India: Yes Bank's trouble was saying no

Sridhar V is not a happy man. The 64-year-old retired insurance salesman pumped most of his life savings into Yes Bank’s stock a few years ago, when the share price’s trajectory appeared bright. Little did he expect one of India’s fastest-growing privately owned lenders to teeter on the brink of collapse.

But in the year to early March 2020, Yes Bank’s shares fell more than 90% and Sridhar lost most of his retirement savings.

Retail investors such as Sridhar owned more than 40% of Yes Bank’s shares at the end of December 2019; they were also large holders of the firm’s rupee-denominated, additional tier-1 capital bonds, which have now been fully written down.

Launched in 2004, this aggressive lender was finally rescued by the government in March, but for those who have followed Yes Bank’s rapid growth in the past few years, something always seemed out of place.

“If you look at the analyst community, they have never really been comfortable about governance at Yes Bank,” says a Mumbai-based senior bank analyst. “And this was before the ouster of the promoter and the shake-up in management, after which all the skeletons started coming out of the closet. It goes to show that the bank was not as well run as some thought it was.”

There were some warning signs, but nothing that revealed the extent of the bank’s distress.

Ratings agency Moody’s Investors Service assigned Yes Bank a Baa3 foreign currency issuer rating in December 2013. In November 2018, it lowered the rating to Ba1 when corporate governance issues started to emerge, following the resignation of various members of the bank’s board.

But even then, the agency maintained that the bank’s reported credit fundamentals were stable and its capitalization adequate.

It did add that while Yes Bank’s asset quality metrics were superior to those of its peers in India, “its aggressive growth strategy” posed some asset risks. Its outlook for the bank was changed to negative from stable at the time.

The agency also indicated possible government support for Yes Bank if necessary, given its importance to the country’s banking system.

What went wrong at Yes Bank, co-founded by the flamboyant and now-disgraced banker Rana Kapoor?

In 2003, Kapoor managed to bag a licence to open India’s first new private-sector lender in a generation. Yes Bank opened for business a year later and listed to much fanfare on the Bombay Stock Exchange in 2005. Over the course of the next decade, it became the go-to bank for corporations and rose to the country’s fourth-largest private lender by assets.

Yes Bank earned a reputation for having an outsized appetite for risk, lending aggressively to companies and tycoons that later got into difficulty when India’s economy deteriorated sharply.

The numbers tell a troubling story.

Yes Bank’s exposure to the corporate sector was 62% of its book as of September 30, 2019 – much higher than the banking sector average of about 40%, according to ratings agency ICRA, which is controlled by Moody’s Investors Service.

The bank’s gross non-performing assets (NPA) ratio rose to 3.2% in the financial year ending March 31, 2019, from 1.3% the previous year.

As of September 2019, the gross NPA ratio stood at 7.4%.

The figures for the latest quarter ending December 2019 were much bleaker. Yes Bank reported on March 14 that gross NPAs were 18.9% for the three months.

Loss before tax was Rs247.7 billion ($3.3 billion), versus a profit of Rs14.4 billion during the same period in 2018. The cost-to-income ratio soared to 100.4% from 44%.

Yes Bank’s stressed borrowers included firms controlled by businessman Anil Ambani, whose Reliance Communications filed for bankruptcy in February 2019, as well as Vodafone, conglomerate Essel Group and Infrastructure Leasing & Financial Services, which defaulted at the end of 2018.

Yes Bank’s capital adequacy ratio dropped to 4.1% as of December 31, 2019, from 16.3% on September 30, 2019 and 17.4% on December 31, 2018. Its common equity tier-1 was wiped out to 0.6% at the end of 2019 from 9.1% at the end of 2018, while its tier-1 ratio dropped to 2.1% from 12%.

The steady downward drift did not go unnoticed at the Reserve Bank of India. The central bank turned up the heat at Yes Bank in 2018 because of concerns over its rising bad debt, its capital adequacy ratio and exposure to the crisis-stricken shadow banking industry.

In September of that year, it ordered Kapoor to step down from his position as chief executive by the end of January 2019. Then in November 2018, the RBI said Yes Bank had under-reported its bad loans for the year ending March 31, as well as for both the 2016 and 2017 fiscal years.

Kapoor duly left early last year. He sold the last of his shares in the bank in November 2019, despite famously tweeting a year earlier that he would “never ever” sell his stake but would instead leave it to his three daughters, because “diamonds are for ever”.

Ravneet Gill, the former chief executive of Deutsche Bank India and a banker with more than 30 years of experience, took over from Kapoor in March 2019 but lasted barely a year in the job. On March 5, 2020, the RBI took over Yes Bank’s board of directors for a 30-day period, citing “serious deterioration in the financial position” of the bank.

The government called in Prashant Kumar, former chief financial officer of State Bank of India, to be Yes Bank’s administrator before appointing him chief executive in the middle of March.

