On 5 March 2020, the Reserve Bank of India ("RBI") imposed a moratorium on Yes Bank following unsuccessful attempts to raise additional capital to cover provisions for non-performing assets and a deterioration of its financial position. This was against the backdrop of the downgrading of Yes Bank's credit rating and concerns over its corporate governance. The RBI has taken over Yes Bank's board and imposed limits on withdrawals to protect the interests of depositors until 3 April 2020. This was followed by a draft scheme of reconstruction published by the RBI on 6 March 2020 for rehabilitation of Yes Bank ("RBI Scheme").
The RBI Scheme is likely to be amended and a revised scheme is expected to be published imminently. At the time of publication of this client alert, it has been reported that Indian cabinet has approved a revised version of the RBI Scheme. These revisions may affect the percentage of equity to be held by the government entities participating, the cash that they are investing, the participation by potential co-investors and the treatment of Additional Tier I Capital ("AT-1") (or its conversion into equity). However, the key issues are likely to remain similar and we have summarised these matters in this client alert.
A chronology of the events that led to the issuance of the RBI Scheme is set out in Appendix 1 and detailed analysis of the potential issues arising out of the proposed reconstruction are discussed in Appendix 2.
- Current RBI Scheme: Yes Bank is under a moratorium imposed by the RBI and will be subject to a scheme under the Banking Regulation Act 1949 ("BR Act") rather than under the Insolvency and Bankruptcy Code, 2016 ("IBC") or the Companies Act 2013 ("CA 2013"). The current RBI Scheme contemplates investment in the equity of Yes Bank by the State Bank of India ("SBI") of 49% of the total share capital at a price not less than INR 10 per share (inclusive of a premium of INR 8 per share) with a 3 year lock in which will see SBI maintain a shareholding of at least 26%. The board of Yes Bank is also proposed to be reconstituted. The RBI Scheme further contemplates a full write down of the AT-1 instruments issued by Yes Bank. This write down is the subject of litigation from certain AT-1 bondholders. However, subsequent media reports suggest that other investors, including various Indian financial groups may participate in the RBI Scheme and that AT-1 bondholders will receive the benefit of a conversion of part of their bonds into equity.
Comment: Regardless of whether or not the RBI Scheme is amended, structurally, there are three issues of note. First, in order for the RBI Scheme (or any variation of it) to succeed, it will need to be aligned to the capital required. The key issue is how much capital will be needed? Second, how will any future capital requirements be satisfied? Will investors be willing to invest further capital, if needed? Experience in other markets shows that the immediate capitalisation may be followed by further equity issuances later. Third, the RBI Scheme envisages a share premium of INR 8. This implies there is equity value left in the company, which would seem incongruous if the AT-1 bonds are being written down. Appropriate pricing of the transaction reflecting the economic position is critical in order for the RBI Scheme to succeed in its objectives. The RBI is expected to publish the final RBI Scheme imminently so clarity on this will emerge soon.
- Write down of AT-1 bonds: The current RBI Scheme contemplates a full write down of the AT-1 instruments issued by Yes Bank. The AT-1 bondholders have challenged the write down before the Bombay High Court on the grounds that such scheme gives preference to shareholders and is against global best practices. Media reports suggest that the bondholders have postponed the matter as the RBI is considering conversion of a portion of the bonds into equity of Yes Bank, so it may be that this aspect of the RBI Scheme changes.
Comment: The RBI has the power to write down all AT-1 instruments pursuant to the Basel III Capital Regulations and the BR Act. However, certain bondholders are challenging this on the grounds of a lack of fairness of the scheme, given that the RBI Scheme proposes investment in Yes Bank's equity at a premium, while the bonds (which rank in priority to common equity) are being written off. Media reports suggest that the RBI has taken note of the bondholders concerns and may offer them the right to convert a part of their bonds into equity in the revised RBI Scheme. The more difficult issue is around the treatment of Tier-2 bonds. Depending on the scale of capital required, will these also need to be written down? From an investor perspective, this is a key issue that will need to be addressed or diligence will need to provide evidence that this will not be required. A failure to address this issue clearly at the outset could potentially lead to further capital calls later or an erosion of the value being provided by investors under the RBI Scheme (or any revised version of it).
- Tax: Any acquisition of equity at a low valuation will need to be structured in a manner that does not lead to adverse tax consequences. Acquisition of shares at less than "fair market value" in any bail-out may be treated as taxable income in the hands of investors.
Comment: This is a critical issue for investors, who will not want to be penalised for appropriate pricing and investors should seek tax advice on this aspect.
