Volatile Zee shares cast a shadow on MFs' loan-against-shares play

Experts say instances of lower share cover can backfire for fund houses as markets remain in a bearish phase

The meltdown in Essel group shares on Friday raised concerns over the loan-against-shares (LAS) model where initial estimates show mutual funds (MFs) have an exposure of at least Rs 23,000 crore.

According to industry sources, fund houses, in some cases, have taken exposure to entities with less than two times the share cover. 

This is lower than what the Reserve Bank of India (RBI) stipulates for non-banking financial companies (NBFCs) that lend against shares.

The RBI stipulates that all NBFCs with more than Rs 100 crore asset size need to maintain a loan-to-value (LTV) of 50 per cent where listed shares are placed as collateral. 

An LTV of 50 per cent means that for a Rs 50,000 loan, the market value of the collateral shares need to be Rs 1 lakh. This translates into two times the share cover.

Experts say that instances of lower share cover can backfire for fund houses as markets remain in a bearish phase.  According to sources, the Securities and Exchange Board of India (Sebi) may look at the recent episode more closely and also develop a more robust risk-management framework, if warranted. Sources added that Sebi asked fund houses to share details of their debt exposure to Essel group companies.

If fund houses had higher share cover, they would have had little reason to be worried after the recent correction in shares of Essel group companies, according to experts. “A share cover of 2.5 times would have fallen to 1.5 times after a correction of 30 per cent. This would still give a higher margin of safety to fund houses,” said the head of fixed income of a fund house, requesting anonymity.    

The reports of Essel group’s alleged link with Nityank Infrapower had caused the initial selloff in the group’s shares on Friday. Shares of Essel group companies fell between 10 per cent and 33 per cent during Friday’s trade. Fears of promoters’ pledged shares getting invoked led to more selling.

Experts added that the loan-against-shares model has its own set of risks as promoter entity pledging the shares doesn’t have any operational cash flows. 

“The cash flows come from dividend income or some upside in equity. If there is no re-financing or roll over, the consequences can be quite severe,” said another fund manager.

According to industry sources, most of the large-sized fund houses have exposure to the LAS market.

For now, concern over fund houses’ exposure to Essel group through LAS seems mitigated with group companies’ shares seeing a sharp bounce back on Monday.

Shares of Zee Entertainment rose 16 per cent on Monday after the company reached an agreement with lenders to not invoke the pledged shares. Shares of Dish TV gained nearly six per cent. Essel group has also denied links with Nityank Infrapower.

The lenders have also taken comfort from the promoters’ call for a speedy resolution through a strategic sale in Zee Entertainment. The lenders have given Zee Entertainment three months to find a strategic buyer.

Under scanner

• Lower share cover can hit MFs exposed to LAS market if stock prices see sharp correction
• RBI stipulates loan-to-value at 50 per cent or 2-times share cover
• Sharp correction in prices of collateral shares can make recovery of dues challenging 
• Sebi has sought details from MFs on their debt exposure to Essel group companies