Should RBI placate Yes Bank’s AT1 bondholder or stand with taxpayer?
Additional tier 1 bonds should be on a par with equity capital if not above, say bondholdersBond investors seek part conversion to equity, so existing shareholders also take a haircut
Yes Bank Ltd’s rescue by State Bank of India (SBI) is resulting in a tussle between equity shareholders and those holding the private sector bank’s additional tier 1 (AT1) bonds, a quasi-equity instrument. The draft restructuring proposal put out by the Reserve Bank of India (RBI) says AT1 bonds will be entirely written off, while equity owners will be spared.
“There was a fairly clear expectation that AT1 bonds were senior to equity from the way they were treated in the past and also those times when some public sector banks were put under the prompt corrective action scheme," said R. Sivakumar, head of fixed income at Axis Mutual Fund.
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Some AT1 bondholders have asked to be issued equity shares, after a haircut of about 80% on the face value of their bonds, according to a report in The Economic Times. The proposal includes a haircut on existing shareholders as well, with the idea that quasi-equity investors are treated at least on a par with equity investors. AT1 bonds have no tenure like equity capital, but have regular yield payouts like a bond.
This seems fair at first glance. However, Basel III standards include minimum requirements to ensure that all classes of capital instruments fully absorb losses at a so-called point of non-viability (PoNV) before taxpayers are exposed to any loss.
In the case of Yes Bank, while the RBI proposal does not explicitly say so, the assumption in the markets is that the PoNV clause was triggered.
The bondholders, too, are challenging the draft proposal, not so much by questioning RBI’s discretion on when the PoNV clause gets triggered, but by pointing out the inconsistency in prioritizing equity over a quasi-equity instrument.
But coming back to the Basel III standards, the moot question for the central bank is whether it should enable both equity and AT1 bondholders salvage some return, or keep the interest of the taxpayer paramount.
“There are compelling arguments for wiping out the existing shareholders... This protects the interests of the taxpayer who is indirectly paying for the bailout, because the rescuer is a public sector bank," wrote Jayanth R. Varma, professor of finance at the Indian Institute of Management Ahmedabad, in a blog post.
SBI may end up investing as much as ₹11,760 crore in Yes Bank, RBI’s draft proposal suggests, and will be the main reason for the private sector bank’s survival. The least one would expect is that this massive capital infusion has greater rights than existing equity. Otherwise, equity owners would be getting a free ride on taxpayer money, which is the complete opposite of what the regulations intended.
Having said this, the decision isn’t easy for RBI, as a blow to AT1 bondholders will hurt banks, some of who are already starved of capital. The test for these bonds will come soon, when banks will have to decide whether or not to call them back.
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