Perpetual bonds are trading at anywhere between 180 bps to 400 bps spreads depending on the bank and rating. SBI trades at the lowest spreads while private banks such as South Indian Bank, Yes Bank and Indusind Bank trade at 150bps- 200bps spread differentials to SBI. Other PSU Banks trade in between SBI and the highest spreads private sector banks.
Perpetual bonds by nature are risky as they are callable and have many covenants that can hurt bond investors if banks loan books turn bad. Investors have already had experience of perpetual bonds being called prematurely, giving them capital loss if they had bought at a premium.
Many bonds are trading at discount to face value, again giving notional capital loss to investors who have bought the bonds at higher price and are holding the bonds or realized capital loss to those who have sold the bonds.
Perpetual bonds carry many risks including interest rate risk, credit risk, liquidity risk and pricing risk, Non institutional investors believe that by holding the bonds until they are called will given them the necessary yield they are looking for and also negate all risks, especially credit risk.
The question of credit risk throws up the perceived implicit support of RBI and the government, where banks are not allowed to fail. This can be both right and wrong. Weak government owned banks are receiving capital support from the government or are being merged with bigger banks eg. Dena Bank, Vijaya Bank with BOB and SBI subsidiaries being merged with itself.
On the private banks, ICICI Bank and HDFC Bank have been classified as too big to fail but will RBI allow other banks to fail? Until now it has not happened but it can always happen, as there is nothing that stops the RBI to let banks fail if they sink under bad loans. No bank has any guarantee from RBI or government though government banks have implicit guarantee.
Until now, no private bank has failed, RBI ensured Global Trust Bank was merged and not allowed to fail but now with many banks facing bad loan issues, it may be difficult for RBI to protect all banks.
The risk levels of perpetual bonds are high and unless investors can evaluate the risk, it is best to stay off such bonds especially the weak banks.
