The Bombay High Court’s verdict last week, setting aside the administrator’s decision to write down AT-1 bonds (additional tier-1 bonds) in the Yes Bank reconstruction scheme of 2020, opens a Pandora’s box. The discretionary powers so far used by the Reserve Bank of India and the Centre in such schemes could be called into question. Restoration of the written-off value of AT-1 bonds as per the High Court order may imply a hit of about ₹8,300 crore or 3 per cent to Yes Bank’s CET-1 capital (Common Equity Tier 1).
This could mean equity losses for the clutch of banks and private equity investors who had infused capital into the beleaguered bank. But even if the AT-1 bonds are restored, there’s no guarantee that bondholders would immediately get their interest or principal. AT-1 bonds are perpetual by definition and the bank is under no obligation to exercise the call option. The bond terms also have built-in clauses that allow the issuer to skip coupon payments should the bank’s capital buffers be under threat.
The petitioners in this case used a variety of arguments, ranging from mis-selling of AT-1 bonds to the legality of equity shareholders enjoying superior rights over AT-1 bondholders. But the Court has used technical grounds to strike down the write-off, without going into why the write-off was necessary. It has pointed to inconsistencies between the draft order for reconstruction issued on March 6, 2020, and the final order issued on March 13, 2020. AT-1 bonds do rank higher than equity shareholders in the seniority of their claims, so the question of why AT-1 investors were forced to take haircuts before equity shareholders is a legally valid one. But claims of sophisticated investors buying these bonds without knowledge of their risky features stand on thin ground. With a minimum investment of ₹10 lakh, AT-1 bonds are available only to corporate and high net worth investors (HNIs). The offer documents disclose their capital write-off and coupon-skipping features in black-and-white and it is for this reason that these bonds carry 200-250 basis point higher yields compared to other bonds. Indeed, the Yes Bank write-off has done the bond markets some good by alerting investors to the fact that risk in AT-1 bonds don’t just exist on paper, but can play out in real life.
Overall, the Yes Bank saga reiterates the fact that India is yet to evolve a standard playbook when large banks or deposit-taking entities suddenly fail and require bailouts. The experience so far suggests that the RBI and the government do need to enjoy some discretion in designing bank rescue packages, based on the facts of each case. For instance, in Yes Bank’s case, the reconstruction package had to be cobbled together in 2019 when the economy was in the grip of a slowdown and there was fear of a run on deposits. There were also allegations of borrowers subscribing to bonds of the bank as quid pro quo. Perhaps litigation can be avoided in future if regulatory orders on bank bailouts, reveal the full findings of investigations and elaborate on the rationale for haircuts.