How Yes Bank’s relationship managers sold its AT1 bonds to retail investors

Harish, a 65-year-old retired human resource manager, and his wife Saroj, woke up on 6 March to a rude shock. About a third of the Delhi-based couple’s retirement kitty had vanished as Yes Bank was placed under administration by the Reserve Bank of India (RBI) and its perpetual debt (AT1 bonds) became worthless. The couple had been sold AT1 bonds by their relationship manager at Yes Bank in Dwarka, Delhi.

The government has assured Yes Bank depositors that they will not be penalized. However, a draft RBI resolution for Yes Bank envisaged a complete write-down of the value of AT1 bonds.

The couple’s son, Saurabh, who vetted the transactions also felt a heavy blow. “The interest rate on the Yes Bank bonds at 9.5% was slightly higher than the rates on fixed deposits at the time,” he said. “The relationship manager asked my father to break his fixed deposit and put the money in these bonds as they were yielding a higher return,” he said.

AT1 bonds are annual coupon bearing perpetual bonds. This means that they have no fixed maturity date. However, they do have call dates, typically at the end of five years. “Banks are under no legal obligation to exercise call options and repay bondholders on the call dates. However, in the market, it is understood that they will exercise call options and pay back the money,” said a Mumbai-based wealth manager on condition of anonymity. Yes Bank declined to exercise call options in January and March on perpetual bonds issued by it. “The bank will pay AT1 coupons only if it has profits or reserves. The second risk is that if the banks go bust, these bondholders will have to take a hit like equity investors,” said Joydeep Sen, founder, wiseinvestor.in.

Given the underlying risks, AT1 bonds yield a high rate which appears to have been the selling point as Indian interest rates dipped from 2015 onwards. And given the low ticket size of ₹10 lakh, senior citizens, who were looking to invest their retirement corpus for better returns but no added risk, were the perfect scapegoats.

Vas Dev Seth, an 86-year-old, was also sold AT1s last year as a high-yield product on par with fixed deposits in terms of safety of capital by his Yes Bank relationship manager in New Delhi’s South Extension branch. “I was assured the bond was secured and I would get payment every year and my principal back after four years,” he said.

The bank is estimated to have issued AT1 bonds worth ₹10,000 crore. Much of these bonds are held by institutional investors, but a small portion is also held by individuals. “It’s a travesty that these bonds were sold to retail. Given the high risk of these bonds, they are terribly under-priced. In fact in Europe, Basel-III AT1 bonds are not allowed to be sold to individuals unless the investor pass size and suitability tests,”said Deepak Shenoy, Founder and CEO, Capital Mind.

The lack of suitability matrix and a market regime that places the onus on the buyers to beware may just result in many individuals kissing their savings good-bye. For instance Rahul Kumar, 43, a former management consultant who now lives a semi-retired life and indulges in his passion for art and writing was very clear from the start that he was risk-averse. “But when I went to renew my FDs, the manager asked me to put my money in these bonds,”he said. “I was told it was a debt bond with a lock-in of five years and if I wanted the money back before five years. My manager assured me the principal was safe given the rich pedigree of the company. At no point did the manager explain the risks. I have been calling my bank for the past ten days about these bonds but nobody answers,” he said. Kumar hopes that RBI would reconsider the proposals and see retail bondholders with care.

Many retail investors who are now facing the heat are guilty of believing their bank who sold them these bonds in place of FDs on the back of better returns. There is now a group of such investors who plan to seek RBI's intervention on the matter.

"Even graduate textbooks tell us that equity is subordinate to debt. But debt holders are being wiped out even as equity holders survive. Alternatively they should convert our bonds to equity to allow us to benefit from any future recovery. If the current RBI plan becomes final, the group of individual investors who have come together about this will mount a legal challenge," said Raghav, 37, a Mumbai-based professional whose family had invested in the bonds.

But according to Shenoy, the options are limited. “Seniority matters in case of liquidation, not in the case of a resolution. In fact as AT1 bond holders you agree to a complete write-off the debt. What’s worse is that while RBI allows it, none of the contracts allows you to convert the debt into equity. This makes it a toxic product as far as retail goes,” said Shenoy.

It’s important to note there are many perpetual bonds open to individual investors. "The extra yield on these bonds is not commensurate with the risk they carry. They are not suitable for retail investors. In situations like this, they should be converted to equity to provide some relief to the affected bond holders," said Prakash Praharaj, founder, Max Secure Financial Planners. AT1s have historically formed the bulk of perpetual bond issuances. Given poor drafting of AT1 contracts, its pricing and the current market dispensation, AT1 bonds are not suited for retail appetite. “It’s about time we move from a buyers beware market to a market where responsibility lies on the sellers too. Product distributors like banks need to have fiduciary duty and there should be basic suitability criteria that will disqualify retail buyers who put life savings in such products,” added Shenoy.