A man talks on his mobile phone as he walks past the logo of the Reserve Bank of India (RBI) inside its head office in Mumbai. (Reuters)
The Reserve Bank of India is having second thoughts about allowing banks to issue subordinated bonds with temporary write-down and write-up features.
The RBI has told Bank of India not to include a temporary write-down and write-up feature on a planned issue of additional Tier 1 capital securities, sources aware of the situation have told IFR.
The central bank is the only Asian regulator to have explicitly allowed the reinstatement of capital securities, but its recent move adds to confusion over its position, potentially also complicating efforts to bring the first deals to market.
Under Basel III rules, all additional Tier 1 instruments must absorb losses, either through conversion to equity or write-downs at the point that a bank becomes non-viable. This is defined in India as a Tier 1 capital ratio of 6.125% or below.
A reinstatement clause, however, would allow write-downs to be reversed, ensuring that holders of additional Tier 1 instruments benefit from a bank's recovery in the same way as common equity holders. The format had been expected to allow Indian banks to raise capital at a lower cost.
The uncertainty from the regulator comes as at least three banks, including IDBI Bank and Indian Overseas Bank, have been discussing the launch of Basel III-compliant additional Tier 1 bonds in the first quarter of 2014.
Bank of India is at a more advanced stage and has already mandated seven banks. Bank of America Merrill Lynch, Barclays, BNP Paribas, Citigroup, HSBC, RBS and Standard Chartered are working on the debut Tier 1 issue, expected to raise up to US$500m.
Sources said that the mandate had been awarded based on an 8.5% yield and the arrangers were also in talks with Bank of India to backstop the transaction - at a price.
Investors told IFR that 8.5% would be appealing only if any losses could be clawed back. Without the capital reinstatement clause, investors are looking at a price of around 11% - equivalent to 18%-19%, if swapped back into rupees.
Analysts put the cost of raising equity for Indian banks at around 13%-14%, meaning BoI will be facing a high price to avoid diluting its shareholders.
High-yielding additional Tier 1 notes, however, could still be an attractive alternative to common equity because Bank of India's stock price has yet to recover fully from the summer selloff. The August 2013 bottom of Rs126.50 was the lowest since August 2006.
Bank of India may not be keen to raise fresh equity, while its stock is at only around 0.5x book value. Indian public sector banks generally preferred to raise equity if that ratio was over 1, said Hatim Broachwala, banking analyst at Karvy Stock Broking Research.
Indian banks need to raise around Rs1.9trn of additional Tier 1 securities by March 2018, according to the RBI's initial estimates, suggesting that the first mover may have an advantage before other banks rush in to crowd the market with similar deals.
Bank of India, rated Baa3/BBB-, is the third largest Indian bank with assets of Rs4.85trn as of June 30 2013.