.8bn (US$45m) non-call 10 perpetual bonds at a yield of 10.5%.

While it was far from the first private placement in India's struggling bank capital market, sources said the deal came alongside a parallel placement in which Yes Bank agreed to buy a similar amount of Indiabulls' subordinated debt.

Such a quid-pro-quo arrangement between two banks would come with no capital benefit, since Indian regulations require lenders to count any sub bonds they buy from other banks against their own capital - a rule designed to ensure risks are spread beyond the banking sector.

However, that rule does not apply to sub debt from non-banking financial companies, meaning Yes Bank and Indiabulls are each in line for a capital boost.

Market participants were quick to criticise the scheme. "Yes Bank's deal is a cosy arrangement. As a pricing benchmark it is not sending the right signal to the market," said a DCM banker away from the deal.

Others saw it as a challenge to the Reserve Bank of India. "Yes Bank's deal is ground-breaking, but, I feel they have gone a bit far by challenging the authority of the central bank," said a Mumbai-based banker.

Both parties have not breached any regulations and Basel rules do not prohibit cross-holdings of sub bonds. However, such a deal also leaves the risk embedded in India's financial system, rather than reducing the chances of a bank failure becoming a systemic crisis.

The controversial deal, though, was born of necessity. Local investors have been shying away from buying new-style capital bonds because of the loss-absorption features, while Indian banks are under pressure to lift capital ratios.

"There will be a good supply of additional Tier 1 from Indian lenders. Hence, it is quite crucial to have a good base of institutional investors, who can buy such bonds. In this context, Yes Bank's deal looks like a good start," said Karthik Srinivasan, an analyst with Icra.

NO LOCAL BID

Under Basel III rules, all sub debt that counts toward a bank's capital must absorb losses, either through conversion to equity or a write-down at the point a bank becomes non-viable.

In addition to the loss-absorption features, T1 bonds face two major obstacles with local investors. First, many debt investors are restricted from investing in debt instruments with equity-like features due to the higher risks involved. Second, as ratings on T1 bonds are typically at least three to four notches below a lender's senior unsecured rating, these instruments automatically fall below the rating thresholds for many funds.

Local rating agency Icra assigned an A to Yes Bank's Rs3bn Basel III-compliant bond programme. The rating is three notches lower than the bank's Basel II-compliant Lower Tier 2 bonds. Most Indian investors are restricted to buying bonds rated at least Double A.

For these reasons, the Rs107.5bn of Tier 2 bonds issued so far under the Basel III rules in India have struggled to attract wider investor participation. Most of the bonds issued so far in the country have been bought a single investor, the Life Insurance Corporation of India.

Only recently, another big investor, the Employees' Provident Fund Organisation, has started buying Tier 2 bonds, including the recent Rs20bn Tier 2 deal from State Bank of India, the country's largest lender. The bank placed the 10-year bonds at 9.69%. However, the public pension fund and other key investors, such as insurance companies and provident funds, cannot buy Tier 1 instruments.

At the same time, though, some have been celebrating the deal as a solution for a shortfall in potential investors for sub debt at a time when Indian banks are in dire need of additional capital.

According to the RBI, banks will need to issue Rs5trn of additional capital over the next four years ending March 2018. Common equity is expected to make up about Rs1.75trn of this new capital with debt accounting for the remaining Rs3.25trn. That includes about Rs1.9trn of Tier 1 and Rs1.35trn of Tier 2 bonds.

The RBI has also been raising capital adequacy requirements for non-bank lenders in recent years.

Yes Bank and Indiabulls did not respond to requests for comment. (Reporting By Manju Dalal; Editing by Christopher Langner and Steve Garton)

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