April 12, 2019

A Complete Analysis on the Current Crisis in Debt Markets

Sunil Jhaveri

Founder - MSJ MisterBond Pvt Ltd An Advisor 2 Advisor - B2B Platform

A Complete Analysis of the Current Crisis in Debt Markets 

A take on the current crisis in Debt Markets due to Mutual Fund Exposure to Essel Group with exposure to Zee shares as Collaterals by MisterBond

First and foremost, let me make this very clear that this note is not to defend or criticize any AMCs for their exposure to this LAS (Loan against Shares) structures of Essel Group against shares of Zee. This note is only an effort to bring back sanity to the already crisis-ridden debt markets and not precipitate it further by our irrational/illogical reactions due to huge negative media glare.

Let us analyze this situation dispassionately and from a distance to come up with some logical conclusion:

Please understand the choices MFs had on debt given to Essel group against Zee shares:

1) if AMCs would have sold pledged shares, prices would have tanked substantially there would have been actual loss and limited recovery.

2) We all know what happened in Jan when “a small lot of” Zee shares were sold by lenders. 1.5 times cover dropped to almost 1.05 times and would have gone in negative if selling would have continued.

3) “Below par recovery would have” negative impact on schemes holding Zee shares as collaterals including FMPs and open-ended credit funds.

4) “A mere liquidity crisis” or “asset-liability mismatch” would have then been converted to actual losses for investors.

5) Most FMPs have paid more than the principal invested barring one FMP has paid out 99.2 % of the principal.

6) At such crisis times, it is better to give time to the AMCs to sort the issues out and come up with solutions.

7) All of us are aware of what happened when the Amtek Auto default happened. We did not give time to AMC and put huge redemption pressures which only harmed the investors. Eventually, AMC actually salvaged 85% of the value of Amtek Auto security. The same thing happened with JSPL. A delay isn’t a loss of full principal.

At least currently:

• Investors have been paid 90% of their investments along with interest (thereby recovering nearly their entire principal)
• 10% portfolio is live and earning interest.
• The possibility of coming up with a solution between now to September ’19 is high.
• Zee shares have stabilized and back with a cover of almost 1.4-1.45 times.
• A one-notch downgrade from Credit Rating Agencies; thereby limited MTM.
• Worst case scenario, AMCs not being paid and resorting to the selling of shares in September at huge discounts. That AMCs could have done even now.
• At least higher probability of recovery during this intervening period if promoters are able to salvage.
• Some AMCs have in the meanwhile been able to obtain the personal guarantee of Mr. Subhash Chandra (promoter of Essel Group)
• Let us understand the benefit of diversification and explain the same to Investors.
• We tend to forget these lessons from time to time and chase returns. Hopefully, we will be more careful going forward
• There is nothing for AMCs to gain by delaying some portion of the investments of your Investors. If at all, they are only trying to resolve the issue and protect the interests of the investors. They could have very easily sold all shares at one go of Zee and recovered maybe 20-40% of the value and passed on the loss to the investors without blinking an eye and rightly so as Credit Risk is part and parcel of investing in debt schemes.

Fortunately, SEBI has stepped in and given guidelines for such structures going forward. Also, I believe one of the FMPs has been extended by one more year. That is not the right solution and should not have been done (if true). That is going against the mandate and interests of the investors.

Of course, lessons to be learned for all participants in the Mutual Fund space:

Asset Management Companies

• AMCs should take cognizance of such structures like LAS (Loan against Shares) and see overall industry exposure to gauge whether it is in excess of what markets can absorb without share prices getting affected dramatically due to it being illiquid stock or not.
• Should such illiquid structures be part of schemes like FMPs?
• AMCs to have their own internal checks and balances; even beyond SEBI guidelines to contain credit, concentration, liquidity risks (I had written about this in a series of articles during JSPL and Amtek Auto crisis in 2016)
• Create an environment to have a common information pool of exposures to different structures in the Mutual Fund Industry and come up with the right exposure to a group or a company for different structures within the overall agreed proportions.

Advisors

• Advisors to understand the risks attached to such structures and its implications and advice their investors accordingly.
• Not get carried away with the greed of the Investors in chasing returns.

We cannot be asking Investors to be patient every time there is a crisis in the Industry. This way they will lose their trust and faith in Mutual Fund as an investing vehicle. Instead, if we can become pro-active as an Industry and self-discipline ourselves on several issues so that we do not have to say those dreaded words “This Time it is Different”.

Let us act maturely, stay calm, think logically, not panic and hand hold investors during such trying times instead of adding fuel to fire which is being done by Media on a daily basis.

Our job as advisors is not to be part of the Herd but be outside the Herd and guide the investors on the right path!