Tag: perpetual bonds

HDFC Bank raises Rs 739 crore via masala bonds, BFSI News, ET BFSI

Banking & Finance

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HDFC Bank on Thursday said it has raised Rs 739 crore by issuing the rupee-denominated masala bonds in the overseas markets. HDFC Bank has issued and allotted rupee-denominated bonds overseas on September 30, 2021, the lender said in a regulatory filing.

The private sector lender will use the proceeds from the issue for banking activities.

The subordinated additional tier I bonds are compliant with Basel III norms.

The perpetual bonds, which are unrated and unsecured, carry a coupon rate of 7.55 per cent.

The notes (bonds) will be listed on the India International Exchange (IFSC) Ltd and NSE IFSC, it said.

Perpetual bonds carry no maturity date, so they may be treated as equity, not as debt.

The rupee-denominated bonds, popularly known as “masala” bonds are instruments that are issued outside India, not in the local currency but the Indian rupee.

In November 2016, the RBI had allowed banks to raise funds by floating the rupee-denominated bonds in overseas markets as part of an additional avenue to raise long term funds. Shares of HDFC Bank closed at Rs 1,595.50 apiece on BSE, up 0.14 per cent from the previous close.



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Perpetual bonds – where do we go from here?

Banking & Finance

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It has been over a month since SEBI announced guidelines for perpetual bonds and almost a month since the valuation of such bonds under the new methodology has been implemented. Before we get into implications of such valuation, lets quickly understand what these bonds are, and how did they actually impact market sentiment.

AT-1 (additional tier 1) bonds are issued predominantly by banks to raise additional Tier 1 capital without any maturity date (perpetual), but they have a call option. Banks issue AT-1 bonds to meet their capital adequacy requirement. Higher capital adequacy norms came into force with the implementation of Basel III guidelines.

These guidelines were formed after the 2008 financial crisis with the collapse of a few banks and financial institutions. Similarly, Basel III Tier 2 bonds issued by banks are expected to provide to their depositors and senior creditors an additional layer of protection.

According to the Basel III guidelines issued by the RBI, Basel III-compliant Tier 2 bonds normally come with a finite maturity.

The regulation

On March 10,SEBI put certain restrictions on investment in these bonds by Mutual Funds – no mutual fund under all its schemes shall own more than 10 per cent of such instruments issued by a single issuer; mutual fund scheme shall not invest (a) more than 10 per cent of its NAV of the debt portfolio of the scheme in such instruments and (b) more than 5 per cent of its NAV of the debt portfolio of the scheme in such instruments issued by a single issuer; and the investments of mutual fund schemes in such instruments in excess of the limits specified may be grandfathered, and such mutual fund schemes shall not make any fresh investment in such instruments until the investment comes below the specified limits. Given that mutual fund ownership of such Tier 1 bonds was around one-third of the total outstanding, it did create some anxiety across the perpetual bond segment.

Yields on such bonds shot up by ~1 per cent. The assumption here was MFs will panic exit such bonds and, hence, bids started inching up.

The volatility in perpetual bond space we saw was largely due to the uncertainty around the impact of valuation methodology. It is important to keep in mind that this in no way was a credit event, but a valuation method change for mutual funds. Since then, the yields have only softened (eased by 50-60 bps) from peak levels as carry chasers stepped in to buy such bonds. Also, we did not see mutual funds undertake panic sales, as the regulator has allowed grandfathering of such exposures.

What’s next?

Markets have now reconciled to business as usual with regard to perpetual bonds. It is important to note that the regulator has not barred MFs from investing in such bonds. Hence, the option remains with MF managers whether or not they would want to own such bonds. All perpetual bonds cannot be categorised as one. Like every debt instrument, perpetual bonds should be evaluated based on the banks fundamentals.

The primary focus remains to evaluate such bonds basis the underlying credit metrics, capital adequacy ratios and systemic importance to the Indian economy. As an investor, one needs to follow the same process in case he/she has exposure to AT1 bonds directly or via mutual funds. The current interest rate scenario may mean adequate liquidity and range-bound interest rates.