When Gill spoke to Asiamoney in early February, a month before he was fired, he was well aware of the size of the task he had taken on.

“The short-term strategy is clearly the need to quickly repair the balance sheet by being able to raise an adequate amount of capital,” he told Asiamoney. “Then as we get going, it will be to have a more diversified revenue demographics across wholesale and retail banking. And the next plan will be to build more flow and more granular businesses.”

Gill had no qualms about the importance of raising capital, emphasizing that numerous times in his meeting with Asiamoney. But that proved impossible for Yes Bank, leading to its eventual downfall.

The bank had been seeking as much as $2 billion in equity, and received non-binding offers from a number of investors, but a deal never materialized. However, the bank did start to make changes, Gill told Asiamoney.

“The old strategy of taking disproportionately large exposures and lending on the basis of just ‘acid cover’ needs to change,” he said, referring to the ratio of a company’s short-term assets to its short-term liabilities.

“We need to get more cashflow-focused and get away from greenfield projects, project financing and a lot of infrastructure lending. Those are areas we have started to de-emphasize.”

This change in approach was critical as Yes Bank faced the brunt of its large exposures to corporations after September 2018, when the collapse of infrastructure financing company IL&FS caused liquidity and leverage issues for companies.

“In an environment like that,” Gill said, “to be able to dispose of assets and monetize assets takes a little longer, which requires provisioning and, in turn, capital. So there was a question with [our] business model, which became a little out of step with the changes that occurred in the market in September 2018.”

While the new strategy had some impact – for example, Yes Bank’s exposure to the corporate sector, while high, has declined and its retail book has expanded – it wasn’t enough.

Then there were the allegations against the board and the management about poor corporate governance.

At the end of 2018, a number of board members stepped down. Then in January 2020, Uttam Prakash Agarwal, an independent director on Yes Bank’s board, resigned, citing deteriorating standards of corporate governance and failure of compliance and management practices at the firm.

When Asiamoney asked Gill about these allegations, he said the focus of Yes Bank was to ensure that “any aftertaste from the past, in terms of anything that may seem to be wrong or not compliant, doesn’t recur”.

To that end, Gill said the bank had put better checks and balances in place, improved controls and systems and made personnel changes – hiring a new chief financial officer, chief compliance officer and chief operating officer – to ensure better governance standards.

Events unfolded rapidly at Yes Bank in March 2020. The central bank imposed a 30-day moratorium on the bank on March 5 (which it lifted after only 13 days), citing the absence of a credible revival plan, a steady decline in Yes Bank’s financial position and the outflow of liquidity.

The RBI also replaced the board of directors on the same day, appointing Kumar as the administrator. On March 14, Yes Bank said the new board would be reconstituted within seven days from the cancellation of the moratorium.

Kumar was appointed chief executive and managing director. Sunil Mehta, former CEO of Punjab National Bank who had retired in September 2019, was hired as non-executive chairman. Two non-executive directors – Mahesh Krishnamurthy and Atul Bheda – also came on board.

State Bank of India, which is now the largest shareholder in Yes Bank after pumping in funds, appointed Partha Pratim Sengupta and J Swaminathan as directors on March 20, while the central bank named R Gandhi and Ananth Narayan Gopalakrishnan as additional directors to Yes Bank’s board.

Gandhi is a former deputy governor at the RBI, while Gopalakrishnan is an associate professor at the SP Jain Institute of Management and Research.

As part of the rescue plan, SBI will take a 49% stake in Yes Bank and hold a minimum of 26% over the next three years. SBI has injected Rs60.5 billion of equity into Yes Bank, while a combined Rs39.5 billion has been pumped in by Housing Development Finance Corp, ICICI Bank, Axis Bank, Kotak Mahindra Bank, the Federal Bank, Bandhan Bank and IDFC Bank.

In addition, Rs84.15 billion of Yes Bank’s Basel-III compliant additional tier-1 bonds have been fully written down, an unprecedented move in India, marking the first time AT1 investors have taken losses on their investments.

The RBI “moved really swiftly” on Yes Bank, which helped to “calm a lot of nerves”, Chirag Negandhi, joint managing director and co-chief executive of Axis Capital, tells Asiamoney.

“The RBI has been flagging up concerns around Yes Bank for a while,” he adds, “especially as Yes Bank has had a number of false starts on their capital-raising. Plugging that hole has been a big question, but with SBI backing Yes Bank, more investors joining, and the tier-1 bonds written down, it is much more manageable.”

Saswata Guha, financial institutions director at Fitch Ratings, points out that the RBI is making a clear distinction between private banks and public-sector banks in the way it has handled Yes Bank’s AT1 bonds.

“The authorities are within their right to do [a full write-off], and investors will take a hit in that scenario,” he says, “but their approach has been one of forbearance in the context of state-owned banks faced with solvency issues.”

The central bank’s orchestrated state takeover of Yes Bank was not the end of the saga.

