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Big Boost For Infra Bonds?

Published on Wed, Jul 16,2014 | 21:17, Updated at Wed, Jul 16 at 21:17Source : Moneycontrol.com 

By: Vinod Kothari, CEO, Vinod Kothari & Co

In quick implementation of the Budget announcement by the Finance Minister, the RBI on 15th July 2014 announced the Guidelines[1] for Long term Bonds for Infrastructure and Affordable Housing finance. For the sake of ease of reference, we will call these bonds Long term Bonds for Infrastructure (LTBI).

Use of the proceeds of LTBI issuance
The proceeds of the LTBI are supposed to be utilised for on-lending to infrastructure sector, as well as affordable housing finance (infrastructure and affordable housing finance collectively referred to herein as Eligible Lending, discussed more elaborately below). These bonds are not asset-backed securities – hence, there is no direct linkage between the proceeds of the bonds and the investment in Eligible Lending. However, since the benefits of the issuance of the LTBI are linked with incremental investment in Eligible Lending, it would be obvious that banks will have a strong motivation to use the money raised by issue of the bonds for Eligible Lending. Thus, it is obvious that these bonds will spur Eligible Lending.

Nature of LTBI
As per the Guidelines, the bonds are unsecured, redeemable and rank pari passu with other unsecured liabilities of the banks. The following pointers explain the nature of the bonds and the investors’ rights therein further:

* Not asset backed bonds: While the bonds are intended to be used for Eligible Lending, the bonds are not asset backed bonds, such as mortgage-backed securities, or asset backed securities. There does not have to be a direct nexus between the proceeds from the bonds and the investment made by the banks into Eligible Lending.

* Not pass through securities: The bonds are not pass through securities. This means that the realisation or recoveries that the banks make from the Eligible Lending does not have to be utilised for amortisation of the bonds. Therefore, the maturity profile of the bonds may be actually unrelated to that of the assets into which the bond proceeds have been invested.

* Not covered bonds: Covered bonds are a special type of secured instrument mostly prevalent in European jurisdictions. LTBI are completely unsecured - hence, they are not covered bonds at all.

* Companies Act benefits will be available to investors:  While the bonds are unsecured, the Companies Act 2013 [sec 71 (10) and (11)] provide a special enforcement mechanism for investors in bonds issued by companies. The investors may approach the National Company Law Tribunal (NCLT) to force the repayment of the bonds or payment of interest on the same, and if the orders of the NCLT are violated, there are serious penal consequences for the issuer. Those banks which are governed by the Companies Act will be covered by these provisions, which will provide effective safety to the investors.

* No other benefits to investors: There are no special tax breaks for investors in the bonds

* DRR requirements: Under the Companies Act Rules, bonds issue by banks are exempt from requirements of debenture redemption reserve (DRR).

* SEBI public issue norms may be applicable: If the bonds are publicly offered, SEBI’s public issue norms will be applicable. If the bonds are privately placed, there cannot be a general circular or open offer inviting subscriptions to the bonds.

* Listing: While listing is mandatory in case of publicly offered bonds, privately placed bonds may also be taken listing under the Issue and Listing of Debt Securities regulations of SEBI. Listing confers several regulatory benefits besides liquidity – for one, foreign portfolio investors become eligible to invest into these bonds, and secondly, deduction of tax at source does not apply.

* Tenure and repayment of the bonds: The bonds must have a minimum maturity of 7 years. Unlike in ECB guidelines, the RBI has not used “average maturity” here, implying that it is perfectly possible to have amortising bonds. That is, the bonds may either pay off in one single bullet payment at the end of 7 years, or may amortise over this period. If the bonds are amortising bonds, they will effectively have a lower weighted maturity.

* Interest rate risk: The bonds may either have a fixed rate of interest or floating rate.

Benefits of the LTBI
The RBI’s scheme of LTBI comes with major benefits – exemption from SLR and CRR requirements, and exemption from priority sector lending requirements.
The requirement for reserve creation (SLR and CRR) is based on demand and time liabilities (DTL). The DTL figure will be reduced by the lower of the LTBI outstanding, or incremental Eligible Lending (as per illustration shown below).

The requirement for priority sector lending (PSL) is based on adjusted net bank credit (ANBC). The computation of ANBC will also be reduced by the lower of the LTBI outstanding, or incremental Eligible Lending (as per illustration shown below).

