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Andhra Bank flips position, to redeem perpetual bonds

At first, the bank had last week decided not to exercise the “call option”, an early exit route for investors.

, ET Bureau|
Dec 09, 2019, 07.48 AM IST
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Andhra Bank and Corporation Bank will be merged with Union Bank of India.
Mumbai: Andhra Bank, currently part of a three-way consolidation involving state-run lenders, last week sought to reconsider its earlier decision to not redeem perpetual bonds, indicating mounting pressure from investors to follow the industry custom on exercising the call option.

At first, the bank had last week decided not to exercise the “call option”, an early exit route for investors. Later, the lender chose to reconsider the decision.

“Now, we wish to inform that the bank intends to consider redemption of AT-1 Series – I by exercising call option on 26-12-2019,” Andhra Bank said in a statement Saturday evening.

Earlier on December 3, it had told stock exchanges that it would not exercise the call option.

Under the Basel-III requirement, perpetual bonds are more of a quasi-equity obligation. If an issuing bank incurs losses in a financial year, it cannot make coupon payment to its bondholders even if it has enough cash. These securities are known as additional tier 1 (AT1) in market parlance, with no fixed maturity. But investors, including mutual funds, see the investments as five-year paper due to the call option.

“The risk of perpetual bonds is clearly mentioned in the term sheet, which is why issuers offer higher rates,” said Ajay Manglunia, MD & head of institutional fixed income at JM Financial.
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“Investors subscribe to perpetual bonds on the presumption that they shall get back money on the call date as they would exit after five years.” “It remains a matter of debate whether such an assumption is justified.”

Andhra Bank sold those perpetual bonds five years ago offering 9.55 per cent. Five-year government bonds were yielding at least 155 basis points lower.

“We can debate whether investors are justified in expecting that call will be exercised, but the point is, if you go against market expectations, the entire instrument category is impacted,” said Joydeep Sen, a consultant with Phillip Capital India.

“When the issuer, Andhra Bank in this case, hits the market in future, it would have to pay a higher yield for the unexpected behaviour. Andhra Bank should call the bonds, and if required, the merged entity can do a fresh issuance later.”

Andhra Bank and Corporation Bank will be merged with Union Bank of India. The Hyderabad-based lender would likely reverse its decision, market sources told ET.

“Any deferment of call option is as per the terms of the bond issue; this will not be treated as a default,” said Anil Gupta, sector head, financial sector ratings, ICRA. “The decision to not exercise the call option on AT1 bonds is likely to widen the spread for these bonds....”

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