It is December 2018; the mutual fund industry is just recuperating from the mess created by IL&FS defaulting on its repayment & major AMCs & rating agencies being dragged into the sludge for their failure to recognise the imminent default – intentional or unintentional is a debate for another day.
Though AMCs were nursing wounds caused by an unprecedented event, their portfolios continued to stand bold with almost INR 8,000 cr. plugged into debt securities of an already troubled Essel Group. What’s more is that over 20% of this was held in portfolios of Fixed Maturity Plans and there was no visible attempt to dilute concentration.
Cut to April 2019.
Even as IL&FS taught the industry a great lesson in risk management, many failed to learn or perhaps chose not to. This is evident by the default on FMPs which has resurfaced for perhaps the first time after the 2007-08 fiasco.
What happened exactly?
Kotak FMP series 183 stood to mature on 10th April, 2019. However, given that ~27% of its portfolio is stuck with relatively illiquid instruments issued by troubled entities – IL&FS and Zee Group companies – Edison Utility Works & Konti Infrapower and Multiventures. Hence, while the invested principal amount was INR 457 Cr., investors were repaid INR 455 Cr.
Why did this happen?
The Essel Group company debentures were rated A+ and secured by the pledge of shares of ZEE Limited as collateral. At the time of lending, the value of collateral was 1.5x the value of exposure which seemed comfortable at the time.
Per communication received from Kotak AMC, on 25th Jan 2019, shares of ZEE Limited tanked by c. 25% in a day which brought down the value of collateral and the borrower was unable to top-up its collateral to secure the debentures adequately.
On 26th Jan, 2019, lenders to Essel group got together to discuss the way forward to recover dues. Majority lenders reached a conclusion that, if all the lenders were to invoke pledge of shares and liquidate the security, it would have resulted in erosion of collateral value and lead to sub-optimal recovery of dues.
The promoters of Essel Group disclosed that they had initiated the process of strategic stake sale in Essel group companies including Zee Entertainment Enterprises Limited. They needed some time to conclude the strategic sale process. They also needed assurance on non-enforcement of security which was required for prospective buyers to remain engaged with them.
Lenders had two choices:
- to invoke the pledge, enforce the security, sell the shares and risk sub-optimal recovery of dues. This would have converted notional loss into an actual loss or
- to provide additional time to promoters to complete the strategic sale process to enable them to pay lenders all their dues along with interest.
Many, like Kotak AMC, chose the latter and have allowed the borrower time till end of September 2019 before they invoke collateral sale as an option to recover dues.
Is there more trouble in store?
Yes. Kotak AMC has withheld certain part of units in 6 FMPs viz. Series 127, 183, 187, 189, 193, 194, represented by portfolio investment in Essel Group companies. This could mean yet another round of principal-eroded repayment for FMPs closing in on maturity.
Meanwhile HDFC AMC has rolled-over its FMP with scheduled maturity on 15th April 2019 to 29 April 2019 as liquidity woes continue to cripple the market. This sets a sombre undertone for typically all funds (especially FMPs) holding lower-rated papers.
While FMPs, by structure, does not let an investor redeem funds till maturity date, we can expect a strong worry-driven run on open-ended funds which cumulatively accounted for ~80% of the industry’s exposure to Zee group.
The trouble only amplifies if Essel Group is unable to liquidate its shares adequately to repay lenders even till September 2019.
Our view on the Essel Group episode
Currently, the situation is viewed as deferment of payment instead of default of payment. However, it is difficult to identify the oasis from the mirage. The street is abuzz with talks of fructification of a stake sale in the group’s crown jewel – Zee Entertainment. But, what’s more important is the value and timeliness of the stake sale – both of which seem hazy at the moment.
The way ahead for investors
We have maintained a strong stance against credit risk and fixed maturity plans since the past year or so and continue to resist temptation to chase higher yields that bring along credit risk and illiquidity.
Customers who have invested in line with our guidance are insulated against this episode. However, for the investors who have chosen funds out of free will and are affected, will receive a rebalancing notification as we try to mitigate the impending risk in those funds.
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If you have any concern, please write to us at ask@fisdom.com or call at 080 48039999, we would be happy to answer your query.
Thanks,
Nirav (Head of Research)
Fisdom
