IL&FS crisis: HFCs with weak liquidity to face heat as MFs on high-alert

Rising redemption pressure complicates the situation for debt fund managers

The downgrade of IL&FS paper from double A plus to junk status in a matter of a few days has created a panic-like situation among debt fund managers and is making them take pre-emptive action against possible risks in their portfolios.

The debt schemes are also staring at redemption from large corporate investors; resulting in money managers shoring up cash levels through asset sales.

According to the head of fixed-income of a large-sized fund house, fund managers are concerned that the liquidity tightness created by the IL&FS crisis can have a wider impact.

“There is a systemic colour to this event. If not addressed credibly, things can spiral out of control. The corporate bond market doesn’t have much depth in any case,” he said.

There is already some spillover effect being felt in the corporate bond market. According to a debt fund manager, this exercise of pre-empting risks could hurt housing finance companies (HFCs) with asset-liability mismatches and high leverage on their books. “IL&FS was also in a way a wholesale-funded entity running high leverage and fund managers don’t want to be again on the wrong side of any rating downgrades,” he said.

This change in sentiment doesn’t bode well for HFCs that also depend on mutual funds for their funding. Data from Prime MF database shows that HFCs get close to Rs 2 trillion of debt funding from mutual funds, which is more than a third of banks’ gross credit extended across non-banking financial companies (NBFCs).

Analysts tracking HFCs reckon that the asset-liability mismatch over the shorter-tenure is a source of concern. “HFCs have migrated toward shorter-tenure borrowings as the rate differential between shorter-tenure borrowings was around 100 basis points cheaper than longer-tenure borrowings. This has created an asset-liability mismatch in the shorter tenure bucket (up to 1 year),” said analysts at JM Financial.

Recently, DSP MF sold some of its debt exposure in Dewan Housing Finance (DHFL). In a TV interview, Kalpen Parekh, president of DSP MF, said that the fund house has sold Rs 3 billion worth of debt papers of DHFL on Wednesday as part of the fund house view to bring down the maturity in its portfolios. Parekh added that the fund house has not only sold DHFL’s papers, but a dozen bonds in recent months, to bring down maturity and plan for some seasonal redemptions. The management of DHFL assured that they were not facing any asset-liability mismatch and the company’s fundamentals remained strong. However, fund managers point out the fact that DHFL papers got sold at 11 per cent yield when such papers typically trade between eight and nine per cent, indicates tightening of liquidity in the system. 

“For HFCs and NBFCs in general, the yields have inched up 50-70 basis points over the last 15 days. People are talking about Triple A and non-Triple A NBFCs given their different profiles,” said Lakshmi Iyer, chief investment officer-debt of Kotak MF.

“Borrowing costs for corporates in last one year has gone up between 100-150 basis points. However, it is more relevant for NBFCs as they are dependent on wholesale markets which react more quickly to the rise in rates,” said another debt fund manager.

Besides debt fund managers becoming more selective with their exposures, experts say HFCs will also now have to contend with the strong competition risk posed by banks. “Banks have now become more aggressive in the mortgage space and have certain advantages over NBFCs such as a better liability side,” a fund manager said. “Rising borrowing costs combined with increased competition can hurt the profitability of HFCs,” the fund manager added.

Further, redemption risks have complicated the situation. Typically, mutual funds face redemptions in September as corporates take out funds to settle their tax obligations. Fund managers say the situation could worsen in the current environment. According to people in the know, the IL&FS event is making some large corporate investors in debt schemes nervous with some already putting requests for redemption. The investor sentiment on debt schemes was already weak with such schemes seeing a net outflow of more than Rs 500 billion in this fiscal year.  

Ajay Manglunia, executive vice-president and head-fixed income of Edelweiss Financial Services, said that the recent asset sales have also got to do with the way mutual funds are structured. “Unlike banks which typically have more leg-room to deal with various risks emerging from debt exposures, mutual funds don’t have much that they can do apart from selling exposures before things worsen,” he said

Manglunia added that fund managers are on high-alert as they look to escape this closely-knit web of problems without getting caught on the wrong foot. Fund managers stay hopeful. “Managements of these (HFCs) companies have come out and assured that they are fundamentally in a good position. Going ahead, we should see things improve,” said Mahendra Jajoo, head of fixed income at Mirae AMC.