Different strokes

IFR India Special Report 2013
6 min read

A Triple A rating for a deeply subordinated issue of Tier 1 bank capital has underlined the significance attached to credit ratings in India’s domestic debt market.

Credit rating agencies operating in India are accustomed to surprises, having faced court injunctions over negative rating actions and countless disputes over unpaid bills. Even in this ultra-competitive industry, however, state-owned Bank of India’s landmark capital market fundraising in July 2014 caused a stir.

BoI’s debut Rs25bn (US$406m) offering of Basel III-compliant Additional Tier 1 securities came with a Triple A rating from domestic agency Brickwork Ratings, with zero notching to reflect the risk of loss absorption or coupon deferral under the Basel III standard.

BoI increased the deal from a Rs12.5bn base size, and the instruments are in great demand in the secondary market.

“If BoI fails, then the entire Indian banking sector will go down. Such an event will never happen.”

How much of BoI’s success was down to the top credit score is unclear. In a falling interest-rate environment, the 11% coupon offered on the non-call 10-year AT1s was partially responsible for sparking the demand for the paper. The Triple A rating, however, also worked as a catalyst, DCM bankers said.

The deal played a big part in introducing Indian investors to the AT1 structure, where investors will be written down if the bank’s capital falls below a certain level. Many are barred from investing at levels below AA+, or have struggled to decide whether the hybrids are dealing with debt or equity, and the takeup of earlier Basel III-compliant bank capital issues had been disappointing.

Brickwork’s peers, such as Crisil, Icra and India Ratings and Research, responded fiercely to the development, issuing press releases and frequently asked questions on AT1s – highlighting the embedded risk in these perpetual instruments.

India Ratings, the local arm of Fitch, was most vocal on this issue, calling the BoI AT1 sale a weak start. According to the agency, the 11% coupon, which is about 175bp higher than other Triple A yields, implies a rating in the range of A–/BBB+. The agency said the pricing had distorted BoI’s yield curve.

“The rating on BoI seems improper, but we should praise the bank for taking the bold step and opening the Indian AT1 market,” said an official from another state lender, mulling an AT1 sale soon. The official, however, said his bank was in favour of notching down AT1s.

The August 6 press release of Brickwork stated that the agency considered coupon discretion, probability of the breach of the higher trigger for CET1, financial performance and capital adequacy levels of BoI, but did not explicitly state the reasons why it did not see any risk in these loss-absorbing instruments.

Nevertheless, these rivals stuck to their stand of notching down the AT1s at least two to four levels, depending on the issuer.

Brickwork does state on its website that it will notch down AT1s zero to four levels below the issuer’s senior rating.

India has never allowed a state-owned lender to go bust, and the rare opportunity to earn high yield from a Triple A-rated state lender appealed to investors, including a charitable trust.

“If BoI fails, then the entire Indian banking sector will go down. Such an event will never happen,” said a DCM banker, ruling out the chance of any state lender becoming non-viable in India. The government holds a 66.7% stake in BoI.

While such a response is typical in the Indian investor base, the rating action of Brickwork was against the global practice of rating agencies, which, typically, knock at least four to five notches off the standalone rating of a bank as a signal to investors of the potential risks of an AT1 bond.

Basel III capital bonds are designed to force subordinated creditors to absorb losses if banking authorities declare any issuing bank to be no longer viable, and it is far from clear whether the government will step in protect subordinated investors in the future.

Even at home and, prior to BoI’s issuance, Indian markets had a precedence of a local AT1 instrument getting notched down.

In December 2013, private lender Yes Bank sold AT1s of Rs2.8bn, with a call after year 10 at 10.50%. The perpetual bonds were placed to a non-banking finance company client in a quid-pro-quo arrangement that highlighted the challenge in placing riskier AT1s in the wider market.

Icra assigned Yes Bank’s AT1s an A rating, three notches lower than the lender’s Basel II-compliant Tier 2 papers.

In its rating rationale on BoI’s AT1s, Brickwork said “it has relied on the bank’s FY14 results, publicly available information and other information/clarifications” the bank had provided. The rationale, issued on July 24 2014, did not offer a clear justification for giving the top-notch rating.

The next AT1 deal from state-owned IDBI Bank received AA– ratings from Crisil and India Ratings, two notches down from the standalone rating of the lender. The Rs25bn offering, with a call after year 10, pays a 10.75% coupon but has struggled to attract investors. The underwriters on the offering were four arrangers that are hopeful of selling the bonds in three months as they expect interest rates to start coming down.

“The IDBI’s AT1s are offering a 115bp to 120bp spread over the prevailing AA– bank bonds. These new bonds are good investments,” said a banker.

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Different strokes