How the YES Bank crisis impacts MF investors

There are 30 schemes across 11 AMCs that held the debentures issued by YES Bank; these took a hit of up to 25 per cent in their NAVs in a single day (March 5, 2020). According to ACE MF, a mutual fund research application, these schemes’ investments in debt instruments issued by YES Bank amounted to around ₹2,819 crore (as of January 2020).

Fund houses, including Nippon India, Franklin, UTI MF, PGIM and Baroda, have decided to side-pocket their exposures to troubled YES Bank bonds in their schemes after the rating agency ICRA downgraded the bonds to ‘D’, which is below the investment grade. Some fund houses have decided not to create segregated portfolio due to negligible holding.

The RBI’s decision to write down the AT1 bonds of YES Bank permanently, in full, with effect from the appointed date, leaves little hope to MF investors upon recovery of the invested amount in the aforesaid bonds.

There is, however, a higher possibility of recovery of the lower tier II bonds held by mutual funds.

The story so far

Currently, mutual funds hold two types of long-term bonds issued by YES Bank – Additional Tier 1 bonds (AT1 bonds) and lower tier II bonds. The exposure to the AT1 bonds and lower tier II bonds as on January 31, 2020 was around ₹2,762 crore and ₹56.6 crore, respectively.

The AT1 bonds are quasi-debt and perpetual in nature. The coupon payment on these bonds is paid to an investor till the time the issuer decides to call back the bonds. The issuing bank is not under obligation to continue with coupon payments in these bonds if it is making a loss. Also, when the bank is not able to maintain a prescribed common equity tier I ratio, these bonds can be written down or converted to equity.

Till March 6, 2020, the AT1 bonds of YES Bank held by mutual funds were rated BBB, which was within the investment grade.

So, considering the recent developments in YES Bank, as required by the valuation matrix, all the fund houses that had exposure to the bank’s AT1 bonds marked down the securities to ₹73.7922 (average price) on March 4 from ₹100; they further marked down the securities to ₹47.4997 (average price) on March 5 . Nippon India Mutual Fund, however, going by its internal valuation committee norms, has marked down the value of AT1 bonds of YES Bank to zero in all its schemes (on March 5) that held those bonds.

In a later development on March 6, the RBI, in its press release, said that “the instruments qualifying as Additional Tier 1 capital, issued by YES Bank under Basel III framework, shall stand written down permanently, in full, with effect from the appointed date. This is in conformity with the extant regulations issued by Reserve Bank of India based on the Basel framework”.

Following this, rating agency ICRA has downgraded (on March 6) all the bonds issued by YES Bank to ‘D’, which is below the investment grade. Since the rating of these bonds downgraded to D, all the schemes are required to mark down the value of all bonds of YES Bank to zero.

SEBI norms give fund managers the discretion to create segregated portfolios if the rating of a bond falls below the investment grade of BBB.

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What should Investors do?

The move to side-pocket will prevent the distressed assets from damaging the returns generated from more liquid and better-performing assets. Once the segregated portfolio in the affected schemes are set up, existing investors in the schemes will be allotted an equal number of units of the segregated portfolio as the main portfolio. No subscription and redemption will be allowed in the segregated portfolio. These schemes (with the segregated portfolio) will be listed in the exchanges. The unit-holders may exit through the secondary market route, but could face liquidity issues. Upon recovery of money, if any, it will be distributed to the investors in proportion to their holding in the segregated portfolio.

With the main scheme NAVs already marked down, investors holding these debt funds will not benefit by exiting. They can, therefore, take a call based on its scheme performance and portfolio composition.

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