* Bank of India launches first Tier 1 bond from state-run
* Top domestic rating shows limits of Basel III in India
* Bonds likely to be bought by funds linked to other banks
By Manju Dalal
SINGAPORE, July 25 (IFR) - A landmark capital raising from
India's state-owned banking sector has reignited a debate over
the application of Basel III standards in the country's local
Bank of India launched a Basel III-compliant
Additional Tier 1 bond on Friday that secured a surprising
Triple A rating from a domestic agency - a grade typically
reserved for risk-free securities.
The offering of a minimum Rs12.5bn (US$207m) in perpetual
non-call 10-year bonds may have been structured and rated to
appeal mainly to other Indian banks, however, adding to the
uncertainty over the depth of demand for the new-style
Basel III capital rules are designed to force subordinated
creditors to absorb losses if the issuing bank runs into
trouble. Often referred to as "bail-in bonds", the securities
may be converted to equity or written down to zero, depending on
local regulations and how the deals are structured.
Global rating agencies typically knock at least four notches
off a bank's senior credit rating to signal the potential risks
in these bonds. Yet Brickworks, a domestic agency, has rated
BoI's bonds AAA, the highest possible rating and the same as
BoI's senior credit rating.
The high rating gives lenders such as BoI a better chance of
attracting investors to the new product, but it also points to a
deep-seated belief in the Indian markets that the government
will not allow any state-owned bank to fail.
India regularly injects capital into its public sector banks
(including US$2.2bn in the last fiscal year), and has a long
history of state-orchestrated bank rescues.
While banking regulators have publicly embraced Basel III
rules designed to limit such bail-outs, few local investors
expect they will risk a systemic crisis by declaring a state-run
bank to be no longer viable.
"If the senior bonds and AT1s under Basel III rules get
similarly rated in the local markets then it clearly indicates
the limitation of Basel III regulations," said an analyst at a
global rating agency.
A senior official at another state-run bank said he was
surprised by the rating.
"It is good news for the state-owned banks to get their Tier
1s rated at Triple A," he said, before asking: "What should be
the rating for our senior bonds? Triple A plus?"
SMALL INVESTOR POOL
A high rating on the Basel III bonds may make the securities
palatable to certain investors. Pension funds, provident funds
and insurance companies often are the key buyers of bank capital
bonds, although the bonds are considered "high-risk" investments
and these investors cannot buy them if they are rated below
Double A plus.
BoI may place most of its AT1 bonds with state-owned bank
provident funds, which would be investing in the bonds mainly as
a show of support as they also may need to raise bank capital
soon. According to RBI's initial estimates, Indian banks need to
raise about Rs1.9trn of AT1 securities by March 2018.
If BoI does, in fact, sell the bonds to such a narrow, and
self-serving, base, it raises questions about the ability to
create a true domestic market for Basel III bonds in India.
"With a Triple A rating and a double-digit yield, the BoI
bonds might certainly look enticing for the PFs, but is the deal
creating the right market? I really doubt it," said a debt
capital markets specialist at a foreign bank.
Investors are demanding a higher yield relative to BoI's
senior and Tier 2 bonds. That suggests they see the AT1
securities as more risky, regardless of the top rating.
BoI is indicating its new-style bonds will have an 11%
coupon, which is an 180bp pick up over the bank's Basel-III
compliant Tier 2 securities.
In September, BoI sold Rs10bn of Triple A rated Tier 2 Basel
III-compliant 10-year bonds at a 9.80% yield. The yields on
those bonds have fallen to about 9.20% in secondary trading.
Such a high yield on a high-rated BoI bond might prove
attractive, but many investors believe the new issue is still
"For the issuer, these bonds are a 10-year paper but for
investors it's a perpetual risk," an investor said. "Because of
the permanent write-off feature there is no protection of even
the principal amount. I strongly feel the deal was priced more
on what the issuer was comfortable with rather than on its risk
Indeed, BoI faced some resistance before agreeing to boost
the yield 50bp to 11%, sources aware of the pricing said. The
Basel III perpetual bonds are structured to write down to zero,
rather than convert to equity, if the bank is declared to be not
Still, market participants believe the deal may complicate
efforts to determine the right price for senior bonds in the
"Since the pricing of bank bonds in India is not reflecting
the true risk, it is not creating the right yield curve," said a
Mumbai-based DCM banker. "This is totally detrimental to the
BoI may also tap the offshore market for additional capital,
a route state-owned IDBI Bank is likely to take. IDBI
discussed a potential US$300m Basel III-compliant AT1 offering
with overseas investors in non-deal roadshows held earlier this
BoI had planned to sell a US dollar-denominated US$400m AT1
bond in January, and had even mandated seven arrangers. The bank
was considering sell the bonds with an aggressive 8.5% yield,
but it faced resistance from investors who could earn a similar
return on much higher-rated European issues, sources said.
Axis Bank, Darashaw, ICICI Bank and Trust Capital are
equally underwriting BoI's AT1 bond. The size of the deal, which
remains open until August 8, could double if BoI exercises a
greenshoe of Rs12.50bn.
(Reporting by Manju Dalal)