In such a scenario, carry yield in fixed income assumes a lot of significance. Such bonds do offer a spread over plain vanilla bonds. The acid test, however, would be to see how the appetite is if banks issue fresh bonds. Also, with valuations now being delinked from call option date, will banks want to continue to hold on to the existing bonds rather than exercising a call option on such bonds?

Markets will get more clarity over next few months as some tier 1 bonds approach their call date. However, market activity in such bonds so far is suggestive of call option being exercised, though it will have to be a wait and watch.

To sum up, AT1 bond offers credit comfort (based on underlying) and reasonable accruals for the investor. In case of MFs, it would best left to the discretion of the portfolio manager to hold the AT1 bonds till call/maturity as per the investment contours of respective schemes. Investors should be aware of the nature of the underlying investment rather than any action based on external noises. After all panic leads to pain, no one really stands to gain.

 

(The writer is CIO – Debt & Head – Products, Kotak Mahindra Asset Management Company. Views expressed are personal and do not reflect the views of Kotak Mahindra Asset Management Company Limited)

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Useful tips to avoid falling prey to bank mis-selling

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In investing, as in life, it is useful to learn from other people’s mistakes. Some retail investors lost big money in Yes Bank’s Additional Tier 1 (AT-1) bonds last year, after Reserve Bank of India decided to write them off as part of a bailout package. But how did safety-seeking depositors in Yes Bank end up owning these risky bonds where the principal could get written off? SEBI’s order in this case offers some learnings on how you can avoid falling victim to mis-selling.

Get it in writing

In their complaints, the 11 investors said that it was the attractive pitches from their bank’s wealth managers that convinced them to buy the bonds. Some were told that AT-1 bonds were ‘super FDs’. Others swallowed the claim that they were ‘safer than Yes Bank FDs and equity shares.’ Some investors even thought they were merely renewing their FDs with the bank at a higher rate.

Given that none of the above statements were true, it is unlikely that the bank’s relationship managers made these claims in writing to the investors. They were simply taken in by verbal sales pitches.

While selling AT-1 bonds, bank managers were mandatorily required to share two documents with investors – an information memorandum and a term sheet. Asked by SEBI why they didn’t do so in this case, they either claimed that they did, or argued that investors ought to have checked these documents for themselves from the BSE website where they are posted.

Most of us are in the habit of investing in financial products based merely on an application form. The Yes Bank case shows just how injurious this can be to our wealth. Today, no financial product can be sold to you without a formal offer document, information memorandum, term sheet or prospectus. If you’re given only an application form, don’t hesitate to ask for and get hold of these additional documents.

The depositor isn’t king

SEBI’s findings show that of the 1,346 individuals who invested in the AT-1 bonds through Yes Bank, 1,311 (97 per cent) were Yes Bank’s own customers. Of these 1,311 customers, 277 prematurely broke their FDs to invest. Going by the amounts of ₹5 lakh to ₹80 lakh that these folks individually invested, wealth managers targeted the bank’s big-ticket depositors to down-sell these bonds.

While you may wonder why a bank’s staff should wean customers away from its own deposit products, this isn’t surprising.

Bank relationship managers in India have a long history of pitching all kinds of risky products to their customers from ULIPs to balanced equity funds to NCDs as fixed deposit substitutes. While they don’t receive any direct commission from such sales, their compensation packages are often linked to how much fee income they generate for the bank from selling exotic products.

So, the next time your bank’s relationship manager sounds as if he or she is doing you a favour by asking you to switch money out of your FD into an exciting new ‘opportunity’, be sceptical.

High returns equal high risk

Investors who are super-careful about avoiding capital losses in equities often turn far less vigilant when it comes to fixed income. The moment a wealth manager or distributor mentions a higher interest rate product, they’re quite eager to switch to make the switch. But the correlation between high returns and capital losses is actually higher with debt instruments than it is with stocks.

In fixed income, if a borrower is willing to offer you a huge rate premium over safe instruments, it is usually a warning sign that they are more likely to delay or default on repayments. Yes Bank’s AT-1 bond investors should have questioned why the same issuer (Yes Bank) should offer its bond investors much higher interest than it does its depositors. The answer quite simply is that AT-1 bonds can skip their interest payouts completely or write off principal, if the bank’s financials are stressed.

