With at least four public sector banks, which have been placed under prompt corrective action (PCA) by the Reserve Bank of India (RBI), deciding to recall their respective additional tier-1 bonds (AT-1), trading in these instruments has almost ceased, market sources said. AT-1 bonds are debt instruments that do not have a fixed maturity and, for the same reason, command a relatively higher coupon. Market sources indicated that four banks have so far indicated a recall of their AT-1 bonds. The latest is IDBI Bank, which has recalled Rs 5,000 crore worth of its AT-1 instruments, with March 15 being the record date for exercise of the call option. Since the recalled AT-1 bonds will be redeemed at par, market participants holding these instruments are not keen to sell their holdings at a discount in the secondary market. As a result, trading has almost ceased in the AT-1 bonds of all banks under PCA. This is in anticipation that the bonds of other banks under PCA too will be recalled and redeemed at par, allowing an opportunity to avoid any loss incurred on selling at a discount in the secondary market.
Ajay Manglunia, EVP at Edelweiss Securities, said, “Since they would be getting their money back at par value, it does not make sense for them to sell their holdings in these bonds. There was a time before the recall news was out, when AT-1 bonds of these banks were being quoted at a heavy discount and yet there were no takers. For example, IDBI Bank’s AT-1 bonds were being quoted at as high as 11.5% but there were no takers, and now, nobody wants to sell,” he said. Lakshmi Iyer, chief investment officer-Debt at Kotak AMC, points out that with the recall of these bonds, there is definitely an oppotunity cost for fund managers. “This opportunity cost is in the form of inability to earn the high coupons that these AT-1 bonds come with. If you ask me whether we would have liked to keep some of these bonds on our books, the answer is yes. But to be fair, there are reasonable opportunities available in the market in the form of high rated bonds that are providing healthy coupons due to the current yield environment. There is definitely an allocation opportunity here for the freed up cash,” she said. Corporation Bank, Allahabad Bank, Bank of India, Indian Overseas Bank, UCO Bank and United Bank of India are some of the banks under PCA that might see a recall of their AT-1 bonds, according to Icra. Central Bank of India, which is also under PCA, does not have any outstanding Basel-3 AT-1 bonds, market sources indicated. Icra had stated in a recent note that as per the terms of the AT-I bonds, banks have a right to exercise an early call option on their AT-I bonds, upon occurrence of regulatory event, among others, provided these are replaced with similar or better quality capital. “This, coupled with confirmation by the RBI that capital infused under recent recapitalisation can be utilised to replace the existing AT-I bonds and subsequent instructions from the Centre to recall their AT-I bonds, has triggered early calls by banks,” it said.