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C. Shivkumar

Tier II capital bonds of public, pvt sector banks

Bangalore April 10 In a bid to increase return on investments, insurers and mutual funds have driven up coupon rates on tier two capital bonds of public and private sector banks.

Banking sources said that Life Insurance Corporation (LIC) recently picked up Rs 300 crore of lower tier two bonds from the public sector Vijaya Bank at yield to maturity of 10.10 per cent through private placement.

Bankers said that the entire lot was picked up LIC. However, bankers said that many of the banks were faced with even stiffer terms from LIC.

Demand discounts

Bankers said insurers and mutual funds were demanding higher yields for investments in tier two capital bonds, by pushing for front-end discounts. This discounting is done by pricing the bonds below face value. Redemption at the time of maturity is done at the face value of the bond.

As a result, the cost of issuing of tier two capital for the banking sector has considerably increased. Bankers said that the pricing of the upper tier two capital bonds were even higher. This was because the risk premiums on upper tier two bonds were at least 15-20 basis points higher than lower tier two bonds. Bank of Maharastra's upper tier two issue for 15-year paper is priced at 10.75 per cent.

Tight liquidity

Bankers said that one of the major factors that contributed to high expectation was the tight liquidity situation. Besides, the placements of tier two bonds were also hit by the 10 per cent cap on cross-holdings of subordinated bonds by banks. Under current prudential norms, bank holdings of other banks' tier two, both lower and upper, is restricted to 10 per cent of the net worth. The sources said that with the year closing, most banks had already reached the upper limits of this cap.

Consequently, some banks have begun revisiting the option of tapping cross-border resources in the form of upper tier two bonds or long-term medium notes linked to the London Inter Bank Offered Rate.

Bankers said that this changed view on cross-border resources was on account of the rupee's 5 per cent appreciation against the US dollar on a year-on-year basis.

The increased cost of raising tier two capital, not withstanding banks' profits as measured by the net interest margins (the difference between the average cost of working funds and the average yield on assets) was unlikely to be adversely affected. This was because the lending rates have also been raised by 50 basis points by almost all the banks. Besides, a low-cost deposit base, comprising current and savings accounts of anywhere between 35 per cent and 40 per cent of their respective net demand and time liabilities, created a cushion to absorb cost increases.

More Stories on : Corporate Bonds | Mutual Funds | Life Insurance

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