The Hindu Business Line : Banks may defer coupon payments on hybrid debt

Mumbai, Nov. 14 Credit rating agency Fitch on Friday said there is increased possibility of a few ‘weak’ banks deferring coupon payments on their hybrid instruments as the possibility of shrinking profits, and even losses, have increased.

The direct fallout of this is that it would widen the notching of hybrid debt instruments of banks where such risks are more pronounced and may downgrade the national hybrid debt ratings of banks whose financial profile is ’weak’.

In the context of the current adverse credit cycle, which will likely worsen over the next year, the credit rating agency said the Individual Ratings of Dena Bank (’D’), IndusInd Bank Ltd (’D’) and UCO Bank (’D’) denote weaknesses of internal or external origin and the concerns regarding their profitability or balance sheet, and more importantly the operating environment or prospects.

The credit rating agency feels that the challenging operating environment faced by Indian banks has highlighted the importance of capital conservation, including coupon deferrals on optionally deferrable hybrid instruments, if necessary.

Upper Tier 2 and Innovative Perpetual debt instruments offer flexibility to banks as coupons on these instruments can be optionally deferred, if such payment results in a ‘net loss’ or an increase in the ‘net loss’. ‘Net loss’ refers both to losses incurred in any financial year, as well as to accummulated loss at the end of the financial year.

RBI approval

Coupon on Upper Tier 2 and Innovative Perpetual debt instruments is not payable - without the Reserve Bank of India’s prior approval - if such payment results in a ‘net loss’ or increase in the ‘net loss’. While the banks may honour payment timelines, provided prior approval from RBI is obtained, Fitch said, it is less clear if such an approval would be forthcoming from the regulator for the ‘weak’ banks that may already be facing pressure on their capital ratios.

The coupon would also be deferred (compulsorily) if the bank’s capital adequacy ratio is below the regulatory minimum, or if payment of such interest results in the bank’s capital adequacy ratio falling below regulatory minimum (currently 9%).

Fitch currently notches hybrid debt instruments of ’AAA(ind)’-’A-(ind)’ (A minus(ind)) rated banks by at least one notch and lower rated banks by two or more. It assigns Individual Ratings only to banks, and these ratings attempt to assess how a bank would be viewed if it were entirely independent and could not rely on external support.

Individual ratings are assigned on the scale of ’A’ to ’F’- ’A’ denotes a very strong bank and ’F’ a bank that has either defaulted or, in Fitch’s opinion, would have defaulted if it had not received external support.

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