It is hard to blame the RBI’s move to fully write off beleaguered Yes Bank’s rupee AT1 bonds. Yes Bank’s financial problems have been longstanding, as the private sector bank faces the consequences of years of rising bad debt, shoddy corporate governance and an aggressive lending strategy.
Instead, the central bank’s decision is a good example of the growing pains that the Indian banking system needs to endure before the market can truly transform to be more transparent, disciplined and stable.
While holders of the AT1s have to suffer the loss of their principal, and other Indian lenders have to face up to a higher cost of capital, both domestically and internationally, the unprecedented event should go beyond that. It should serve as a much needed wake-up call for the Indian, and even the Asian, bank capital market.
Asian dollar AT1s have long been considered expensive and not of much value to international investors. Admittedly, the region is home to some of the world’s top-rated banks, scattered across Singapore, South Korea and Hong Kong, which have consistently pushed pricing lower on their capital banks.
DBS Group Holdings, the holding company of Singapore’s DBS Bank, for one, scored the tightest price globally with its $750m 3.6% perpetual non-call five AT1 in 2016, before beating its own record earlier this year by pricing its new $1bn perp at a jaw-dropping 3.3%.
However, what has become increasingly unsettling is the price that lower quality credits are getting away with, for their tier two notes and even AT1 bonds, relative to their much stronger regional and global peers. The single A rated big Chinese banks managed to compress pricing for their double B rated deals while still achieving jumbo sizes in 2015 and 2016. But over the following couple of years, even weaker lenders in the BBB bucket from the mainland managed to price their unrated AT1s with a 5% handle. Some squeezed pricing even further to4.5%, when their European or US peers were pricing their rated AT1s around the 7% or even 8% marks.
State Bank of India (SBI), the only Indian bank to have come offshore with a Basel III AT1, sealed its B+/B1 rated $300m perp at 5.5% in 2016.
Some may argue that the strong domestic buyer base drove the unrealistic pricing of these Asian — mostly Chinese — deals. That may be so, especially as many of the bonds have widened since their pricing. But bankers and analysts still say that the levels do not properly compensate investors for the risky nature of the AT1s, particularly those from weaker lenders.
A perfect example was Liaoning province based Bank of Jinzhou, which the People's Bank of China put on life support in June last year, before eventually having to bail it out. Despite the latest round of injections from other state-owned firms, it looks like the troubled lender may be, once again, forced to cancel the upcoming coupon payment for its nearly $1.5bn 5.5% perp non-call 2022 bonds in October.
Events like Bank of Jinzhou’s fall and Yes Bank’s AT1 write-off will hopefully bring the primary market for Asian AT1s back to a more realistic place.
Over the past few years, the market has, to a large extent, proved to be a win-win for both issuers and investors, with buyers picking up additional yield to bank senior notes and borrowers raising capital on the cheap.
When the outlook is rosy, it could be easy to downplay or even overlook the very nature of these instruments — that they are designed to be loss absorbing and are higher yielding for a reason. But the outlook is not rosy anymore. What the Yes Bank AT1 bail-in should do is create an environment that goes back to fundamental analysis. One where investors buying AT1s demand better compensation as their principal could be written down fully or convert to equity with severe haircuts.
Difficult times are ahead for Asian — and global — banks, corporates and other institutions as they face the Covid-19 pandemic. Yes Bank's AT1 holders will not be the last to get burned. Investors must be prepared.