RBI’s stance on AT1 bonds may deter investors

MUMBAI: The Reserve Bank of India's stance that Yes Bank’s Additional Tier 1 bonds and subsequent write-offs are investments gone bad may act as a deterrent for fund managers and investors from investing in new issuances, especially those of mid-sized lenders with weak capital buffers.

They fear that if a bank’s capital falls below regulatory levels, these bonds could be written-off putting their investment at risk. In the Yes bank episode, investors saw more than ₹8,000 crore of their investments written off even though the bank had the option of converting the amount in full or part into fresh equity.

The Reserve Bank of India (RBI) in an affidavit, in Madras high court earlier this month, had said these bonds carry higher interest rates in lieu of risks and that these can be written off.

"Investors in AT1 bond would need to brace for such a complete write-off of investment especially in those of smaller-sized banks. So it is unlikely we would subscribe to fresh issuances," said a fund manager declining to be named.

This comes at a time when at least four banks--Bank of Baroda, HDFC Bank, Canara Bank and State Bank of India--have announced that a part of their fresh fund raising would be through AT1 bonds. Bank of Baroda plans to raise ₹13,500 crore through these issuances and so far it has been able to raise ₹765 crore, according to a report by Bloomberg Quint.

Yes Bank wrote down its AT-1 bonds worth ₹8,415 crore in the March quarter, upsetting large creditors including Nippon Mutual Fund, Franklin Templeton India, Barclays and Kotak Mutual Fund. Subsequently, Axis Trustee Services Ltd, which represents several direct and indirect retail bondholders through mutual funds, insurance firms and provident funds, who filed a case in the Bombay high court.

Separately 63 Moons Technology Ltd, which had invested ₹300 crore, moved a petition in Madras high court in June against the RBI and Yes Bank Ltd.

RBI in its reply laid the onus on bond holders.

In its petition 63 Moons argued that previously, in the case of public sector banks, the bonds were redeemed first and reconstruction took place thereafter. In the present case, reconstruction took place first and thereafter the bonds were written down.

"This is illegal and contrary to the provisions of Section 45 of the Banking Regulation Act," said 63 Moons.

An email sent to RBI seeking a response was not answered immediately.

"Investor sentiment towards this fund raising instrument has only worsened post RBI stance. Majority of fund managers have been offloading and selling AT1 bonds from their portfolio. As per RBI’s master circular on Basel-III norms, these bonds were either to be written down or converted to common equity. In this case, bond holders got nothing and RBI stance is not helping. What is it to say that it won’t happen in other cases. Majority of banks are facing high bad loan issues,” said a fund manager with a mid-sized fund house declining to be named.

"Due to covid-19 related slowdown we are expecting bad loans to rise by December. It is possible that the Yes Bank episode and RBI stance will be taken as precedence and AT1 bond liabilities could be written off. The yields are pretty high on weaker public sector banks so market is aware of the potential risk of rising NPA levels,” he added.

Deepak Shenoy, CEO at Capitalmind Wealth said that ideally no one should touch these AT1 bond issuances.

"There are enough warning bells sounded by now to hit home the point that these are toxic assets," he said.

According to Ajay Shaw, partner, DSK Legal, the treatment of bondholders including retail investors has been below of equity holders.

"This will further hurt investor sentiments and also impact the ability of banks to raise AT1 capital. It is a conflict of interest situation and the interests of the public good will be the supervening factor in such matters. The fall out of this is that people investing into such securities will need to have the ability to absorb the risk in case of a downside whilst enjoying better returns in normal situation," said Ajay Shaw, partner, DSK Legal.

According to Renuka Sane, associate professor at the National Institute of Public Finance and Policy (NIPFP), poor regulation is now leading to a situation where the bondholders are being made to pay, while the shareholders are not.

Securities and Exchange Board of India (Sebi) is also uncomfortable with investors getting exposed to AT1 bond, specifically retail investors.

"Sebi does not want public sector banks to raise funds from retail investors through AT1 bonds as these are turning out to be extremely risky. Sebi is also collating data of mutual fund exposure to these instruments and wants it to be reduced over time. These schemes are essentially investing investors’ money in these instruments so the risk is being passed on to retail investors,” said a regulatory official declining to be named.

RBI in its reply in Madras high court also said that the bondholders were contractually bound and thus write-off decision cannot be challenged.

"The Petitioner (63 Moons) along with various other similarly placed bond holders subscribed to both 9.5 % AT-1 Bonds and 9% AT-1 Bonds issued on December 2016 and October 2017 respectively by the 3rd Respondent i.e. Yes Bank which were in compliance with the Basel-III Master Circular. The Petitioner and other similar placed bond holders thus, subscribed to high return investments which carried this inherent risk (write off),” RBI saidin its reply.