Tier 1 bond crunch will push capital infusion

The government may have to increase its capital infusion to state-owned banks if lenders are unable to sell additional Tier 1 bonds in the financial year that begins April 1, say analysts.

In the interim budget announced on Monday last, the government said it will inject Rs 11,200 crore ($1.8 billion) of capital in the state-run banks. Typically, the government's capital infusion is for common equity Tier 1.

According to estimates from India Ratings & Research, the local arm of Fitch, India's state-owned banks will need about Rs 6,800 crore in the next financial year to maintain their existing minimum common equity Tier 1 levels.

The banks, which constitute nearly 70 per cent of the industry in terms of assets, however will require between Rs 25,000 crore and Rs 36,000 crore to maintain their total minimum Tier 1 ratio of 8 per cent in 2014-2015, according to Moody's.

That amount includes Additional Tier 1 capital and is 1 per cent higher than the 7 per cent regulatory floor under the new banking regulation in India. The Reserve Bank of India's Basel III regulations require Indian banks to have a minimum total capital of 9.625 per cent as a percentage of risk weighted assets as of March 31, 2015 That includes minimum common equity Tier 1 capital of 5.5 per cent, minimum additional Tier 1 capital of 1.5 per cent, a capital conservation buffer of 0.625 per cent and Tier 2 capital of 2 per cent.

The capital injection of Rs 11,200 crore will be sufficient to cover the minimum common equity Tier 1 needs of state-run banks as it keeps the average common equity tier 1 ratio of state-run banks above 8 per cent — it is currently between 7.5-8 per cent, according to India Ratings, but the remaining additional Tier 1 needs would have to be met some other way.

"Since there is no ready market for the additional Tier 1, the government will have to take a mid-year call to supplement this and increase the overall capital infusion in its banks," said Ananda Bhoumik, senior director, India Ratings & Research.

Few options

India's biggest lender, State Bank of India, is the only state-run bank so far to have successfully raised equity under the Basel III requirements, which came into force last April.

SBI's $1.3 billion equity offering last month, however, is not a great precedent for other lenders. The offering was finalized at a lower price and volume than it originally targeted.SBI sold 51.2 million shares, short of its intended 58.9 million share target. The placement priced at Rs 1,565, at the bottom of the Rs 1,565-Rs 1,580 price range.

The qualified institutional placement of SBI was subscribed 70 per cent by domestic banks and insurance companies, with Life Insurance Corp of India buying almost $450 million."

"Most other public-sector banks trade at valuations below SBI, indicating that markets are not yet receptive to further equity offerings from these banks," Moody’s said in a note this week.

Institutional investors including insurers, pension funds and provident funds buy equity offerings or additional Tier 1 from state-owned banks. These institutional investors, however, have limits on the amount of assets they can own from a single name, and they have rating caps.

The Basel III ideal

Private sector lender Yes Bank is the only Indian bank to have issued Basel III-compliant Tier 1 bonds. Yes Bank sold its locally rated Single A Tier 1 bonds to yield 10.50 per cent in a bilateral deal.

The government is believed to be pushing the pension fund and insurance regulators to allow their industry players to buy additional Tier 1 bonds of state-owned lenders.As of now, state-insurer Life Insurance Corp remains the biggest equity investor for state-run lenders.

The need for capital for Indian banks is just beginning to rise in the run up to meet the Basel III capital requirements in full by 2018. According to India Ratings' estimates, the government's contribution to the common equity Tier 1 capital of its banks will total Rs 1.306 trillion or $22 billion over the Basel III implementation period, including Rs 15,600 crore in 2015-2016, which will increase to Rs 40,400 crore in 2016-2017.

On the additional Tier 1 front, the rating agency estimates, state-owned lenders will require a total Rs 26,000 crore in 2014-2015 and Rs 40,400 crore in 2015-2016.

"Banks would have to either revert to common equity raising or cut growth to meet Basel III requirements if an investor pool for such instruments is found lacking," India Ratings said in a note earlier this month.