BL Research Bureau

Nippon Mutual Fund, which has a significant investment in YES Bank’s AT1 bonds, made an announcement in the morning that it was marking down the value of the bonds to zero, as a precaution. From a post-market press release from the RBI, however, it appears that the AT1 capital issued by YES Bank will be written down permanently, in full.

So, investors of the various MF schemes — not just Nippon MF — who had put money in YES Bank’s AT1 bonds, and those who had invested in these bonds directly, are set to lose out.

What are AT1 bonds?

Additional tier 1 bonds, or AT1 bonds, also known as perpetual bonds, are quasi-debt. While these bonds carry a higher return (interest rate is higher than AAA-rated tier II bonds) for investors, there is also a higher risk attached to them.

Over the past few years, many banks have raised capital through these bonds to comply with Basel III norms stipulating higher tier I capital.

These bonds have no maturity date. The coupon payment to the investor continues till the time the issuer decides to call back the bonds. Though these bonds promise a higher yield, there is some risk. One, the issuing bank is not under obligation to continue with coupon payments if it is making a loss. Two, when the bank is not able to maintain a common equity tier I ratio, the bonds can be written down or converted to equity.

While earlier it was only HNIs who flocked to perpetual bonds, of late, in the chase for higher yield, even retail investors have been purchasing them from the market. Many debt and hybrid funds also have exposure to these schemes today.

Last month, a retail investor who purchased the YES Bank perpetual bond did so for a yield of 39.91 per cent. The call option date of the bond was December 23, 2021, and the coupon rate, -9.5 per cent.

When the yield is so high, not every investor is willing to hold back and give the investment and associated risks some thought.

Note that perpetual bonds are also rated by credit rating agencies, but are generally a few notches below the secured bonds of the same issuer.

Nippon MF’s move

Nippon Mutual Fund’s investment is in the AT1 bonds of YES Bank. Per the information memorandum of AT1 bonds, in the case of reconstitution or amalgamation of the bank under Section 45 of the Banking Regulation Act, 1949, the bank will be deemed as non-viable, triggering a writedown or conversion of AT1 bonds into equity.

However, while moving the bank under moratorium by itself doesn’t erode all the value of its AT1 bonds, fund houses may want to take a precaution and mark down their value. This is what Nippon Mutual Fund did.

Now, though, it appears that the RBI has decided that the AT1 capital issued by YES Bank shall stand written down permanently, in full (with effect from the appointed date).

So, investors have to prepare themselves for a loss from NAV drop in all the funds that have invested in the AT1 bonds of YES bank. Those who invested in these bonds directly, too, have to brace up for a loss.

Published on March 6, 2020