To meet the US$17 bn of capital requirement of Indian banks, we see a few options—(1) reduce payout ratios, as a dividend holiday since FY2010 could have improved tier-1 ratio by ~100 bps, (2) rights issue, given the current multiples, is another alternative as experimented by international banks in the depths of financial crisis and (3) other options like dividend reinvestment could be explored if the regulatory framework is enabled.
The problem with dividend payment and capital infusion in public banks
Public banks have repaid 60% of the capital infused (US$7.8 bn, which is ~40-45% of capital required to meet the core tier-1 regulatory capital requirements of the sector) between FY2010 and FY2014E (see Exhibit 1). In other words, our calculation suggests that the tier-1 ratio for the sector could have improved by ~100 bps (see Exhibit 2) in this period. Further, Government of India (GoI) shareholding has been consistently rising as it is being raised at a significant discount to book value and these banks have been raising capital primarily through preferential placement.
Curtailing dividend or issuing DRIP could be alternate solution
One of the solutions that we have seen in other countries is the usage of DRIP (Dividend Reinvestment Plan). International banks like HSBC, Standard Chartered Bank, Lloyds and UBS have given option to their shareholders to choose dividends between cash or stock. By enabling a share issuance in the form of dividends, the bank is able to conserve its net worth while giving liquidity to the shareholder. GoI could explore this option while keeping the net worth in these banks and look to sell its shares whenever it needs cash for its internal requirements. This could be an option that can be used in banks where the GoI and LIC holding is reasonably high. There would be a price overhang if the largest shareholder would remain a seller, but we feel this would be better than a combination of capital infusion and dividend payment to the same shareholder. We understand Indian companies would not be able to give this option as shares cannot be issued out of the current year’s earnings but they can issue redeemable preference shares or bonds. Zee Entertainment explored this option in FY2013 by giving a redeemable preference share at a yield of 6% and Dr. Reddy’s issued bonus debentures in FY2011, which are redeemable in 36 months.
Rights issue could be another solution, especially for banks with lower GoI holding
Another alternative worth exploring would be a rights issuance. Investor appetite is low when existing investors are being diluted when banks are raising capital through a preferential placement at a discount to reported book value. During the depths of the global financial crisis, international banks had raised capital through rights issue, issued at a discount of 35-50% (Exhibit 3) as it enables better participation. It would be easier to raise the desired capital as the largest shareholder (GoI) is committed in the issuance as evidenced in the past few years. Indian banks have raised capital through rights issue though the instances are far fewer (Exhibit 4).
Private banks have raised capital through ESOPs (Exhibit 6) and SBI has been mulling this as an option though we are not too sure if it would be successful in public banks.
What is a good price: FY2001-03 saw capital raised by Indian banks at 0.2-0.7X book
In FY2002-04, we saw several Indian banks (see Exhibit 5) raising capital at 0.2-0.7X book. The underlying situation was probably similar as the gross NPLs were at 9-10% and net NPLs were at 4-6%. A similar comparison today shows gross NPLs at 4%, net NPLs at 2% and restructured loans at 5% of loans. However, Indian banks were able to raise capital by issuing shares at a significant discount to book value.
The problem with dividend payment and capital infusion in public banks
Public banks have repaid 60% of the capital infused (US$7.8 bn, which is ~40-45% of capital required to meet the core tier-1 regulatory capital requirements of the sector) between FY2010 and FY2014E (see Exhibit 1). In other words, our calculation suggests that the tier-1 ratio for the sector could have improved by ~100 bps (see Exhibit 2) in this period. Further, Government of India (GoI) shareholding has been consistently rising as it is being raised at a significant discount to book value and these banks have been raising capital primarily through preferential placement.
Curtailing dividend or issuing DRIP could be alternate solution
One of the solutions that we have seen in other countries is the usage of DRIP (Dividend Reinvestment Plan). International banks like HSBC, Standard Chartered Bank, Lloyds and UBS have given option to their shareholders to choose dividends between cash or stock. By enabling a share issuance in the form of dividends, the bank is able to conserve its net worth while giving liquidity to the shareholder. GoI could explore this option while keeping the net worth in these banks and look to sell its shares whenever it needs cash for its internal requirements. This could be an option that can be used in banks where the GoI and LIC holding is reasonably high. There would be a price overhang if the largest shareholder would remain a seller, but we feel this would be better than a combination of capital infusion and dividend payment to the same shareholder. We understand Indian companies would not be able to give this option as shares cannot be issued out of the current year’s earnings but they can issue redeemable preference shares or bonds. Zee Entertainment explored this option in FY2013 by giving a redeemable preference share at a yield of 6% and Dr. Reddy’s issued bonus debentures in FY2011, which are redeemable in 36 months.
Rights issue could be another solution, especially for banks with lower GoI holding
Another alternative worth exploring would be a rights issuance. Investor appetite is low when existing investors are being diluted when banks are raising capital through a preferential placement at a discount to reported book value. During the depths of the global financial crisis, international banks had raised capital through rights issue, issued at a discount of 35-50% (Exhibit 3) as it enables better participation. It would be easier to raise the desired capital as the largest shareholder (GoI) is committed in the issuance as evidenced in the past few years. Indian banks have raised capital through rights issue though the instances are far fewer (Exhibit 4).
Private banks have raised capital through ESOPs (Exhibit 6) and SBI has been mulling this as an option though we are not too sure if it would be successful in public banks.
What is a good price: FY2001-03 saw capital raised by Indian banks at 0.2-0.7X book
In FY2002-04, we saw several Indian banks (see Exhibit 5) raising capital at 0.2-0.7X book. The underlying situation was probably similar as the gross NPLs were at 9-10% and net NPLs were at 4-6%. A similar comparison today shows gross NPLs at 4%, net NPLs at 2% and restructured loans at 5% of loans. However, Indian banks were able to raise capital by issuing shares at a significant discount to book value.
