In theory, the international bond market and Indian AT1s seem like a perfect fit. Indian banks need a tremendous amount of capital to fully comply with Basel III.
Unfortunately, relying on the domestic bond market is out of the question. It simply cannot supply the Rp1.85tr ($27.7bn) of shortfall that has to be met by 2019.
This means the dollar bond market with its abundant liquidity is a natural candidate for the job. IDBI certainly seemed to think so in 2014, when it held a non-deal roadshow for what would have been the first offshore AT1 from India. But the talks ended nowhere.
Investors back then were asking for a juicy double-digit yield to compensate not just for the subordinated nature of the notes but also the weak credit profile of the country’s banks. IDBI chose not to pay up and instead relied on the domestic bond market, raising Rp25bn with a 10.75% AT1 in October 2014.
Fast forward two years and IDBI is once again mulling an offshore AT1 as it is no closer to meeting Basel III requirements by March 2019 than it was in 2014. But if it thought that finding favourable terms in the international market was tough two years ago, it will likely find things much harder now.
For starters, when IDBI first toyed with the idea of an offshore AT1, it was at the height of “Modi mania”, coming just a few months after new prime minister Narendra Modi took charge. Indian credits generated one of the best returns globally that year, posting an annual return of 10.8% while the rest of emerging markets could only deliver 3.6%.
But while positivity around Modi remains, momentum is starting to stagnate especially as the pace of reforms has so far failed to meet expectations.
Since the end of October 2015, for example, bond investors have begun reducing their India exposure with spreads on financial bonds widening by about 50bp. It also hasn’t helped that Moody’s and Standard & Poor’s have warned that Indian banks are at risk of negative rating actions if they fail to raise additional capital. Fitch rates the sector stable yet fragile.
Taking these factors into account, it will certainly be interesting to see how investors would react to what is highly likely to be a single B or at most BB- rated AT1 from an Indian bank whose financials are not in the best shape.
When factoring in the increased volatility since the start of 2016 and the environment only gets more challenging. Now more so than before, pricing will be the number one determining factor for the debt market and there is no question that IDBI will have to fork out more now than it was willing to in 2014.
The government will of course continue to drip-feed capital into the lenders and there is now increasing talks about a consolidation in the banking sector. But those moves will only go so far to improve bank profiles.
If Indian lenders are serious about complying with capital requirements, it is time they get moving with their offshore plans — even if they have to cough up to woo investors. Market conditions may be far from ideal now, but with pessimism about their asset quality only increasing, it is unlikely to get better any time soon.