Yes Bank AT1 bonds write down proposal: Impact on investors and financial services industry

Most of you would be aware of the Yes Bank crisis, which has been dominating news headlines along with Coronavirus for the last few days. The RBI has announced a draft restructuring plan which includes capital infusion by SBI and picking up 49% stake in Yes Bank but the proposal to fully write down the Additional Tier 1 (AT1) Bonds issued by Yes Bank is one proposal which has made a lot of investors very worried. We think that this will have serious downstream consequences which policy makers must take into consideration.

Impact on investors

Retail investor investment in debt mutual fund has been growing steadily in percentage terms. As per AMFI data, debt (including liquid) fund investments constituted around 30% of total retail and HNI AUM. About Rs 2,800 crores of AT1 Bonds issued by Yes Bank are owned by mutual funds on behalf of investors (large numbers of them are retail investors).

Apart from mutual funds, several hundreds of Crores of retail investor money was invested in these bonds by insurance companies and pension funds. On top of that Rs 466 crores, have been invested in these bonds by retail investors directly. If they are written off it will impact hundreds of thousands of investors.

Though debt funds are subject to market risks, they are perceived to be significantly less risky than equity. RBI’s proposed write-down of Yes Bank AT1 bonds will not only be detrimental to the financial interests and may cause panic redemptions in situations where it is not warranted, it will severely affect investor’s confidence in debt markets and financial institutions.

Impact on banking and financial system

It is not just the credibility of buy side institutions (mutual funds, insurance companies etc) which will be affected by this. AT-1 Bonds in India have emerged as an important source of capital for scheduled commercial banks. Banks, both PSU and Private, regularly issue AT-1 bonds in the Debt Market to shore up their Tier I Capital.

Total outstanding AT-1 bond issuance by various Banks stands at Rs 91,000 crores of which private banks account for about Rs 38,000 crores (with Yes Bank at Rs 8,400 crores as on 23rd February, 2020).

As mentioned earlier, any write-down on existing AT1 bonds will set a wrong precedence as it may lead to drying up of the AT-1 market in India completely for all issuers, especially in light of the fact that the banking system seems to be under stress. This will have implications for banks looking to grow their loan book and maintaining capital adequacy requirements – if the AT-1 markets dry up, then banks will have to raise capital for growing their loan book through the equity market. Any negative impact on these bonds could also increase the credit spreads across the assets classes and would have a detrimental impact on RBI’s objective of transmission of rate cuts to the larger economy.

Unfair towards AT-1 bond-holders

All stakeholders expect principle of fairness to be applied in decisions made by Government and central bank. In the Yes Bank crisis, while we appreciate the Government’s commitment in protecting the interests of a number of stakeholders like depositors, bond holders, stock holders, preferred equity, dollar bond holders, commercial paper holders etc., it is unfortunate that the policy makers chose to ignore the interests of AT-1 bond holders citing a fine print clause in the term sheet.

In conventional finance theory, bond-holder obligations are given a priority over share-holder obligations. The situation with AT-1 bonds is unique because they are perpetual bonds where the issuer has the right (call option) to retire bonds, but in the given circumstances with capital raising difficulties we do not see this happening in most situations where banks are facing financial stress.

This leaves AT-1 bond investors in a lurch and we think that it will set a bad precedence in debt markets. The least which could have been done was to convert the perpetual bond to common stock so that it could be held by fund managers to recover their money in due course.

Precedence of Government / RBI supporting AT-1 bonds

In past, RBI and the Government have axed the AT-1 guidelines to ensure the timely servicing of coupon and early buy back of AT-1 bonds in stress scenarios:-

• On 14th January, 2016, RBI allowed Banks to pay coupons on AT-1 bonds if current year profits are not sufficient, from historical profits.


• On 2nd Feb 2017, RBI allowed Banks to pay coupons on AT-1 bonds from statutory reserves. Without this change in regulations, coupon on AT-1 bonds of Indian Overseas Bank due on 3rd Feb 2017 was at risk of non-payment.


• In August, 2017 – Government injected Rs 1,861 crore as capital into IDBI Bank, so that the bank does not miss coupon payment on AT-1 bonds.


• In February, 2018 – Government of India directed 10 banks under Prompt Corrective Action to retire all outstanding AT-1 bonds under regulatory buy-back clause.


• In December, 2019 – Andhra Bank had decided not to exercise call option on the AT1 bonds, but on the next day, the bank changed the decision and decided to exercise the call option.

Conclusion

In our view RBI’s proposal of writing down AT-1 bonds issued by Yes Bank is a retrograde step. It not only harms the interests of retail investors in the short term, but more significantly, has serious long term consequences on the banking and financial services industry.

We also expect the regulator to ensure fairness for all stakeholders (depositors and investors) in the current situation and similar instances in the future. AT-1 bond holders, direct or indirect (through mutual funds) have been unwittingly left in the lurch by this proposal. Many of these investors are senior citizens and other investors who rely on investment income.

Finally, the Government and the RBI has in the past, stepped in to protect the interest of the multitudes of AT-1 bond investors – why should the policy makers make investors suffer this time? RBI is one of the greatest institutions of our country and has played a huge role in our economic progress. On behalf of all investors, we urge the RBI to revisit its proposal of writing down AT-1 bonds.