Write-down of LVB bonds may hit private-sector tier-II issuances

The write-down of Lakshmi Vilas Bank’s (LVB) tier-II bonds to zero could be a deterrent for private sector issuers in the space going forward, market experts said. The Reserve Bank of India (RBI)’s decision in this regard is being widely seen as a wake-up call for investors who may have turned oblivious to the risks associated with Basel III-compliant instruments.

The RBI had in September 2014 stated that the terms and conditions of all non-equity capital instruments — both additional tier-I (AT-I) and tier-II — issued by banks must have a provision that requires such instruments, at the option of the central bank, to either be permanently written off or converted into common shares upon the occurrence of the ‘point of non-viability (PONV)’ trigger event. Earlier this year, Yes Bank’s AT-I bonds worth Rs 8,415 crore were written down to zero under the scheme for reconstruction of the bank.

Market participants said that since the tier-II exposure being written off in the case of LVB is small at Rs 318 crore, there will be little direct impact on the market. However, the development is sure to warn off relatively weaker issuers. Ajay Manglunia, managing director and head – institutional fixed income, JM Financial Products, said that the move sounds an alarm for all investors in Basel III instruments. “This move could impact lower-rated banks as issuers in the non-PSU space. Now people know it well that Basel III-compliant bonds are having loss-absorbing clauses at the point of non-viability for any bank, which RBI can enforce using its powers under banking regulations,” he said, adding that people had earlier been ignoring this aspect of the risk.

Rating agencies also took the view that weaker private banks are most at risk. Anil Gupta, sector head – financial sector ratings, Icra, said that the RBI has set a precedent with the proposed write-off as this is the first time a tier-II bond is being written off. “Investors should factor in the risk in Basel III instruments as these instruments can be completely written off in case the bank gets into trouble. We expect the risk premiums for such instruments to increase for weaker private banks to increase, given this event,” he said.