Suggested options for equity infusion under Bank Recap plan

As discussed with A Rajagopal (Scient Capital), Ratnesh Kumar (BOB Capital), G Padmanabhan (Chairman, BOI) and N. Damodharan (ED, BOI)

Suggested options for equity infusion into Indian banks by Government of India (GOI), under the Bank Recapitalization plan.

1) The Options

There are four possible routes that can be adopted by GOI (either directly or indirectly through an intermediate entity), for infusion of equity into Indian banks under the Bank Recapitalization plan. These are:

a) Preferential Allotment of Shares (PAS) to GOI
b) Rights Issue
c) Combination of PAS and a Qualified Institutional Placement (QIP) 
d) Additional Tier I (AT1) issuance

2) Principles for evaluating the options

Suggest the objectives for evaluating the alternatives should be:
a) Try and obtain fresh infusion from other investors alongside GOI, to fill the INR 58k external requirement, and to maintain GOI stake in Indian Banks at current levels. Getting external funds would also help avoid the complications of >5% creeping acquisition guidelines and breach of 74% holding by GOI as largest shareholder
b) Be fair to all stakeholders, especially to minority shareholders, in all aspects including pricing
c) Keep the process as simple as possible, and minimize the need for forbearance/ exceptional approvals from SEBI/ RBI etc.

3) The suggested route

Given the above objectives, we suggest the best route is the PAS + QIP one.

Operationally, this is simple to do, and can be done in 30-45 days. For larger banks, QIP money should come in readily, to keep the percentage of GOI stake at pre-recapitalization levels. The pricing for both PAS and QIP is market linked per SEBI rules, and this protects minority shareholders - there is no undue advantage to any large investor, and any minority investor worried about dilution of her stake can always buy additional stock in the current market.

Market experts reckon that through a QIP process, getting in INR 58k of other investor money by March 2018 should be achievable.

We would not recommend a Rights issue. On the positive side, this option does provide minority shareholders equal opportunity to participate in the infusion. However, as mentioned earlier, a simultaneous QIP and PAS achieve pricing protection for minority shareholders as well. Also, Rights issue pricing typically happens at a discount to Theoretical Ex-rights Price (TERP). Lastly, and importantly, a rights issue process is just too onerous – it involves reaching out to millions of investors, going through an exhaustive legal and operational process, etc. Minority shareholders should not be averse to a PAS + QIP, in fact they generally welcome them as improving the value of their holdings.

However, a PAS + QIP (or even a Rights Issue) may not work for weaker banks, where non-GOI investor interest may be low. In those cases, a straight PAS or an AT1 issuance may have to be looked at. A straight PAS may involve issues of creeping acquisition of more than 5%, and breach of 74% stake limit by GOI in some banks.

Alternatively, perhaps weaker banks should not be funded directly - instead, stronger banks may be given more PAS/ QIP infusion than needed, giving them space to consolidate the smaller banks.

On the possibility of AT1, there are a few considerations to mull over. For one, the real bank capital issue is the pressure of low Common Equity Tier I (CET1), and not so much overall Tier 1 capital. An AT1 doesn't really help in such cases. Secondly, from a GOI perspective, they are taking substantial equity risk through the infusion - why would they not take it as straight equity, which gives them the best possible upside. Thirdly, bankers see AT1 as having too much of a real bottomline cost, as opposed to common equity. Lastly, AT1 instruments are fairly illiquid. With common equity, GOI always has the option of doing an equity sale for divestment at the appropriate time, whereas with AT1, they would typically have to wait for redemption.

