YES Bank's Rs 10,800 crore bonds could soon turn into wastepaper

One relevant clause is that if minimum Tier-1 capital falls below 6%, there is scope for the write-off of AT-1 bonds as these bonds are supposed to provide an additional cushion to capital adequacy

The Yes Bank collapse was a train wreck expected to happen. Finance industry professionals had been predicting it for months. When Yes Bank delayed publication of its third quarter results for financial year 2019-20 (Q3FY20), the writing was on the wall. There were big withdrawals by savvy depositors just before the Reserve Bank of India (RBI) imposed its 30-day moratorium on March 3.

However, the RBI action caught some institutions by surprise. The bailout by State Bank of India (SBI) is accompanied by a categorical guarantee of deposits. But it may leave big bondholders in the lurch. The moratorium was imposed on March 3, just before a payout of about Rs 82 crore was due on March 5, on Rs 10,800 crore of perpetual bonds that Yes Bank had issued to shore up Additional Tier-1 Basel III Capital (AT-1 bonds). On March 2, before the RBI action, these bonds were trading at a yield of above 19 per cent, indicating high degree of nervousness.

The draft Yes Bank Reconstruction Scheme, 2020 proposal reads: "The instruments qualifying as additional tier-1 capital, issued by Yes Bank under Basel-III framework, shall stand written down permanently, in full, with effect from the appointed date". This means Rs 10,800 crore of AT-1 bonds could turn into wastepaper. The draft is open for comments until March 9.

Given that Yes Bank is a Nifty 50 constituent, every index fund and exchange traded fund (ETF) is exposed to the crash in the share price, and so are many diversified equity funds. There are some 32 debt mutual funds, and an undetermined number of other companies with exposures to the AT-1 bonds. The list of AT-1 holders includes Nippon Life India AMC, mutual fund house Franklin Templeton, UTI Mutual Fund, SBI Pension Fund Trust and Indiabulls Housing Finance, among others. High net worth individuals (HNIs) and retail investors, therefore, have exposure to AT-1, either via their mutual fund holdings, or directly in the case of some HNIs.

These entities could go to court if the draft does not change and have a case worth arguing. When the AT-1 bonds were issued, the commitment was: “The claims of the bondholders in bonds shall be superior to the claims of investors in equity shares and perpetual non-cumulative preference shares issued by the bank.”

One way to interpret this is that the bond value cannot be written down to zero, until and unless the equity of the bank is also written down to zero. More broadly, lenders’ claims are generally held to be superior to equity-holders’ claims in all sorts of bankruptcy actions. Equity is considered risk capital, bonds are not. So, legal contest is highly probable if the AT-1 are written off in the proposed reconstruction scheme.

Meanwhile, mutual funds and treasuries holding these instruments will have to write-off their value completely, or side-pocket them. Either way, investors holding exposures to the relevant debt funds will have to endure a period of uncertainty.

Despite the commitment made at the AT-1 issue, there is a chance that the bonds could be written down. One relevant clause is that if minimum Tier-1 capital falls below 6 per cent, there is scope for the write-off of AT-1 bonds because these bonds are supposed to provide an additional cushion to capital adequacy.

As of September 30, 2019, the Rs 10,800 crore of Yes Bank’s AT-1 bonds constituted over 40 per cent of the bank’s net worth of roughly Rs 27,000 crore. The bank estimates that it had Rs 10,000 crore or so of problematic loans, which could work out to around Rs 7,000 crore in net non-performing assets (NPAs). The situation is very fluid, given the arrest of Rana Kapoor and there may be “revelations” pushing up NPA estimates.

The debt mutual segment will surely take a hit. Other banks such as IndusInd Bank, which were proposing to raise similar AT-1 instruments, could find they need to offer much higher yields because the risk perception has become worse.

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Disclaimer: Devangshu Datta is an independent market expert. Views are his own.