A sharp decline in profitability and mounting losses could wipe out revenue reserves of some public sector banks (PSBs) and hamper their near-term ability to service coupon on additional tier 1 (AT1) bonds issued under Basel III capital regulations, says a research note. The Basel III-compliant AT1 bonds are meant to be loss absorbing in times of stress.
In the report, ratings agency CRISIL says, "...some banks are reporting revenue reserves in their audited balance sheets without adjusting for profit and losses (P&L). Instead, these losses are being shown as a negative ‘balance in P&L Account’ on the liability side. As a result, reported revenue reserves do not deplete despite losses. For loss-making banks, the ability to service coupon on AT1 bonds depends only on adequacy of revenue reserves."
As many as 13 of the 21 PSBs (taking the State Bank of India and its associates as a consolidated entity, reported losses for fiscal 2016, and almost half of them could do so again this fiscal. As on date, 14 PSBs have Rs22,600 crore of AT1 bonds outstanding. "While Government of India has committed capital support to PSBs to sustain their capital ratios above regulatory minimum, the coupon on AT1 bonds can only be serviced through current year’s profit or from revenue reserves and hence any capital infusion by government alone cannot improve the bank’s ability to service coupon on these bonds," the report says.
Krishnan Sitaraman, Senior Director for Financial Sector and Structured Finance Ratings at CRISIL says, “A part from high probability of posting losses this fiscal, negative or low revenue reserves are likely to make six PSBs vulnerable. Of these, four have AT1 bonds outstanding, where continued losses could wipe out their revenue reserves and pose a challenge when it comes to coupon servicing. The other two have not issued any AT1 bonds so far."
According to the ratings agency, four other PSBs are also expected to post losses in the near term, but they have adequate revenue reserves, after adjusting for expected losses, to service coupon on AT1 bonds outstanding. "However, their ability to continue to do so over the medium term will depend on a return to profitability. On the other hand, 11 banks are expected to report a profit in the near term or have sizeable revenue reserves despite weaker profitability, which would help them service coupon obligations on AT1 bonds over the medium term," the report says.