Yes Bank Faces Capital Risk After AT-1 Verdict; Citi Cuts Target, Morgan Stanley Retains 'Underweight'

Citi has cut its target price on Yes Bank to Rs 17.50 from Rs 22, warning that the reversal of the Rs 8,415-crore Additional Tier-1 (AT-1) bond write-off could erode the lender's book value and necessitate a capital raise. 

Morgan Stanley has retained its ‘Underweight' rating and a target price of Rs 17, flagging the Supreme Court ruling as a negative for the bank while awaiting clarity on the extent of the potential financial impact.

The brokerages' assessments follow Thursday's Supreme Court verdict upholding the Bombay High Court's decision to quash the write-off of Yes Bank's AT1 bonds, which were extinguished during the lender's rescue in March 2020. Yes Bank shares hit the lower circuit in the previous session after the verdict, falling as much as 20% to Rs 16.96.

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Citi Cuts Yes Bank Target To Rs 17.50, Warns Of Capital Raise

Citi has maintained its 'Sell' rating on Yes Bank but lowered its target price to Rs 17.50 from Rs 22, describing the Supreme Court ruling as a reversal of the AT1 bond write-down that reopens the bank's capital-related concerns.

READ | Supreme Court Sets Aside Yes Bank's Rs 8,415 Crore AT1 Bond Write-Off In Big Win For Bondholders

The brokerage estimates that the development could result in a 250-basis-point reduction in Yes Bank's Common Equity Tier 1 (CET1) capital ratio, taking it to 11.5%. This estimate is based on the principal amount alone, assuming coupon payments are discretionary and non-cumulative.

Citi also expects the potential liability to erode the bank's book value by 13–14%, potentially necessitating a capital raise to restore its capital buffers.

The extent of the final impact will depend on the implementation of the ruling and the treatment of the outstanding AT1 bonds. Citi's assessment highlights the risk that the reversal could put pressure on the bank's capital position and create a need to replenish its buffers.

Morgan Stanley Retains Underweight On Yes Bank

Morgan Stanley has maintained its Underweight rating on Yes Bank with a target price of Rs 17. The brokerage described the Supreme Court's order as prima facie negative for the lender, but said it was awaiting details on the percentage of AT1 bonds that would ultimately be allowed to be written off.

Morgan Stanley estimates that the post-tax amount of Rs 6,300 crore would represent around 12% of Yes Bank's net worth. It could also reduce the bank's current CET1 ratio of 14% by approximately 190 basis points.

The brokerage noted that the AT1 bond issue had remained an overhang for the stock and that the shares had reacted sharply to the verdict. It will watch for any review petition and further clarification from the bank.

A key question for Morgan Stanley is whether the decision fundamentally challenges the loss-absorption feature of AT1 bonds or is primarily related to the process followed by the administrator during Yes Bank's reconstruction.

Why The Supreme Court Quashed Yes Bank's AT1 Bond Write-Off

The Supreme Court on Thursday dismissed appeals filed by Yes Bank, the Reserve Bank of India (RBI) and the Centre against the Bombay High Court's January 20, 2023 judgment quashing the write-off of Rs 8,415 crore in AT1 bonds.

The bonds were written down to zero as part of Yes Bank's reconstruction in March 2020, when the lender faced a severe crisis involving rising bad loans and declining depositor confidence. The RBI superseded the bank's board and imposed a moratorium, following which the government approved a reconstruction scheme backed by capital infusion from an SBI-led consortium.

READ | Who Wins, Who Loses: Decoding The Supreme Court's Yes Bank AT1 Verdict

The bank's administrator subsequently wrote off AT1 bonds issued in 2016 and 2017, wiping out the investments of institutional and retail bondholders. The investors challenged the decision, arguing that the final reconstruction scheme did not contain a provision allowing the write-off, even though the draft scheme had contemplated it.

The Bombay High Court agreed with the bondholders and set aside the decision, holding that the administrator appeared to have exceeded his authority by writing down the bonds after the reconstruction scheme had come into force.

The Supreme Court declined to interfere with the high court's judgment, leaving the decision to quash the write-off intact. 

What The Verdict Means For Yes Bank And Bondholders

The ruling is a setback for Yes Bank, the RBI and the Centre, which had challenged the Bombay High Court's decision. For bondholders, it offers a path to seek restoration or repayment of investments that had been written down to zero.

However, the precise mechanics of any restoration or repayment, including the treatment of interest, will depend on the operative directions and subsequent implementation of the judgment.

For Yes Bank shareholders, the principal concerns are the potential impact on core equity capital, any cash outflow and the possibility of a capital raise. The bank had previously said that any financial liability arising from the verdict would be recognised in the relevant future reporting period and that it did not expect a material financial impact.

The distinction between overall capital adequacy and core equity capital is important. Following the 2023 high court ruling, then-CEO Prashant Kumar had said that restoring the bonds would not affect total capital adequacy, although in an extreme scenario CET1 capital could decline while AT1 capital increased.

Why The Decision Matters For India's AT1 Bond Market

The verdict could have implications beyond Yes Bank. During the Supreme Court proceedings, the Centre argued that nearly Rs 1 lakh crore of AT1 bonds were outstanding across Indian banks and that an adverse ruling could weaken investor confidence in these instruments and complicate future bank rescues.

Bondholders argued that the case centred on whether the write-off had followed the law and the applicable process.

AT1 bonds are perpetual, unsecured instruments that banks use to strengthen their capital. They carry higher risk than conventional bonds because they can absorb losses through a write-down or conversion into equity under specified conditions.

The Supreme Court's decision leaves the Bombay High Court's ruling intact, but questions surrounding the financial implications for Yes Bank remain. 

For investors, the next developments to watch include any review petition, clarification from the bank and greater certainty on the treatment of the outstanding bonds.

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