An argument that wealth managers used to sell AT-1 bonds to individuals was that they were sound investments, as they were already owned by institutions. This is a poor argument, as risk appetite and return expectation of a retail investor is seldom the same as that of an institutional investor. Institutions that held those bonds probably invested a minuscule portion of their portfolios while HNIs took concentrated exposures.

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HDFC Bank looks to raise ₹ 50,000 crore …

Banking & Finance

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HDFC Bank plans to raise ₹50,000 crore of capital through perpetual debt instruments.

“The bank proposes to raise funds by issuing perpetual debt instruments (part of additional tier I capital), tier II capital bonds and long-term bonds (financing of infrastructure and affordable housing) up to total amount of ₹50,000 crore over the period of the next 12 months through private placement mode,” it said in a regulatory filing.

The Board of Directors would consider this proposal on April 17.

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Easing of valuation rule for perpetual bonds to help in avoiding panic redemption, feel experts

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Easing of valuation rule for perpetual bonds by Sebi will provide a breather to the mutual fund industry, which has an exposure of over ₹35,000 crore to such instruments, as they get time to redeem their positions, industry experts said on Tuesday.

They further said there will be no panic redemption in these bonds with this temporary relief.

However, experts differ on views whether the move will help banks, which raise capital through such bond issuances.

In a late evening circular on Monday, the Sebi eased valuation rule pertaining to perpetual bonds.

The move came after the finance ministry had asked Sebi to withdraw its directive to mutual fund houses to treat additional tier-1 (AT-1) bonds as having maturity of 100 years as it could disrupt the market and impact capital raising by banks.

AT-1 bonds

AT-1 bonds are considered perpetual in nature, similar to equity shares as per the Basel-III guidelines. They form part of the tier-I capital of banks.

Under the new rule, the deemed residual maturity of Basel-III additional tier-1 (AT-1) bonds will be 10 years until March 31, 2022, and would be increased to 20 and 30 years over the subsequent six-month period.

From April 2023 onwards, the residual maturity of AT-1 bonds will become 100 years from the date of issuance of the bonds.

Green Portfolio co-founder Divam Sharma said the new framework will provide some relief to mutual funds as they get time to redeem their positions, which are generally not liquid. There will be no panic redemption in these bonds with this temporary relief.

No relief to banks

For banks, this latest circular does not provide much relief as they are likely to find it difficult to get investors for their AT-1 bonds, he added.

“There is no change/deferment in the imposition of the 10 per cent capping of ownership of bonds in a particular mutual fund, which might have an immediate impact on the bond yields,” he added.

Gopal Kavalireddi, head of research at FYERS, said the move would provide a breather to the mutual fund AMCs, which already have a total exposure of ₹35,000 crore, and also provide relief to banks which raise capital through such bond issuances.

Omkeshwar Singh, head (RankMF) at Samco Group, the deem maturity has been changed in phased manner for valuation of perpetual bonds exiting by Sebi.

Effective from April 1, 2023, onwards, the deemed maturity to be considered 100 years and in between, it will be 10, 20 and 30 years in three phases till March 31, 2022, September 30, 2022, and March 31, 2023, respectively.

“These two years in between will provide sufficient time for funds to align there investments into AT-1 bonds (perpetual) , and the sudden shock in net asset value (NAV) can be avoided in the schemes that have exposure to these bonds,” Singh noted.

Harshad Chetanwala, co-founder of MyWealthGrowth.com, said the recent amendments in valuation rule of perpetual bonds will still have an impact on the overall duration of the debt fund portfolios and will increase their sensitivity to interest rate changes.

“Longer the duration, higher will be the sensitivity to interest rate changes. The revaluation could impact the portfolio’s value and reduce the NAVs of the mutual fund scheme holding these instruments in their portfolio,” he added.

As per Sebi, deemed residual maturity of Basel-III Tier-2 bonds would be considered 10 years or contractual maturity, whichever is earlier, until March 2022. After that, it will be in accordance with the contractual maturity.