On March 8, the Enforcement Directorate, an agency responsible for fighting economic crime in India, arrested former CEO Kapoor for alleged fraud.

The allegations focused on potential conflicts of interest when Kapoor was running Yes Bank, including alleged favouring of some clients over others in return for kickbacks, leading to the ballooning bad debt crisis at the firm.

Kapoor has denied the accusations.

The Central Bureau of Investigation is also understood to be conducting an independent investigation into Kapoor.

A head of investment banking at a private-sector lender thinks the RBI, led by governor Shaktikanta Das, had done its homework to prevent a run on Yes.

“Step one was bringing SBI as a backstop so the impact on Yes Bank and its depositors is not too hard,” he says, “and the second was dealing with the authorities on [Kapoor’s] arrest.

“If they had done one before the other, then withdrawals of capital and the panic would have been much higher.”

Moody’s Investors Service downgraded Yes Bank’s long-term foreign currency issue ratings to Caa3 on March 6 from B2, before bumping it up to Caa1 on March 16 thanks to the bailout of the bank’s depositors and senior creditors.

Fitch doesn’t rate Yes Bank, but said in a note in early March that the RBI’s takeover and the related developments would be seen as a “failure of the bank on a standalone basis”.

Yes Bank’s demise comes at a difficult time for India.

It is still recovering from a crisis among non-banking finance companies triggered by the default of IL&FS at the end of 2018.

It also had to contend with a financial sector shaken to its core in recent years: in early 2018, a $2 billion fraud was uncovered at Punjab National Bank, while at the end of 2019, another fraud was discovered at a cooperative bank.

India’s economy is slowing with a slump in consumption, while more recently the coronavirus pandemic has spread to India, causing further uncertainty.

“Pressure from the virus has increased in the past few days,” says a head of investment banking at a state-owned bank, speaking to Asiamoney in the middle of March. “The supply chain will be impacted, and some Indian companies have already announced impacts on their production.”

This means that a further credit slowdown is likely, he adds, as well as a rise in non-performing loans as risk appetite shifts yet again.

The rapid spread of coronavirus makes a flight to quality more likely.

Fitch’s Guha points out that the operating environment for banks in India has been negative for a while, and as Yes Bank’s woes surface, it “doesn’t bode well for the sector”.

“There is ample liquidity in the system,” he adds. “But [as] the authorities [have bailed] in the AT1, it could potentially shake depositor confidence and prompt flight to safety towards [state-owned] banks.

“Liquidity is there, but I won’t be surprised if it gets reallocated.”

Guha reckons some small, private-sector banks could be more vulnerable now, especially those that have been in the news already over asset-quality concerns.

Axis Capital’s Negandhi adds that some depositors may panic and put their money in firms such as Axis Bank, HDFC and SBI instead. But he draws a comparison between how the RBI handled Yes Bank versus how the difficulties at non-banking finance company Dewan Housing Finance Corporation (DHFL) unravelled in the middle of last year.

DHFL defaulted on about Rs15.7 billion of debt in August, before the central bank stepped in, took over the board and filed insolvency proceedings against the company.

“Had things with Yes Bank gone the DHFL way,” says Negandhi, “it would have been a very different outcome. So how the RBI is resolving it is truly impressive.”

But not all bankers in India are as impressed: some think the central bank should have been far more proactive, tackling the issues at Yes Bank much earlier.

“There have been murmurs around Yes Bank for a few years now,” says a senior investment banker at a privately owned bank. “And from what I know, many people have been going to the RBI over the years to tell them that things are not fine at Yes Bank. The buck really stops with the RBI.”

The head of investment banking at a state-owned lender compares the Yes Bank resolution to the functioning of a hospital.

“It’s like when you go into surgery at the intensive care unit,” he says. “The problem was identified earlier, but the medicines didn’t work. So now, surgery is needed.

“That’s how it was with Yes Bank. The RBI found big divergences under the previous management, identified the issue around [Kapoor] and demanded a CEO change, but that wasn’t enough and now it has gone further.”

The senior investment banker at the privately owned bank reckons the RBI acted a bit too late.

“Their wake-up call was when Raghuram Rajan [the former RBI governor] asked them to be more proactive around asset-quality review (AQR). Now, I suspect the government will push them to be more proactive.”

The RBI started the AQR in December 2015, in a bid to force banks to classify their non-performing loans, which were until then mainly being ignored. But the last such AQR is understood to have been done in late 2016 and early 2017.

“I don’t think the big banks are in danger; there won’t be any skeletons coming from there,” adds the senior investment banker. “But the small, local, cooperative banks are very community-driven and lend to businesses that may not be stable. These banks could be wiped out if problems or frauds emerge in their businesses.”

He reckons the government should give a big push to consolidating these cooperative banks before they get into further trouble.

“The metrics for these small banks need to more stringent,” he adds. “Be it their capital ratios, tier-1 capital or adequacy ratios, it needs to be more stringent and more frequent review is needed.”