Accounting Tweaks May Improve PSU Banks’ Ability To Service AT-1 Bonds, Says ICRA
Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Accounting Tweaks May Improve PSU Banks’ Ability To Service AT-1 Bonds, Says ICRA

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The recent proposal by some of the state-owned lenders to set-off their accumulated losses against the share premium account balances may improve the ability of these banks to service their additional tier 1 bonds, according to rating agency ICRA.

Share premium is the amount received by a company over and above the face value of its shares.

Four public sector banks—Bank of India, Bank of Maharashtra, Punjab National Bank, and Union Bank of India—recently secured shareholders' approval on the proposal and are awaiting regulatory nod, ICRA said in a report.

"The recent proposal by some public sector banks to set-off their accumulated losses against the share premium account balances could improve the ability of these PSBs to service their AT-I bonds," it added.

While the regulatory approval is awaited, there has been a precedence in this respect when Indian Overseas Bank did the same accounting adjustment in FY2018, it said.

This accounting adjustment will not impact the net worth and capital ratios of the banks, but will significantly lower their accumulated losses (and improve their distributable reserves - DRs), thereby improving their ability to service the coupon on their AT-I bonds, the report said.

The servicing of the coupon on the AT-I bonds of banks is contingent on their profits (including accumulated profits). In a year of loss, the banks can use their accumulated profits or DRs to pay the coupon on these bonds, it added.

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"With sizeable losses in recent years, many PSBs have significantly eroded their DRs and this process can be seen as one more measure after a series of measures to prevent defaults on the AT-I bonds issued by PSBs," ICRA's financial sector ratings head Anil Gupta said in the report.

The agency said the share capital, including the share premium, is not a part of accumulated profits or DRs. Hence, capital infusion by the government or through other means does not improve the coupon-servicing ability on these AT-I bonds in case of losses.

With this accounting adjustment, the coupon payment is now effectively serviceable through capital infusions, it said, adding "this could improve the risk appetite of investors and improve the ability of PSBs to rollover the large quantum of AT-Is when the first call option falls due".

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As per the agency, the outstanding volume of AT-I bonds of PSBs is estimated at Rs 60,880 crore or around 1.1% of their risk-weighted assets as of Oct. 1, 2020.

Of these, the first call option is falling due on bonds totalling Rs 23,365 crore in FY2022.

"If PSBs can rollover these bonds, it will reduce the recapitalisation burden on the government," the report said.

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