It's a no-go for Yes Bank

When speaking about the scandal at Wells Fargo (a US bank), Warren Buffett once quipped, "What you find is there's never just one cockroach in the kitchen when you start looking around." It seems the same is the case with Yes Bank.

A recap of the Yes Bank fiasco
For a while, Yes Bank indeed flew high. It was one of the fastest-growing private sector lenders and was once the fifth-largest in the private lending space.

However, the red flags were quite visible to those who were looking. Sluggish deposit rates that could never keep up with the loan book growth, high exposure to troubled borrowers, namely IL&FS and DHFL, and the top brass quitting citing governance issues, the signs were all there.

Finally, when the country was grappling with the first wave of the pandemic in 2020, the abysmal asset quality of the Bank forced the hand of RBI to step in and impose a moratorium on the lender, meaning RBI suspended the Bank's activities until the issues were resolved.

To salvage the sinking lender, RBI proposed a reconstruction plan that entailed SBI taking a 49 per cent stake in Yes Bank. Further, RBI suspended the board and appointed Prashant Kumar, the SBI CFO, as the administrator to guide the reconstruction.

AT1 bonds and the present uncertainty
The appointment of Prashant Kumar and the reconstruction news led to an all-around optimism in the market around Yes Bank, which skyrocketed its share price nearly four times (from Rs 16 to Rs 60).

In March 2020, the Yes Bank administrator wrote off additional tier 1 (AT1) bonds worth Rs 8,415 crore.

Banks primarily issue AT1 bonds to meet the capital requirements stipulated in the Basel III norms. However, unlike other bonds, AT1 bonds have no maturity dates. In addition, banks have the liberty to stop paying interest on these bonds if they are low on capital. All-in-all, a very risky investment. Thus, these bonds have high coupon rates, around 9.5 per cent in the case of Yes Bank.

Unsurprisingly, the bondholders were not pleased with these write-offs and took the bank to court. The bondholders petitioned that the administrator did not have the right to write off these bonds after the final reconstruction scheme was notified. Moreover, in the final reconstruction scheme, the provision for writing off the bonds were removed.

And the Bombay High Court has heard the pleas and has ruled in favour of the bondholders.

But what does it mean for Yes Bank?

What happens now?
At present, the Bombay High Court has put a stay on the order for six weeks. It is highly likely that Yes Bank will now approach the Supreme Court.

However, if the Supreme Court also quashes Yes Bank's plea, there's a chance that the bank would be required to make interest payments or pay off the entire Rs 8,415 crore.

An alternative course of action would be to convert these bonds to equity. In fact, this was brought up by the bondholders in March 2020. They wrote to the RBI seeking an allotment of 170 crore shares instead of a write-off. As of December 2022, the bank had around 2,875 crore shares outstanding. An addition of 170 crore shares would represent a 6 per cent dilution for the current shareholders.

What is the market's take?
At the opening on January 23, 2023, the stock was down 12.4 per cent. While the latest development regarding the AT1 bonds indeed had an impact, the poor Q3 FY23 results did not help either.

The bank's net profit was down 79 per cent year-on-year as provisions for bad loans more than doubled. To add to the injury, at a time when even PSU banks are witnessing strong loan book growth, Yes Bank's loan book grew by a meagre 10 per cent year-on-year.

But there is some light at the end of the tunnel for Yes Bank, albeit dim. After transferring bad loans worth Rs 43,715 crore to JC Flowers (an asset reconstruction company), its gross and net non-performing assets have fallen from 14.7 and 5.3 per cent, respectively, in December 2021 to two and one per cent, respectively, in December 2022.

However, don't let this dip in bad loans and the current valuation entice you. While the new management has been trying their best, there are still some cockroaches yet to appear.