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Zee effect: We've to improve our process to safeguard investor interest, says Nilesh Shah

This is the first time after 2008 where investors in FMPs are not getting repaid in full on maturity.

ET Bureau|
Updated: Apr 12, 2019, 08.21 AM IST
Investors in eight Kotak FMPs maturing between April 4 and May 15 will not get back the entire money on account of the delay in repayment by the two Essel group companies — Konti and Edison – which are backed by security of shares of Zee Entertainment Enterprises Ltd. This is the first time after 2008 where investors in FMPs — a debt product with a lock-in – are not getting repaid in full on maturity. ET spoke to Nilesh Shah, managing director, and Lakshmi Iyer, chief investment officer (debt) and head (products) at Kotak Mutual Fund.

Edited excerpts:

Banks don’t fund promoters against their shares, while NBFC funding is shrinking. Will mutual funds too be reluctant to do this kind of loan against shares especially after critics have commented mutual funds saying they are behaving more like lenders than investors…

Nilesh Shah: Till today in the 25 plus years history of debt mutual funds, there is no incidence of a mutual fund losing money in loan against share (LAS). Now in an instrument where mutual funds have never lost money, just because there is one restructuring, should mutual fund stop investing? We have to manage risk to generate return. The entrepreneurs of India need risk capital. This was provided by NBFCs to a great extent, insurance companies to some extent and by mutual funds to a much lesser extent. In CY19, there has been five pre-payments or repayments by promoters of companies like Emami, Apollo Hospitals, Bajaj Corporation, Future Retail and Bharat Forge. No doubt we have to learn from the current event and improve our process to safeguard investor interest.

Critics believe, fund houses agreeing to give time to Zee promoters to repay till September 30 is not a good precedence?

Nilesh: This is not a precedence. In last quarter itself, we have taken full prepayment on breach of margin requirement in one of the investments. In the case of Essel Group look at the sequence of events that has happened. On 25th of January, share price of Zee collapsed from Rs 434 to Rs 319. It happened because some lenders sold zee shares on margin call for a small amount. The sharp correction of more than 25 % happened as market was pricing panic selling by other lenders whose margin call got triggered after the crash.

There was a collective exposure of ~ Rs 13,500 crore by mutual funds, NBFCs and offshore lenders against shares of Zee Entertainment, Dish TV and Essel Infra. Lenders had two choices, either invoke the pledge, sell the shares and recover whatever is there or extend the timeline and give promoter ability to do a strategic stake sale to repay dues in full. We felt that by selling the shares we would have recovered substantially lower money than our dues and converted notional loss to actual loss.

If we had exercised the option of selling the shares of Zee along with other lenders and realised lower money than our dues then we would have been asked why we sold shares cheap for the benefit of the buyers rather than wait for the strategic sell process and recover full dues. We firmly believe that our unit holders are better protected in terms of recovery of dues with this extension as strategic stake sale normally fetches higher price than market price.

Shouldn’t fund managers consider the quantum of pledge by promoters while valuing a security?

Nilesh: There is certainly learning for us from the Zee episode. Now when we are doing such deals, we are putting caps on how much promoters can borrow in both absolute and/or relative terms through share pledging. This cap is put to ensure that even if the stock price falls by 50-60%, the promoter will have the ability to provide security for margin and doesn’t become overleveraged to repay or get refinance from the market.

In the Zee Episode, don’t you think the rating agencies could have done more since they waited long to downgrade the paper?

Lakshmi: In our opinion the rating agencies have done a fair job. Post IL&FS, they have become extra careful on the rating side. In Zee case, the lenders have provided allowance of time for repayment of dues. There has been a downgrade in the rating by one notch to reflect the current situation which we believe is appropriate.

Do you have the power to change the terms of agreement, like extend it by six months etc…?

Lakshmi: It is very much part of the prerogative of the lender. This change is approved by a majority of lenders to Essel Group Cos, which vouches its appropriateness.

What is your Plan B, if the stake sale deal doesn’t go as planned?

Nilesh: We are reasonably sure about Plan A as we are better secured and better rewarded compared to what we were on Jan 26, 2019. We have taken personal guarantee from promoters as additional security over and above the existing security of Zee shares to safeguard our unit holders’ interest. We have also received a graded upside sharing contingent upon strategic stake sale in Essel Group Cos over and above 11.1% coupon which will be paid up to the repayment. The entire proceeds received from the interest and upside sharing is for the benefit of our unit holders. In case Plan A doesn’t work out by Sept 30, 2019, then we retain the option of selling the shares, enforcing personal guarantee and recovering our dues.

If there is reluctance from fund houses to lend to promoters, do you expect the inter-corporate deposit (ICD) market to get bigger?

Nilesh: I think it is extremely unlikely. The ICD market is unregulated. While it thrived for a while in the pre-2000 era, it ultimately resulted in far bigger defaults. The process of giving loans to promoters against shares being followed by MFs will improve, fund houses will take more precautions. We will demand higher security as well as capping of leverage. Please also remember that we can’t view all the loans against shares from the same point of view. Some of the promoters pledge their shares for institutional borrowings by their companies.

Will the returns of debt mutual funds go down because fund managers will take lower risk due to this episode?

Nilesh: Our job is to optimise riskadjusted return. Debt funds can be broadly classified based on the risk they take. There are funds which manage credit risk to generate return. A minor portion of our assets are in credit risk category. Our total exposure to Zee is less than 0.38% of total debt portfolio. There are funds which manage interest rate risk to generate return. Majority of our money is in funds which manages interest rate risk to generate return.

There are NCDs offering as much as 9-10% returns to investors, while EPFO is also giving 8.65%. Debt funds have been returning lower than this…

Lakshmi: The EPFO invests up to 15% in equities and locks in investors for a long period of time. The debentures that offer 9-10 % now is almost similar to the yield we have on our credit risk funds. Our portfolio quality is more diversified and has higher credit rating. If we do the mark-to-market of this debentures, over last year they have started offering higher coupon the holding period return for last one year will almost be similar to our debt fund return.

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