South Indian Bank's decision to not redeem its tier 2 bonds before maturity is unlikely to have long-term market implications for the banking sector, according to Ratings on Monday.
We believe the action is bank-specific and not necessarily representative of the broader market, given the associated reputational risk.
A spokesman for the private sector lender said on November 25 that they had decided not to exercise a five-year call option on tier 2 bonds due at the end of the previous month. A call option is a choice that a bank has to redeem a bond before its maturity.
In an email to 'Business Standard, Chithra H, South Indian Bank's chief financial officer, said on Monday that the decision on the call option was based on the lender's priorities at that point of time.
There have been occasions when the decision of a bank to refrain from exercising a call option on a bond has been interpreted as an indicator of a weak capital position. South Indian Bank's decision does not indicate any weakness in the capital position, according to Fitch.
The rating agency said that they can also choose to exercise a call if they demonstrate capitalisation well above regulatory requirements after the call is exercised, but we don't think this is the reason for SIB's decision.
The bank reported a common equity ratio of 12.3 per cent and a total capital ratio of 16.0 per cent for the first half of the financial year ending March 2023, against minimum requirements of 8.0 per cent and 9.0 per cent, and we estimate that the debt is only 1.1% of risk-weighted assets.
The rating agency believes that the bank's decision was driven by the current environment of rising interest rates, which has made it more expensive for borrowers to issue debt. The repo rate has been raised by 190 basis points since May to rein in the rising inflation. The benchmark policy rate is expected to be raised further.
Fitch said the bond's local rating has been downgraded since the time of issuance and the bond's local rating has been lowered due to asset quality and profitability pressures coupled with a drop in provisioning and capital buffers in 2020.
The decision of South Indian Bank not to exercise the call option is unlikely to affect pricing of debt issuances of larger highly rated entities, but lower rated issuers could see a rise in borrowing costs, treasury officials said.
Since the full bail-in of Yes Bank's Additional Tier 1 debt and the write-off of Lakshmi Vilas Bank's subordinated Tier 2 debt in 2020, local investor interest in such capital instruments issued by small private has been arguably reduced, along with a higher risk premium on such bonds, according to Fitch.