Perpetual bonds dying an early death in India?

MUMBAI: Perpetual bonds, a way of ensuring that banks have sufficient capital during times of stress, may be dying an early death in India.

With few takers in the secondary market for such securities due to inadequate pricing and their hybrid nature, institutions that bought them are sitting on mark-to-market losses, four people aware of the matter told ET.

So far, banks have sold about Rs 13,500 crore of perpetual bonds, with rates offered in the range of 9.15-11%. Last February, state-owned Punjab National Bank raised Rs 1,500 crore offering 9.15%, the lowest rate in this space.

AK Capital was the arranger and took the securities on its books. Later, it was said to have sold a sizable part of the holdings to a large private sector bank, according to the people familiar with the matter. Bought with the intent of trading, both are now stuck with their investments.

With yields of perpetual bonds having risen about 125 basis points over the past two months, prices have been pushed down, resulting in mark-to-market losses.
Emails and text messages sent to AK Capital and other arrangers did not elicit any response till the time of going to the press.

“The risk-reward is perhaps not balanced for perpetual bonds,” said Piyush Wadhwa, head – trading at IDFC. “Investors are demanding higher rates due to inherent risk factors. Now, there are few takers for perpetual bonds, where some arrangers may be sitting on losses. Issuers have to price it reasonably for further issuances.”

In addition, there are curbs on investments by provident funds in perpetual bonds. They cannot invest in such bonds with a rating below AA. Their holdings of perpetual bonds cannot exceed 2% of their total portfolio and 20% of an issuance by a bank.

Active arrangers for such bond sales include Trust Investment, AK Capital, Darashaw, ICICI Securities Primary Dealership Ltd and Axis Bank.

Perpetual bonds mostly have a 10-year call option where an issuer can call back the investment and investors need not to hold infinitely.

“Rates offered are way below when compared to its inherent risk,” said Badrish Kulhalli, fund manager, fixed income at HDFC Life Insurance. “If the issuer does not call at the end of 10 years, investors are stuck as the secondary market liquidity is poor. It also suggests that the bank is not in good shape.”

In August last year, Bank of India raised Rs 2,500 crore by issuing the country’s first Basel-III compliant perpetual bonds, which do not offer a fixed maturity and are treated as quasi-equity. Basel-III is an international standard for banking capital requirement norms.

The issuance was rated as triple-A by Brickwork Ratings, Bengaluru-based company, and offered 11%. Given the equity-like features of Basel-III compliant perpetual bonds, they should be rated a few notches below the issuing bank’s standalone rating. Bank of India had a AAA rating.

Globally, perpetual bonds are priced about 300 basis points over and above benchmark bond yields. Reasonable pricing has led to a robust secondary market overseas. Back home, the secondary market is extremely dry. Past two weeks, there would not be a single trading on perpetual bonds, dealers said.