This must be seen as a major benefit for the banks. Currently, if banks raise funds by issuing bonds, a large part of the funding gets immobilised in form of SLR and CRR requirements, and a still larger part is invested in weaker or low-yielding credit because of PSL requirements. Therefore, banks have to earn substantially higher net interest margin (NIM), that is, the difference between their lending rate and the cost of borrowing, so as to break even and meet the cost of overheads. With the reserve requirements as well as PSL requirements waived off, there will be a direct correlation between the resources raised by the bonds, and the investment in Eligible Lending. In fact, the funding raised by LTBI will be remarkably more efficient than the money raised by retail deposits, which have both a higher servicing cost, as also leads to lower discretionary lending as mentioned above. On a longer run, this may lead to retail deposits getting transformed into bonds as banks will find it attractive to offer a higher rate of interest on the bonds, as compared to the interest offered on retail deposits.

Computation of incremental eligible lending
The idea of the RBI is to relate the regulatory benefits for LTBI to the incremental lending; the regulatory benefits will be computed based on the step-up of the lending in the eligible sectors.

Eligible sectors are infrastructure financing, as well as affordable housing. The definition of affordable housing has been amended for this purpose to qualify houses costing Rs 65 lacs (loan size Rs 50 lacs) in 6 metros, and Rs 50 lacs (loan size Rs 40 lacs).

The existing investment in eligible sector is presumed to be linearly paid off over the next 6 years. The computation of the regulatory benefit for eligible lending (EC) is illustrated in the table below.

Assume a bank has Eligible Lending to the extent of Rs 5000 crores on 15th July. Now the bank steps up the investment in Eligible Lending to raise to Rs 10000 crores, and then comes with issue of LTBI amounting to Rs 10000 crores. The computation of the regulatory benefit is shown in Scenario 1 below:

Scenario 1    
Investment in eligible sectors at the time of Issue of LTBI (B) 10000  
Investment in eligible sectors as on 15th July 2014 (A) 5000  
     
Regulatory benefit (EC)    
     
     
Period Eligible Credit = EC Computation
From the date of circular till March 31, 2015 B - 0.84A 5800
April 1, 2015 – March 31, 2016 B - 0.7A 6500
April 1, 2016 – March 31, 2017 B - 0.56A 7200
April 1, 2017 – March 31, 2018 B - 0.42A 7900
April 1, 2018 – March 31, 2019 B - 0.28A 8600
April 1, 2019 – March 31, 2020 B - 0.14A 9300
April 1, 2020 onwards B 10000
Where,    
A =Outstanding ‘Standard’ loans to Infrastructure sector (project loans) and affordable housing on the date of this circular    
B = Outstanding ‘Standard’ loans to Infrastructure sector (project loans) and affordable housing on the date of issuance of the bonds    

 

Even if the bank does not increase the investment in the Eligible Lending, and still decides to go for issue of LTBI, the bank will still be benefited, as the existing portfolio of Eligible Lending will be presumed to linearly amortise over time, which will give the bank a benefit over time. We take another illustration to explain this:

Assume the bank has, as on 15th July 2014, Eligible Lending to the extent of Rs 5000 crores. We further assume that this lending will amortise over the next 5-6 years in the manner given in the table below. Now, if the bank decides to finance its existing investment in Eligible Lending, it will be entitled to the regulatory benefit shown in the computations below:

Scenario 2        
Investment in eligible sectors at the time of Issue of LTBI 5000  
Investment in eligible sectors as on 15th July 2014 5000  
         
Regulatory benefit (EC)        
         
         
Period Eligible Credit = EC Computation Actual portfolio of eligible loans Regulatory benefit
From the date of circular till March 31, 2015 B - 0.84A 800 5000 800
April 1, 2015 – March 31, 2016 B - 0.7A 1500 4000 1500
April 1, 2016 – March 31, 2017 B - 0.56A 2200 3000 2200
April 1, 2017 – March 31, 2018 B - 0.42A 2900 2000 2000
April 1, 2018 – March 31, 2019 B - 0.28A 3600 1000 1000
April 1, 2019 – March 31, 2020 B - 0.14A 4300 500 500
April 1, 2020 onwards B 5000 0 0

 

Who may invest
Banks cannot cross invest into LTBI of other banks. With that restriction, anyone – corporates, individuals or other investors may invest into LTBI. Even foreign portfolio investors, subject to conditions, may also invest.

Portfolio acquisitions financed by LTBI
On the question whether a bank may acquire portfolios of Eligible Lending from other institutions, and use LTBI to refinance the same, the RBI has not closed its mind, but such acquired portfolios may be considered for regulatory benefits only subject to approval of the RBI.

Conclusion
Unlike schemes such as infrastructure debt funds, etc brought in the recent past, this one is certainly free from lots of regulatory shackles, and may certainly prop up infrastructure and affordable housing lending by banks. The Guidelines are certainly a strong push to infrastructure sector in the country. The Guidelines are currently limited to banks – hopefully, similar guidelines may soon be issued for infrastructure finance companies.

 
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