Yes Bank Rescue Brings With It Two New Risks For Mutual Funds

For India’s mutual funds, two new risks have emerged from the rescue of Yes Bank Ltd.—the potential impact of lock-in of shares and the risk of Additional Tier-1 bond write-off.

Asset managers with investments in exchange-traded funds tracking domestic indices could be stuck with holdings in the private lender, after the shareholders were barred from exiting for three years under the rescue plan. This is the first time such a lock-in has been placed on equity investors while saving a company.

And the RBI’s decision to extinguish AT-1 securities, while retaining equity, will alter the risk profile of such securities issued by other lenders. Mutual funds hold AT-1 bonds worth more than Rs 37,000 crore of all lenders put together, according to Morningstar.

The Reserve Bank of India superseded the board of Yes Bank and appointed an administrator after placing it under a moratorium and capping withdrawals at Rs 50,000 for a month citing deteriorating financial position. It also drafted a rescue plan that included investments by a consortium of lenders led by State Bank of India and comprising ICICI Bank Ltd., Kotak Mahindra Bank Ltd., Housing Development Finance Corporation Ltd., among others.

Also Read: In The End, It Took A Whole Village To Rescue Yes Bank

ETFs Stuck With Shares

According to the plan, 75 percent of the shares held by existing and new investors will be locked in for three years from March 13—the date of notification. Only those holding less than 100 shares are exempt.

Yes Bank was part of the Nifty 50 and Nifty Bank Index and was to be replaced by Shree Cement Ltd. and by Bandhan Bank Ltd., respectively, from March 18.

Twenty index funds track Nifty indices where Yes Bank is one of the constituent, according to data compiled by BloombergQuint. Together, these funds held assets worth Rs 5,600 crore as of January.

There shouldn’t be any issue with the index funds and most have already replaced Yes Bank, a senior executive at a large mutual fund told BloombergQuint on condition of anonymity since the person can’t talk about investments.

But Yes Bank is also part of the exchange-traded funds—17 domestic ETFs based on Nifty 50 and six tracking Nifty Bank. Eleven international ETFs also track Nifty 50. The three categories of ETFs, holding combined assets worth Rs 1.2 lakh crore, couldn’t have replaced Yes Bank till the index actually replaced it.

Also Read: Yes Bank Rescue: Echoes Of The 1998 LTCM Bailout

The impact will, however, vary with the weight of Yes Bank in their portfolios.

Most ETFs will have to live with Yes Bank for the next three years, the person quoted earlier said. They, however, have the option of transferring the share to another scheme in off-market trade depending on the mandate, he said, adding that the lock-in will remain.

But less than 0.15 percent of the portfolio may get impacted with a tracking error of 0.05-0.1 percent, he said. The schemes can record one-time adjustment in net asset value, the executive said.

Credit Risk

The AT-1 bonds, perpetual securities issued to raise funds that were considered at tier-1 capital, were akin to equity. The Yes Bank reconstruction scheme has now made them inferior to equity.

Yes Bank had issued Rs 8,450-crore AT-1 bonds, and a large chunk is held by mutual funds. The write-off changes the risk perception of such debt issued by other banks as well.

How do you diversify the credit risk, especially when these bonds don’t have a buyback option, the executive quoted earlier said.

Also Read: Moody’s Upgrades Yes Bank Rating By A Notch, Outlook Positive

According to Lakshmi Iyer, chief investment officer, debt and head, products at Kotak Mutual Fund, asset managers will start distinguishing these bonds in categories like too big to fail banks, systemically important banks and sound banks. The market has already started pricing this in, she said.

But being guided by equity may not be the prudent way to look at AT-1 securities, she said. “Have patience.”