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A role reversal seems to be happening in the Indian financial markets, with India Inc lending to banks instead of borrowing from them.

High returns on investments in Additional Tier-I (AT) bonds issued by public sector banks is proving to be attractive for large corporates even as bank credit to them has declined.

This development comes amid mutual funds avoiding AT-1 bonds (Perpetual Debt Instruments) due to SEBI restrictions.

Given that corporates have substantially deleveraged over the last few years and are sitting on the fence when it comes to fresh capital expenditure, they are channelising their surplus funds parked with banks and mutual funds into AT-1 bonds, according to a fund manager with an MF.

Bank credit to large industries contracted by 1 per cent in September 2021 against a contraction of 0.2 per cent a year ago, per latest RBI data.

Opportunistic investment

The investment by corporates in PSBs’ AT-1 bonds is opportunistic. Banks are offering relatively higher interest rates on these bonds to attract investors after SEBI’s March 2021 circular on “investment in instruments having special features and valuation of perpetual bonds” discouraged MFs from investing in them.

Union Bank of India recently raised ₹2,000 crore via AT-1 bonds at a coupon rate of 8.70 per cent. The PSB had earlier mopped up resources via AT-1 bonds twice — ₹1,000 crore (coupon: 8.64 per cent) in early January 2021 and ₹205 crore (8.73 per cent) late the same month.

Though AT-1 bonds are perpetual in nature, banks usually exercise the call option at the end of five years from the date of issuance. So, a corporate can earn higher returns by investing in these bonds than by parking in a five-year term deposit which fetches about 5.50 per cent.

PSBs are raising resources through AT-1 bonds as they have call options due in the current fiscal and the next on the bonds they had issued earlier. Bank of Baroda, Canara Bank and Punjab National Bank are among the PSBs believed to be considering raising resources via AT-1 route.

MFs shrink away

Among the reasons for MFs to keep away from these bonds is that their maturity is treated as 100 years from their date of issuance for the purpose of valuation as against the current practice of valuing them based on the time left for the next call option date.

So, MFs fear mark-to-market losses due to this change in the valuation norm, for if interest rates rise, the price of longer tenure bonds will depreciate much more than the short-to-medium term instruments.

By ICRA’s estimates based on industry data, MFs held 30 per cent of the outstanding Tier-I bonds and 14 per cent of the outstanding Tier-II bonds as on February 2021.

The credit rating agency assessed that the holding of Basel III compliant AT-I and Tier-II instruments is estimated at 8 per cent of the assets under management of MF schemes holding these instruments, thereby limiting the headroom for incremental investments.

ICRA, in its outlook for the banking sector for FY22, had estimated the Tier-I capital requirements for PSBs at ₹43,000 crore, of which ₹23,000 crore is on account of call options falling due on AT-I bonds, while the balance is estimated as the equity.