- Investor eligibility: It is likely that any meaningful participation by investors will need RBI approval. This is because any acquisition of shares or voting rights in excess of 5% of Yes Bank, requires the prior approval of the RBI. The RBI has placed limits on ownership based on categories of investors (where no acquirer can exercise voting rights in the bank in excess of 10%), but the RBI has the power to relax such requirements if such acquisition is in the public interest. Further, any bidder proposing to acquire Yes Bank will need to fulfil RBI's 'fit and proper' criteria and be able to demonstrate its financial and operational capability to run a banking business.
Comment: This is an RBI requirement, so the RBI may be prepared to be flexible within boundaries to address the capital needs.
- Listed company issues: Unless the Securities and Exchange Board of India ("SEBI") is willing to grant exemptions in light of the exceptional circumstances, various securities regulations will apply. For instance, the scheme is likely to need an exemption from SEBI if the takeover requirements in India are not to apply. Schemes under CA 2013 or resolution plans under the IBC are exempt from these requirements, but a scheme under the BR Act is not specifically carved out. Similarly, SEBI has various pricing and other requirements for the preferential allotment of shares. Will SEBI be willing to grant a specific exemption here? Investors will also need to consider the possibility that they might be treated as "promoters" of Yes Bank depending on the size of their investment. Also, investors will need to consider insider trading issues around access to 'unpublished price sensitive information' at the time of conducting diligence. Finally, investors should not expect to retain a set of customary private company style investor protections as long as Yes Bank remains listed. SEBI has allowed limited investor rights (such as board nomination rights) in the past, but expectations should be managed as far as what may be possible and as to the influence they will have on management of Yes Bank going forward.
Comment: These are practical issues that will need to be worked through. Much depends on whether SEBI and the RBI work together in a concerted fashion to ensure that the scheme is complemented with supporting flexibility from SEBI.
- Money laundering risk: It is alleged that Yes Bank's ex-promoter, Rana Kapoor received kick-backs for loan recovery forbearance by Yes Bank from Dewan Housing Finance Limited ("DHFL") and he is under investigation by the enforcement directorate ("ED"). Under Indian law, any person who directly or indirectly is involved in the 'proceeds of crime' and claims such property to be 'untainted' is guilty of the offence of money laundering and the Government has the power to attach the assets (or value equivalent) involved in the offence of money laundering.
Comment: Since the bail-out of Yes Bank is outside the scope of the IBC (where bidders are immune from offences committed by the ex-promoters), there is some risk that the allegations of fraud involving Rana Kapoor could lead to attachment of Yes Bank's assets. However, such attachment will need to follow the process set out under law in this regard.
- At the time of publication of this client alert, it has been reported that the Indian cabinet has approved certain revisions to the RBI Scheme, so the revised RBI Scheme is expected to be published shortly. Media reports suggest certain Indian financial groups and other Indian investors are likely to co-invest with SBI to fund the capital shortfall in Yes Bank. It remains to be seen as to what shape the RBI's ultimate scheme takes, but in similar banking crises in Europe, ultimately, the state has needed to bail-out financial institutions. Therefore, even if private investors do participate, from an economic perspective, they may view their investment as having an implicit "put" to the Indian government (not in the sense of formal legal rights, but implied comfort as to the ultimate recourse in relation to further downside).
- The other issue is that it is likely that any immediate rescue plan will only be the first step. Once re-capitalised, the management of Yes Bank may need to consider strategic decisions such as whether to separate out good and bad asset pools, whether to sell better parts of the business and other measures. There is also the question of how to deal with any further capital which may be needed. Will new investors be willing to fund a future rights issue for instance, if further capital needs arise? These are all questions that will need to be considered.
- Much of the restructuring will be simpler if Yes Bank were to de-list as it would allow the resolution of Yes Bank's situation to be undertaken in private and without the ongoing disclosure and other obligations of a listed company. SEBI may not be favourably disposed to this because of public / retail shareholders who may then hold illiquid shares and so it remains to be seen whether the ultimate RBI Scheme features a de-listing, but it is an issue that will need to be structurally considered.
Takeaways for international investors
The success of the RBI Scheme (or any variation to it) will hinge on clearly and verifiably establishing the capital needed in a limited timeframe and addressing the key commercial issue around pricing. The question of "who bears the pain" and the speedy implementation of the RBI Scheme will require flexibility from the various regulatory authorities in India. Even if international investors are unable to participate in the current recapitalisation of Yes Bank (or if the terms proposed do not provide them with sufficient comfort), it seems likely that this will be a first step and that the restructuring will be a much longer term endeavour. Therefore, it is possible that there may be further developments and opportunities to invest in the aftermath of the initial capitalisation.
To read Appendix 1 and Appendix 2, please click here.
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