To the credit of the RBI and the government, the LVB crisis was resolved in record time. Despite imposing a one-month moratorium on Lakshmi Vilas Bank, the merger deal with DCB Bank India was sealed in a week and the 1-month moratorium was cut to 10 days. That surely gives confidence to the depositors of public and private sector banks.
However, investors in equity and bonds may not entertain the same feeling. The entire equity capital along with free reserves and share premium was written off against the negative net worth. That resulted in equity shareholders getting virtually nothing. What is more; the RBI even asked LVB to write down Rs320cr worth of Tier-2 bonds to zero value. Even as investors cry hoarse over the treatment meted out to investors; there are 5 wise lessons investors must pick up from the LVB-DCB deal.
Bank depositors will get first priority in any bank crisis
Trying to fish in troubled banks is nothing new. People tried it in Global Trust Bank and failed, they tried it in Yes Bank and failed and it has not worked in LVB too. The reason; RBI and the government have first accountability to bank depositors. Any scheduled private or PSU bank runs on the trust of the depositors. Letting depositors incur losses is to create systemic risks. In any bank crisis, the focus will always be the protection of the depositor. Keep that in mind when you invest in bonds or shares of weaker banks.
Tier 2 Bonds and AT1 bonds are high risk bonds
When Yes Bank went into moratorium, first thing the RBI did before bringing in SBI was to write off Rs8,415cr of Additional Tier-1 or AT1 bonds. These are perpetual bonds and so you can call them quasi equity. The risk of these bonds is there in the fine print. The same applies to Tier-2 bonds also where LVB wrote down Rs318cr. Here again, these bonds are purely bought for higher yields with full knowledge of the risks. Ignorance of the law and not reading the fine print cannot be excuses.
If you speculate on a bank crisis, be prepared for the risk
Let us face it; any investor who bought stressed bonds of a bank at low prices or who bought the stock at low levels took a calculated risk. The temptation is that even if you get a few such trades right you make big money. People buying stocks or bonds of troubled banks know very well that the outcome can be discrete. It could result in supernormal profits but it could also end up wiping out your investment. To be fair, you cannot speculate on a bank in crisis and then claim that the smooth-talking salesman mis-sold to you. Invest in these bonds knowing that the outcomes can be discrete. Be prepared to lose your money.
In most bank crises, equity investors will get nothing
There is no rocket science to this. Look at the most high profile cases. Shareholders of Global Trust Bank and LVB got virtually nothing. Yes Bank shareholders may have got something but that pittance has come at a huge price. Why do equity shareholders of troubled banks almost always get nothing? Normally, banks are sent into moratorium when the net worth is substantially eroded. Any potential buyer would insist that they would be willing to take over the balance sheet without the accumulated losses. The only option for the RBI then is to write down the capital against existing equity and against the Tier-1 and Tier-2 bonds. Unless the bank is a PSU bank with a substantial government holding, equity would be the first casualty of any bank rescue.
Watch for warning signals: net worth, ratings, bond prices
It is one thing to say that troubled banks should be avoided. That is extremely prophylactic in nature. There are occasions you may have bought the stock in better times. LVB was at Rs.200 just 2 years back. What if you bought a troubled bank at the recommendation of your broker because you thought the risk was worth it? The key is to look for triggers. Watch out if the net worth is eroding rapidly as it puts your equity at risk. Look for spike in bond yields. Think with your feet if an M&A deal falls through. These are typical indications that something is wrong. Lastly, if you see a significant rating downgrade, it is best to exit. In the case of LVB, CARE had issued a credit warning note just 45 days back. You could have still escaped with something in your kitty.
To be fair, investors must appreciate the Caveat Emptor principle. Let the buyer beware; is at the core of any such transaction. Know your risk and if you find triggers, just exit. That is what the LVB fiasco actually teaches!