A draft RBI resolution for Yes Bank envisaged a complete write down of the value of AT-1 bonds (Photo: PTI)
6 min read
. Updated: 08 Mar 2020, 06:56 PM IST
Neil Borate, Deepti Bhaskaran
Many of the investors are guilty of believing that the bonds are as safe as FDs and will give better returnsGiven the low ticket size of ₹10 lakh, senior citizens, on the look out to invest their retirement corpus for better returns but no added risk, were the perfect scapegoats
Sixty-five-year-old Harish, a retired HR manager, and his wife Saroj, both based in Delhi, woke up on 6 March to a rude shock. About a third of their retirement pot had gone up in a puff of smoke as Yes Bank was placed under administration by the RBI and its perpetual debt (AT-1 bonds) became worthless.
The couple had been sold Additional Tier-1 (AT-1) bonds by their relationship manager (RM) at Yes Bank in Dwarka, New Delhi. Much of the money had come from Harish’s matured Employees’ Provident Fund corpus which was initially parked in a fixed deposit. While the government has assured Yes Bank depositors that they will not be penalised, a draft RBI resolution for Yes Bank envisaged a complete write down of the value of AT-1 bonds. For the bondholders, this means a complete loss of principal. The couple’s son, Saurabh who works in IT and had 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 and the troubles with Yes Bank were not on the horizon,” he said. “The relationship manager asked my father to break his FD and divert the money to these bonds as they were yielding a higher return,” he added. According to Saurabh, at no point did the relationship manager explain the risks. “My father was told that he would get stable determinable annual payments like FDs and will get capital back at the end of the period just like FDs,” added Saurabh.
AT-1 bonds are annual coupon bearing perpetual bonds, meaning that they have no fixed maturity date but they do have call dates, typically at the end of five years. “Banks are under no legal obligations to exercise call options and repay bondholders on the call dates. However, in the market, it is understood that they will exercise the call options and pay back the money,” said a Mumbai based wealth manager on condition of anonymity. Yes Bank refused to exercise its call option in January and March on perpetual bonds issued by it. AT1 bonds are seen as quasi equity products because they form the risk capital of the bank. “This means banks will pay the coupon only if it has profits or reserves. This is called coupon discretion. The second risk is with loss absorption. If the banks go bust, these bondholders will have to take a hit like the equity investors,”said Joydeep Sen, founder, wiseinvestor.in.
Given the underlying risks, AT-1 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, on the look out to invest their retirement corpus for better returns but no added risk, were the perfect scapegoats.
Vas Dev Seth, an 86-year-old retired individual, too was sold AT-1 bonds last year as a high yielding product, which is on a par with FDs in terms of safety of capital, by his Yes Bank relationship manager at South Extension branch in New Delhi. “Last year I was advised by my relationship manager to put money in AT-1 bonds as they were giving a higher interest rate,” recollects Seth. “I was given the assurance that the bond was secured and I would get payment every year and my principal back after four years. I even got one instalment,” he added.
It is estimated that the bank has issued about ₹10,000 crore worth of AT-1 bonds. While much of these bonds are held by institutional investors such as other banks and mutual funds, a small portion is also held by individual investors. “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 AT-1 bonds are not allowed to be sold to individuals unless the investor passes 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. 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 RBIs 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 AT-1 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. AT-1s have historically formed the bulk of perpetual bond issuances. Given poor drafting of AT1 contracts, its pricing and the current market dispensation, AT-1 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.