Accumulated losses vs share premium a/c balances: PSB proposal will improve ability to service AT-I bonds: ICRA

The recent proposal by some public sector banks (PSB) to set-off their accumulated losses against the share premium account balances could improve the ability of these PSBs to service their AT (Additional Tier)-I bonds, according to ICRA.

Four PSBs – Bank of India (BoI), Bank of Maharashtra (BoM), Punjab National Bank (PNB) and Union Bank of India (Union) – recently secured shareholders’ approval to set-off their accumulated losses against the share premium account balances and await regulatory approval.

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

Accumulated losses

ICRA assessed that while the above accounting adjustment will not impact the net worth and capital ratios of the banks, the move 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 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.

Anil Gupta, Sector Head – Financial Sector Ratings, ICRA, said: “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.

“Although investors as well as rating agencies do factor in the sovereign ownership of PSBs at the time of rating their borrowings (including AT-I bonds), it is difficult to factor in such one-off relaxations ab initio while rating these bonds.”

The agency underscored that share capital, including the share premium, is not a part of accumulated profits or DRs. Hence, capital infusion by the Government of India (GoI) 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. 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,” the agency said in a note.

Reduce recap burden

Gupta felt that the development has significant importance for PSBs as they may explore raising AT-I bonds to shore up their capital position, considering the limited capital budgeted by GoI for recapitalisation during the current year.

If PSBs can roll over their upcoming AT-I bonds due for call option over the next two fiscals, it may reduce the burden on the GoI for recapitalisation in future years, he added.

As per ICRA’s estimates, the outstanding volume of AT-I bonds of PSBs is estimated at ₹60,880 crore or about 1.1 per cent of their risk weighted assets as on October 1. Of these, the first call option is falling due on bonds totalling ₹23,365 crore in FY22. If PSBs can rollover these bonds, it will reduce the recapitalisation burden on GoI.

ICRA said this development could be seen in conjunction with various regulatory relaxations given in the past on AT-I bonds, including the broadening of definition of DR in February 2017.

Subsequently, in Q4 (January-March) FY18, inclusion of weaker PSBs in prompt corrective action (PCA) framework of the RBI was termed as a regulatory event, which triggered these weaker PSBs to exercise an early call option on their AT-Is totalling ₹21,900 crore during Q4 FY18 and Q1 (April-June) FY19, thereby reducing the risk of a coupon skip on their AT-Is, it added.

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