Further, if the issuer does not exercise call option for any bond then the valuation will be done considering maturity of 100 years from the date of issuance for AT-1 bonds and contractual maturity for Tier-2 bonds, for all bonds of the issuer, Sebi said.

In addition, if the non-exercise of call option is due to the financial stress of the issuer or if there is any adverse news, the same need to be reflected in the valuation, it added.

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Relief for MFs: SEBI eases norms on perpetual bonds

Banking & Finance

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In a major relief, the market regulator SEBI has allowed mutual funds to meet its norms on valuation of perpetual bonds in a time bound manner with the life span of bonds increasing over the years.

On March 10, SEBI had stated that the maturity of all perpetual bonds shall be treated as 100 years from the date of their issuance for the purposes of valuation.

Based on the representation of the mutual fund industry to consider a glide path for the implementation of the policy, it has been decided that the deemed residual maturity for the purpose of valuation of existing and new bonds issued under Basel III framework will be achieved over a period of two years.

In the financial year ended March 2022, the AT-1 bonds will be valued at 10 years or the call date mentioned in the bond. From April to September 2022, it will be valid at 20 years and from October 2022 to March 2023 it will have a life span of 30 years. Finally, from April 2023, the perpetual bonds will be valid at 100 years.

All Basel-III tier-two bonds will be valid at the contractual maturity.

Further, if the issuer does not exercise the call option for any of the perpetual bonds, then the valuation and calculation of duration shall be done considering a maturity of 100 years from the date of issuance for AT-1 bonds and contractual maturity for Tier-2 bonds, said SEBI.

If the non-exercise of call option is due to the financial stress of the issuer or if there is any adverse news, the same shall be reflected in the valuation, it said.

The Association of Mutual Funds in India has been advised to issue detailed guidelines with respect to valuation of bonds issued under the Basel III framework, which shall be implemented by April 1, 2021.

The change in rules comes after the Finance Ministry had raised concerns over the duration of perpetual bonds.

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Perpetual bond yields move up 25-35 bps

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The yields on perpetual bonds floated by banks have moved up 25-35 basis points in the past two days following the SEBI circular on valuation of mutual fund investment in these bonds and the subsequent Ministry of Finance letter directing SEBI to withdraw the circular.

The MF industry has invested about ₹35,000 crore in perpetual bonds of banks with tenure of 100 years.

The top four mutual funds alone hold 80 per cent of the investment in these bonds.

Last week, SEBI directed mutual funds to value the perpetual bonds as a 100-year instrument and limit investments to 10 per cent of the assets of a scheme.

According to SEBI, these instruments could be riskier than other debt instruments.

Mahendra Jajoo, CIO – Fixed Income, Mirae Asset Mutual Fund, said the yields will further move up by 50-75 basis points if SEBI retains the circular without any changes, as there is nervousness and uncertainty over the regulator’s next move.

Though the investment cap prescribed by SEBI is absolutely fine, the net asset value (NAV) of schemes holding these bonds will come down if yields firm up further, he added.

Risk profile

SEBI has a valid point in restricting the mutual fund investment in these perpetual bonds as the Employees’ Provident Fund Organisation and insurance companies including LIC, which manage long-term money of investors, do not invest in these bonds due to its risk profile, said an analyst tracking mutual fund investments.

Moreover, some short-term debt schemes have also made huge investment in these perpetual bonds, breaching their investment mandate and putting investors’ money at risk, he added.

The RBI had recently allowed a complete write-off of ₹8,400 crore on AT1 bonds issued by YES Bank as part of a bailout package led by State Bank of India.

Perpetual bond prices fall if yields firm up, and the NAV of the schemes which hold these bonds will go down. Mutual funds will be forced to sell other debt paper to meet the redemption pressure.

Subsequently, the quantum of investment in AT1 bonds of these schemes will move up and test the 10 per cent cap imposed by SEBI. It is a sort of double whammy and needs to be dealt with immediately, he said.

