Yes Bank AT1 bond writedown impact on mutual funds
The Yes Bank AT1 bond writedown of March 2020 was a regulatory action by the Reserve Bank of India under a Yes Bank crisis resolution scheme that reduced the value of approximately Rs 8,415 crore of Yes Bank’s Additional Tier 1 (AT1) bonds to zero. For Indian mutual fund schemes and other institutional investors that held these instruments, the writedown caused immediate, total, and permanent NAV losses on that exposure. The episode raised fundamental questions about the risk classification, disclosure, and distribution of AT1 instruments in Indian markets and prompted the Securities and Exchange Board of India to impose new restrictions on mutual fund holdings of AT1 and Tier 2 bank bonds.
Background: Yes Bank and its AT1 bonds
Yes Bank was established in 2004 and grew to become India’s fourth-largest private sector bank by assets under the leadership of its founder and Managing Director, Rana Kapoor. By 2018, Yes Bank had a balance sheet of approximately Rs 3.8 lakh crore and had issued multiple tranches of AT1 bonds in the domestic market totalling approximately Rs 8,415 crore outstanding as of early 2020.
AT1 bonds, also known as perpetual bonds or Basel III-compliant AT1 capital instruments, are subordinated debt instruments that carry a provision for principal writedown or equity conversion when a bank’s Common Equity Tier 1 (CET1) ratio falls below a contractual trigger level, or when a resolution authority invokes its statutory powers. Unlike conventional debentures, AT1 bonds do not have a fixed maturity; they are perpetual instruments with optional call provisions. Indian banking regulation permits AT1 bonds to be written down without any obligation of further payments to holders if the bank reaches the “point of non-viability” as determined by the RBI.
Yes Bank’s AT1 bonds had been rated investment-grade through 2018 and were widely held across mutual fund schemes, particularly credit risk funds, medium duration funds, and banking and PSU debt funds. The attractive yields relative to sovereign instruments made them popular with yield-seeking schemes.
Deterioration of Yes Bank
From 2018 onward, Yes Bank faced escalating asset quality concerns. The RBI’s asset quality review had identified a significant gap between the bank’s declared gross non-performing assets and the actual stressed loans identified during supervisory inspection. The RBI declined to extend Rana Kapoor’s tenure as MD and CEO beyond January 2019. His successor, Ravneet Gill, oversaw a period of accelerating losses and credit rating downgrades as the bank’s true bad loan level was recognised.
By late 2019, Yes Bank had lost the ability to raise fresh capital. Its AT1 bonds had been downgraded to sub-investment grade by domestic rating agencies. Mutual fund schemes began writing down Yes Bank AT1 holdings as the instruments moved to non-investment-grade status, but the write-down was partial rather than total, schemes carried the instruments at a fraction of par rather than zero.
The resolution scheme: March 2020
On 5 March 2020, the RBI placed Yes Bank under a Moratorium, suspending its activities and imposing withdrawal limits on depositors. Simultaneously, the RBI announced a draft reconstruction scheme under the Banking Regulation Act, 1949, under which State Bank of India and other institutional investors (Axis Bank, ICICI Bank, HDFC Bank, Kotak Mahindra Bank, among others) would infuse capital to reconstruct Yes Bank.
The reconstruction scheme, notified on 13 March 2020 and taking effect from 18 March 2020, provided that Yes Bank’s AT1 bonds would be permanently written down to zero as part of the restructuring. This was consistent with the terms of the AT1 bond instruments under Basel III regulations and Indian banking law, which explicitly provide for AT1 writedown at the point of non-viability as determined by the regulator.
Mutual fund impact
For mutual fund schemes holding Yes Bank AT1 bonds, the writedown to zero required recognition of a total loss on those instruments, over and above any partial write-downs already taken. The marginal impact varied by scheme:
- Schemes that had already written the instruments down to near-zero on the basis of rating downgrades experienced a relatively small additional NAV impact.
- Schemes that had maintained the instruments at higher carrying values, either through valuation methodology choices or because the rating downgrade had only recently occurred, experienced larger additional single-day NAV falls.
Estimates of total mutual fund exposure to Yes Bank AT1 bonds ranged from approximately Rs 2,500 crore to Rs 3,000 crore across the industry at the time of writedown. Single-day NAV falls of 1–2 percent were recorded in several affected schemes.
SEBI regulatory response
The AT1 writedown, occurring in the same market period as the IL&FS and DHFL credit crises and just weeks before the Franklin Templeton wind-up in April 2020, prompted SEBI to act decisively on the classification and risk disclosure of AT1 bonds in mutual funds.
SEBI circular of March 2021
On 10 March 2021, SEBI issued Circular No. SEBI/HO/IMD/DF4/CIR/P/2021/032, which imposed the following requirements on mutual fund investments in AT1 and Tier 2 bank bonds:
- Valuation as 100-year maturity instruments: SEBI directed that for valuation and interest rate duration purposes, AT1 bonds without a specific maturity date should be treated as instruments with a residual maturity of 100 years. This dramatically increased the duration risk classification of AT1 holdings and made them unsuitable for short-duration mandates.
- Concentration caps: No single scheme was permitted to invest more than 10 percent of its AUM in AT1 and Tier 2 bonds, and overall mutual fund industry exposure to AT1 bonds of any single issuer was capped.
- Prohibition in short-duration categories: SEBI clarified that AT1 bonds, given their perpetual and loss-absorbent characteristics, were inappropriate holdings for liquid funds, overnight funds, money market funds, and short-duration funds. Schemes in these categories were directed to divest existing AT1 holdings within a phased transition period.
- Disclosure in Scheme Information Documents: AMCs were required to prominently disclose AT1 bond holdings, their writedown risk, and the absence of maturity guarantees in scheme information documents and fund factsheets.
The 100-year valuation directive caused immediate yield to maturity recalculations across industry portfolios, resulting in mark-to-market losses for schemes that revalued their AT1 holdings accordingly, before they could fully divest. After industry representations, SEBI modified the implementation timeline but maintained the substantive 100-year duration framework.
Broader significance
The Yes Bank AT1 episode exposed a structural mismatch in the Indian bond market: AT1 instruments with loss-absorbency and perpetual features had been sold to retail and institutional investors, including mutual funds, at relatively modest yield premiums over conventional bonds, without adequate disclosure of the writedown risk embedded in the instruments. The marketing of AT1 bonds to retail investors through the debenture distribution network, often with emphasis on the relatively attractive coupon rather than the regulatory loss-absorption feature, was a specific concern for both SEBI and the RBI in the aftermath of the Yes Bank resolution.
The episode contributed to the broader regulatory trend of tightening mutual fund exposure to complex bank capital instruments. It also reinforced the argument for enhanced investor education around risk-adjusted yield comparisons, a theme that SEBI embedded in its revised risk-o-meter and product labelling framework implemented in 2021 in the wake of the Franklin Templeton winding-up.
Key dates
| Date | Event |
|---|---|
| 2018–2019 | Yes Bank asset quality deteriorates; AT1 bonds downgraded |
| 5 March 2020 | RBI places Yes Bank under Moratorium |
| 13 March 2020 | Reconstruction scheme announced; AT1 bonds to be written to zero |
| 18 March 2020 | Yes Bank reconstruction scheme takes effect; AT1 writedown finalised |
| March 2020 | Mutual fund schemes recognise total loss on AT1 holdings |
| 10 March 2021 | SEBI circular: 100-year valuation rule; AT1 restrictions for MFs |