RBI's move to take control of YES Bank puts Mutual Funds on the edge

As many as 32 mutual fund schemes have exposure to bank's AT-1 bonds.

The Reserve Bank of India’s (RBI) decision to takeover YES Bank has put mutual funds (MFs) in lurch, which are bracing for sharp mark-to-market hits on their exposure to the additional tier-I (AT-1) bonds of YES Bank. These bonds carry higher risks compared to other debt securities.

As many as 32 MF schemes are exposed to YES Bank debt with total exposure of close to Rs 2,800 crore (as of January 31, 2020 data).

According to industry participants, MFs are expecting rating downgrades and repricing of the bonds given the higher risks linked with the AT-1 bonds.

“Valuation agencies have already taken a markdown of 35 per cent. These bonds carry equity-like characteristics, and may not get treated at par with other types of debt securities,” said a fund manager, requesting anonymity.

Further, AT-1 bonds have some loss-absorption features, which can get triggered if the bank’s capital falls below certain thresholds.

On Thursday night, Nippon India MF marked down its exposure to YES Bank’s AT-1 bonds to zero after RBI’s move.

The fund house in its note pointed out that as per information memorandum (IM) of AT-1 bonds, in case there is reconstitution or amalgamation of bank under section 45 of Banking Regulation Act, the bank will be deemed as non-viable and trigger for write-down or conversion of AT-1 bonds will be activated.

However, the fund house was not yet able to side-pocket the exposure as the option can only be exercised once the security is downgraded to below-investment grade.

On Friday morning, rating agencies were yet to take any action on grading of the bonds and the instrument remained at investment grade of BBB-minus.

Experts say the bank’s decision on Thursday not to exercise its call option on these perpetual bonds can also be considered as a material event by the rating agency and be grounds for a rating action.