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How to check the health of debt MFs

Personal Finance

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The unfolding of many adverse credit events over the last couple of years has highlighted the risks associated with investing in debt mutual funds to investors.

These funds have often been mis-sold as a higher-return ‘safe’ alternative to fixed deposits. As with other investments, these funds too require a credit risk assessment.

You can use the MF monthly fact sheet along with some online search for a basic credit quality check before you invest. Here’s how you can go about it.

Best-in-class

You can begin by checking what percentage of a debt MF scheme portfolio is invested in the highest rated papers. That is, how much is in AAA and A1+ (that is, AAA and equivalent) and sovereign debt papers.

AAA is the highest rating assigned to long-term debt instruments, those with a maturity of over one year. A1+ is the highest rating for short-term debt instruments such as commercial papers (CP) and certificates of deposit (CD) with a maturity of up to one year. Instruments with these ratings are meant to carry the lowest credit risk with respect to principal repayment and interest payments.

Sovereign debt papers comprising Government of India bonds, State government bonds and Treasury Bills are ranked the highest on the safety front.

If you want to play safe, you can narrow down on debt MF schemes that invest a high percentage, say over 90 per cent, of their portfolio in such instruments. Also, be sure to check the scheme portfolio over a period of time to ensure that this has been done consistently.

It’s not the same

Mahendra Jajoo, CIO – Fixed Income, Mirae Asset Investment Managers India, says that while AAA and A1+ rated papers are usually clubbed together from a credit quality perspective, not all A1+ rated short-term instruments can be considered equally safe.

This is because the issuers of short-term A1+ papers may not themselves always enjoy the highest long-term ratings. To get a better grip on this, one can check the long-term ratings for these issuers on the websites of rating agencies such as CRISIL, ICRA and CARE Ratings.

Also note, many AAA ratings are suffixed by SO (structured obligation) or CE (credit enhancement). AAA (SO) and AAA (CE) cannot be treated completely at par with AAA ratings.

These are assigned to debt papers where the standalone rating is below AAA and has been enhanced (and hence suffixed by SO or CE) by way of a guarantee, pledge of shares or escrow mechanism where cash flows meant for debt servicing are deposited by the borrower in an escrow account, and the like.

Typically, long-term ratings, in order of highest to lowest are: AAA, AA+, AA, AA-, A+, A, A-, BBB and so on. Similarly, short-term ratings follow the order: A1+, A1, A1-, A2+, A2, A2- and so on.

Perpetual bonds

After the write-down of Yes Bank AT1 bonds, which were also held by many mutual fund schemes, perpetual bonds came under the spotlight.

Perpetual bonds (including AT1 bonds) have no maturity date and the issuer has the option to simply keep paying interest on them without returning the principal. The interest payment too can be skipped if the issuer has incurred losses.

It would therefore help you to know if a debt MF scheme holds perpetual bonds (riskier than regular bonds) in its portfolio. But, this information may not always be disclosed in the fund fact sheet. You can, however, ascertain this with some research. You can go to the AMFI website (tinyurl.com/debtmf) to access the portfolio disclosure for most mutual funds.

You can take the ISIN (International Securities Identification Number) code for any security from here and use it to check on the CDSL or NSDL websites whether a bond is perpetual or regular.

There is another way too. Joydeep Sen, a corporate trainer (debt markets) and author, suggests that if the rating on a debt paper (say, a corporate bond) from a particular issuer, in a scheme portfolio is lower than what it would usually be, then it is likely to be a perpetual bond. You can find the usual rating for any company’s bonds from rating agency websites.Apart from the usual bonds, CDs and CPs, you may also find a portion of a debt MF corpus in reverse repo and triparty repo (TREPS), both of which are unrated instruments. These are sometimes shown separately (under 5 per cent) and at other times, along with cash and term deposits in the factsheet.

Both reverse repo and tri party repo are collateral-backed (government securities) short-term borrowing-lending transactions. The former involves only the borrower (company) and the lender (mutual fund in this case) and the latter involves also an additional third-party intermediary such as the Clearing Corporation of India. Practically speaking, both reverse repo and tri-party repo are considered not risky.

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