Debt Cleanup Faith Tested by First India Capital Dollar Bond

  • Asset quality at ‘forefront’ of investor minds: Western Asset
  • Investors need to be compensated for risks: NN Investment

India is testing global investors’ faith in its steps to clean up bad debt with the first bank offering of a dollar bond that counts toward new rules on capital.

State Bank of India will start investor meetings from Sept. 12 to market the nation’s first sale of dollar additional Tier 1 securities since the country introduced Basel III rules, a person with knowledge of the matter said on Friday. Such capital is a lender’s first line of defense against financial shocks after equity, as their value can be written down and interest payments deferred. DBS Group Holdings Ltd. sold a $750 million AT1 note in late August that yielded 3.58 percent on Friday.

Western Asset Management Co. said Indian banks’ asset quality and capital levels remain at the “forefront” of investors’ minds, while NN Investment Partners said that buyers ‘need to be compensated for the higher risk’ on these type of securities. The proportion of stressed assets in the nation’s financial system surged to a 16-year high of 11.5 percent as of March 31, straining risk buffers at lenders given a March 2017 deadline by regulators to provision for a clean up.

“The RBI’s stance in forcing a bad debt recognition and clean up is a long-term positive for the banking sector,” said Lim Swee Ching, portfolio manager at Western Asset Management in Singapore. “However, this has resulted in many state-owned banks reporting losses due to heightened provision costs and being even more reliant on capital injections from the government.”

‘Name Recognition’

A spokesman for SBI said on Tuesday that he couldn’t immediately comment. The Mumbai-based lender’s senior unsecured 2024 dollar notes yielded about 3 percent on Friday. S&P Global Ratings said on Thursday that SBI’s AT1 notes are rated B+, four notches below the lender’s BBB- rating, reflecting the bank’s ability to cancel interest and write down the notes.

Fitch Ratings Ltd. analyst Saswata Guha said an issuance from State Bank of India will help open up the market, set a price benchmark and widen the investor base for other top 10 issuers to tap. He added that “name recognition” will play a significant role in the U.S. dollar market. Fitch estimates that banks face a shortfall of $90 billion of capital over the next several years as regulatory requirements build to meet Basel III rules by 2019.

SBI earlier this year posted the sharpest drop in quarterly profit since 2011, with net income plunging 66 percent in the three months through March 31 from a year earlier. Profit sank 32 percent in the June quarter.

NN Investment said that investors are "concerned about Indian banks’ bad loans” and that some smaller lenders will need to raise equity before they can tap the bond market.

"Indian banks do need capital," said Shilpa Singhal, senior credit analyst at NN Investment in Singapore. “If they are able to tap the U.S. dollar AT1 market, it will help raise their capital ratios. But some of the smaller banks are really in need of capital and it would be difficult for them to issue because their equity buffers are thin.”

While the nation’s banks have been raising additional Tier 1 capital selling rupee bonds, Mitsubishi UFJ Securities HK Ltd. said the onshore market isn’t deep enough to meet their needs. Only one lender, Syndicate Bank, issued a 9.3 billion rupee ($140 million) 11.25 percent bond this year, compared with nine banks raising 79 billion rupees in 2015, data compiled by Bloomberg showed.

“It would be good for India’s flagship lender State Bank of India to open the offshore AT1 market for Indian banks,” said Nicholas Yap, a credit strategist at Mitsubishi UFJ in Hong Kong.

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