Comments

  1. Banker5 November 2017 at 10:54

    Ananth, I just came across your blog via facebook and it's a great effort on your part. I have some comments both on this as well as the previous post. First I think not granting SLR/LCR eligibility to the new class of issuances will end up issuing an instrument neither here nor there. First, irrespective of the tenor of issuance, it's likely to affect the interest rate structure of the risk free curve if it's not made at least repoable with RBI. Second, we can make the structuring of the bond sui-generis, so that the exact market equivalent is not available. I have a principal amortising structure in mind with loans linked to 6 month T-Bill rate. It gives banks some incentive to make their deposit rates T-Bill linked so that the structure has some interest hedging in place (the principle amortisation structure means, notwithstanding the floating rate nature, it will still have non trivial pv01). Such a sui-generis nature means it's likely to have limited liquidity and hence not extending it LCR eligibility status won't be a stretch. With grant of SLR status , it makes it RBI / market repo eligible and hence source of liquidity for banks- moreover, i think with a declining slr trajectory, LCR is going to be more and more binding and hence not granting it LCR eligibility will be more consequential going forward. The broad point I'm making here is that there is scope in the recap bond for government to explicitly tie up the coupons with some of broad macro- health / money market characteristic like say CPI / T-Bill yield / oil price such that the structure becomes sufficiently sui-generis so as to minimise impact on the sovereign yield.
    As regards, the issuance structure of the balance 58K, it clearly cannot be uniform. A BOI which under an aggressive provisioning would have its Tier-I below regulatory norms cannot have its tier-I issuance structure same as SBI, which under such provisioning will still have its head firmly above water. One distressing feature of the Indian market is that they haven't understood the underlying risk of AT-1 bonds at all- we have debt mutual funds, sundry pension funds / provident fund trusts piling on to such bonds (based on market reports) as if they are nominal coupon bearing bonds. Sadly even credit rating institutions are issuing them ratings typically associated with bond instruments. Given this asymmetry, a sidha -sadha FPO after an aggressive clean-up from markets is my preferred route. This should be specified upfront so that banks themselves demand non trivial changes in their internal governance structure and Board constitution , right away.
    Regards
    Indranil

    ReplyDelete
    Replies
    1. Ananth Narayan5 November 2017 at 17:26

      Hey Indranil, great to hear from you, trust all good.

      The recap bond and the equity infusion is a cash-neutral transaction for every concerned party - GOI, the bank and RBI. It is only a risk transformation, where GOI takes risk, hopefully earns the return, and allows the bank to absorb more risk. If we allow the bank to repo this bond with the RBI, and take the extreme case that the bond is repo-ed every day to maturity, then effectively, RBI has lent money to the bank, to lend to GOI, to infuse as equity into the bank. Between RBI & GOI, this is printing of money to infuse as equity - and might not even show up as part of the fiscal deficit. Completely avoidable, I think.

      The original composite bond+equity transaction is a special situation that does not create any liquidity excess or shortfall for anyone, and it's best kept that way, rather than allow RBI repos to create liquidity mismatches where none exist.

      This is different from the LAF repo of normal GOI bonds, as I have tried to explain in the original blog.

      From a different perspective, equity infusion by itself does not create any outflow for the bank from an LCR/ NSFR perspective - and so granting the bonds held against this equity infusion HQLA status is effectively giving them straight LCR relief.

      Agree with you that we do not have a one-size-fits all solution for the 58k, across the variety of banks in question. I have listed the 4 options possible. I think a PAS + QIP for the big banks (as determined by the market) is a clean way of doing this, to ensure overall GOI %age stake remains the same, and to do this at an appropriate market price that is fair to all stakeholders. This approach would leave the weaker banks to be sorted out via a consolidation route, rather than a recap route - maybe that's a toughie.

      If we need individual solutions for the weaker banks as well, we may have to do a PAS standalone, or an AT1, for them. PAS standalone would likely breach SEBI guidelines of 5% creeping acquisition and 74% single ownership, and necessitate some ownership structuring or SEBI forbearance. AT1 may simply not solve the CET1 issue, and may need some RBI/ Basel leeway.

      Let's chat on the phone sometime? Cheers

      Delete
  2. Unknown20 November 2018 at 15:32

    Hey there,
    Nice blog
    check out our blogs
    Home loan rejection in India

    ReplyDelete

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