Stuck In Quicksand
Debt funds are fast losing sheen as they draw fire for falling prey to defaulting securities. A host of negative incidents such as fixed maturity plans (FMPs) not paying full maturity amounts, and erosion of debt funds' NAVs have put a question mark on their stability. This also makes them a weak link in the chain.
The past 8-9 months have been particularly brutal for the debt mutual fund (MF) schemes, which manage Rs 11.63 lakh crore, due to a series of defaults in the Indian bond market. This is cause for serious concern as, according to Association of Mutual Funds in India (AMFI) March data, income funds and liquid funds together make up as much as 48 per cent of the Rs 24 lakh crore Indian MF industry. Any trouble will have a far reaching effect.
The trigger point was when IL&FS, which had a debt of $13 billion (about Rs 91,350 crore), defaulted on some of the repayments in September 2018. The dust had barely settled when rumours of a liquidity crisis at Dewan Housing Finance (DHFL) led to a steep fall in its share price. Following this, concerns regarding Essel Group's repayments cropped up, which led fund houses to default on their redemption proceeds and push forward maturity dates.
The latest among the series come from Anil Ambani's Reliance Group entities, Reliance Home Finance and Reliance Commercial Finance, which have been downgraded to below investment grade. This has thrown a shadow on MFs' exposure of about Rs 2,500 crore to them. Other large companies in trouble include DHFL, Essel Group and Yes Bank.
By late 2018, bad business decisions led a set of large companies to default on their loans leaving behind a financial mess. "The shadow banks, NBFCs and MFs, which had lent money to IL&FS and Essel Group to stand, have their backs broken by the massive unpaid dues," says Alok Agarwala, Senior Vice President and Head of Investment Analytics, Bajaj Capital.
FMPs were also caught off guard. Kotak Mahindra Asset Management informed investors of Kotak FMP Series 127 that they would not be able to redeem the entire amount because of the fund's exposure to the Essel Group. HDFC Mutual Fund also decided to extend the maturity of some of its FMPs for the same reason.
Weak Foundation
These rollovers were caused largely due to restructuring of bonds that were backed by share pledges, say experts. "In case of share pledge instruments, the credit risk assessment is largely driven by the price of shares, hence risk assessment of share price is extremely critical," says Bhushan Kedar, Director, Funds and Fixed Income Research, CRISIL. For instance, on January 25, 2019, invocation of a mere 0.6 per cent of equity share capital of Zee Entertainment Enterprises (ZEEL) resulted in a fall of 26 per cent in its share price. So, even if a few major lenders had invoked the pledged shares, share prices would have fallen and the realised value against the debt would have been significantly lower. "Given the sharp drop in share prices on sale of a small quantity of pledged shares, their panic selling would have further exacerbated the situation and resulted in sharp drawdowns in investor values," says Kaustubh Belapurkar, Director-Fund Research, Morningstar.
Nine fund houses have exposure of about Rs 6,945 crore to Essel Group companies, according to Morningstar data. HDFC MF's FMPs have the highest exposure of Rs 876 crore. Aditya Birla MF tops the chart as a fund house (Rs 77 crore is in FMPs).
Market experts are being cautious and believe that if the Essel Group fails to repay on the agreed date, the lenders may try to recover from pledged shares. "The standstill agreement ends on September 30, after which MFs and other holders of Essel Group's pledged shares may come to the market to realize dues, if the 'Zee horror show' continues," says Agarwala. If this happens, the situation could worsen.
As a result of their exposure to defaulting companies, the debt schemes of several MFs have seen their NAVs erode. Some schemes have even lost their entire year's gain as the fund houses have marked down their investment in the downgraded securities. Past one-month returns of some debt schemes (as on May 9) are down by over 6 per cent due to this. For instance, UTI Banking and PSU Debt Fund's one-month return is down by 6.37 per cent. Similarly, for Reliance Strategic Debt Fund it is down by 3.26 per cent. Both the fund houses confirmed to Business Today that they have marked down their NAV as per the prescribed guideline.
Loss of Value
Based on a March 22 circular by Sebi, Amfi issued a circular on April 30, to apply standard haircuts for sub-standard securities. For example, 50 per cent for the infrastructure sector and 75 per cent for manufacturing and financial institutions.
"Given the quantum of paper that is coming up for maturity in the next few months, it is unlikely that things are going to settle anytime soon. So, one should not be surprised if the outstanding loan of more corporates is downgraded based on stress faced by the group," says Agarwala.
"Once we receive the funds and securities are repaid, the valuation will be written back and all investors who remain invested in the MF schemes will not be impacted at all," says a Reliance MF spokesperson. On April 8, the fund house sold pledged shares of Zee Enterprises worth Rs 410 crore.
In five years, debt funds' AUM has almost doubled from to Rs 11.63 lakh crore in March 2019. "Higher growth in AUM led to some complacency from the fund management's point of view," says Agarwala. The IL&FS default was a wake-up call; its rating was cut to junk status from triple-A in a matter of weeks, he adds. Such events also put in doubt the effectiveness of credit rating agencies in alerting the system of risks lurking beneath the surface.
The writer is a Mumbai-based finance journalist
