Yes Bank and AT1 Bonds

 

YES BANK Reconstruction Scheme and its AT1 Bonds

Appeal against Restoring AT1 Bonds: YES Bank Ltd. (Yes Bank) and the Reserve Bank of India (RBI) have filed an appeal in the Supreme Court (SC) against the Bombay High Court's (High Court) ruling favouring the bondholders of the bank's AT1 bonds worth Rs.8300 cr. that were written down. The High Court set aside the order of the Yes Bank administrator that the additional tier-1 (AT1) bonds of the bank worth Rs.8300 cr. be written off, as part of the reconstruction scheme(Drafted by RBI and approved by the government) in March 2020. The reasons cited by the High Court were:

• The clause for write down of AT1 bonds, which found a place in the RBI Draft Reconstruction Scheme of Yes Bank, was absent in the Reconstruction Scheme notified by the government on 13th March 2020.
• As such, the administrator of Yes Bank, who implemented the reconstruction scheme, exceeded his authority.

Points that may be relied upon by Yes Bank in the appeal petition before SC: 
Immediately after the verdict of the Bombay High Court, Shri Prashant Kumar, MD & CEO, Yes Bank confirmed that the bank would be moving the top court, as the grounds for appeal are favourable.  I presume that the following points, which might have weighed in the decision of the bank administrator to write down the AT1 bonds, might find a place in the appeal:

Ø  Issuance and maintenance of AT1 bonds are as per Master Circular Basel III regulations issued by RBI. In accordance with annexure 16 of  the said regulations,  AT1 bonds carry principal loss absorption provisions that requires such instruments, at the option of RBI, to either be written off or converted into common equity upon the occurrence of the trigger event, called the 'Point of Non-Viability' (PONV) Trigger.

Ø  PONV is the earlier of 

a)     Decision that conversion or write-off is necessary, without which the firm would become non-viable, as determined by RBI and 

b)     Decision to make a public sector injection of capital or equivalent support, without which the firm would have become non-viable, as determined by the relevant authority.

Ø  In this regard, any decision of RBI to reconstitute a bank under Sec.45 of BR Act, 1949 means that the said bank is deemed non-viable (or approaching non-viability) and the trigger points at the PONV for conversion/write down of its AT1 bonds are activated. (paragraph 2.15- annex 16 of the regulations). 

Ø   RBI placed Yes Bank under moratorium on 5th March 2020 and subsequently issued a 'draft' scheme of reconstruction under Sec.45 of BR Act, 1946 on 9th March 2020. citing the rapidly deteriorating financial position of the Yes Bank Ltd. relating to liquidity, capital and other critical parameters, and the absence of any credible plan for infusion of capital.

 

Ø  As per the draft scheme, State Bank of India (SBI), a public sector bank expressed its willingness to make investment in Yes Bank Ltd. and participate (49% stake) in its reconstruction scheme.

 

Ø  Since the PONV trigger relating to public sector funds being injected as equity, without which the bank would become non-viable, was triggered, the draft scheme of RBI stated as under: " The instruments qualifying as Additional Tier 1 capital, issued by the Yes Bank Ltd. 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"

My views on the appeal: 
1. Unlike the cases of (i) Lakshmi Vilas Bank, which was taken over by DBS Bank (India) Ltd. and (ii) PMC Bank, amalgamated with Unity Small Finance Bank (Unity SFB), the reconstruction scheme of Yes Bank envisaged public sector participation in terms of equity, board representation and change of management. PONV trigger specifically advises write-off/conversion, when injection of public sector funds are involved. The wordings in the Basel III Capital regulations, were borne out of the experience in US during the  global crisis of 2008 that required the government to bail out the 'too big to fail' banks. So, the spirit behind the Basel III guidelines in respect of perpetual debt instruments was to invoke the write down/conversion clause, whenever public money is involved in rescuing a bank. (Please also refer Master Circular on Basel III regulations, Annex. 16. paragraph 1.2 for rationale)

2. SBI, the largest public sector bank, was the main partner in the reconstruction exercise. It not only gave equity, but its then DMD & CFO became the MD & CEO of Yes Bank. The reputation of SBI prevented a run on Yes Bank by its depositors, as they were reassured with the presence of SBI in equity, management and the board. This aspect may be impressed upon to underline the spirit behind the relevant guidelines that talks about AT1 bonds and its principal loss absorption features.

3. The government in its gazette notification also advised - " If any doubt arises in the intrepretation of the provisions of this scheme, the matter shall be referred to the Reserve Bank and its views on the issue shall be final and binding on all concerned". RBI has joined the appeal along with Yes Bank in the SC for reversing the order of the Bombay HC. This is an indicator to assume that RBI was of the view that the AT1 bonds were to be written down, when the reconstruction scheme was implemented. So, in all probability, the administrator might have acted in consultation with the regulator that was made the final authority by the Gazette notification for a binding view on any intrepretation

In case, SC validates HC Order: MD & CEO of YES Bank said that in the event of SC upholding the verdict of the Bombay High Court, there may not be any impact on the Tier-I Capital/CAR of the bank, as the CET-1 may reduce by 3 per cent and the share of AT-1 will go up by the same per cent within the Tier-I capital. He also appeared confident on the issue of redemption/payment of coupon to AT1 bonds in that situation, by saying that the call options and coupon payment decisions rests with the bank in the perpetual instruments as per terms and conditions governing the same. 

In my view, even if SC validates HC order, the PONV conditions should still apply, as the bank was reconstructed and public sector injected majority of the funds as capital. If it is not a write down, the bank should have the right to convert the AT1 bonds into common shares as per applicable rules and calculations in such situations. (though the absence in the gazette notification might still create some confusion in the matter). 'This will obviate the necessity to make coupon payments. Though as per terms and conditions, coupon payments on AT1 bonds are at the discretion of the bank, the bank is generally not liable to pay coupons only in conditions where (i) the bank's CRAR is below the minimum regulatory requirement or (ii) paying the coupon results in CRAR remaining/ falling below the regulatory requirement prescribed by RBI. However, the bank's CET 1 and CAR  were respectively at 11.2% and 17.5% in March 2021, 11.6% and 17.4% in March 2022 and 13.0% and 18.2% in December 2022. So if the bank faces an adverse order in the SC, the best option would be to exercise the other option in the PONV trigger, viz., convert the AT1 bonds into equity, rather than keeping them as AT1 bonds and denying coupon payments. The bank, which filed an appeal, is the best judge to take a call. 

Regards

V. Viswanathan

16th February 2023.