Why Loan Moratorium May Be A Problem For Mutual Funds
Even as the market regulator eased norms for rating agencies amid disruptions caused by the coronavirus outbreak, mutual funds may not be in a position to restructure any debt instruments.
But SEBI guidelines are not clear, a senior executive at a domestic mutual fund house told BloombergQuint on the condition of anonymity as the regulator is involved. SEBI has left it to the understanding of mutual funds and credit rating agencies, he said.
According to Rajat Bahl, chief ratings officer at Brickwork Ratings India Pvt. Ltd., all SEBI said is that obligations can be rescheduled. Earlier, restructuring of obligation to avoid potential default was considered as default, but now it will not automatically be considered a default, he said.
Rating agencies will do the diligence and take an appropriate rating action that could be maintaining same rating or a downgrade, Bahl said. They will have to assess whether the restructuring is due to the temporary liquidity issue because of lockdown or is it a solvency issue, he said.
In the case of bank loans, the understanding among credit rating agencies seems to be clearer and uniform. India Ratings and Research Pvt. Ltd. said, in a media statement, that it will not treat missed payments before approval as ‘default’. But any bank subsequently not providing necessary approval for a missed payment by a borrower will necessitate the entity’s Issuer Rating being downgraded to ‘IND D’.
For mutual funds, the problem is that they’re required to seek investors’ approval before restructuring any instrument, such as a bond or debenture, issued by a borrower. That is a challenging requirement given the current circumstances when the majority of investors may seek redemption rather than restructuring.
Moreover, it’s also not certain investors will agree. Mutual funds will find it difficult as they have retail and high net worth investors to convince, and their own investment committees, Bahl said.
India Ratings clarified in its statement that investor approval for non-payment is necessary to avoid being rated as a default.
If an issuer decides to avail a moratorium for any payments related to debentures/bonds/Pass Through Certficates/Commercial Papers, India Ratings and Research will require a prior approval from the investors (through the trustee(s) or otherwise) before the due date of the payment. Non-payment without the prior consent of the investors may be treated as a Default by the agency.India Ratings and Research Statement
Another issue that the mutual fund industry faces is pass-through-certificates—a kind of fixed-income security based on a pool of loans. If an originator or a lender provides a moratorium to its borrowers as per the Reserve Bank of India’s guidelines, investors in PTCs won’t receive any amount for three months.
Hardly any PTCs in the last couple of years have enough buffer to cover three months of no collections in the underlying pool, Bahl said. 90 percent of such certifications may not be able to cover a scenario of no collections.
Wherever a mutual fund is involved, it’s not an easy call to restructure, he said.
According to Bahl, mutual funds will need to speak to the borrowers and ask them whether they will be able to pay else put up these instruments to the banks under LTRO. Banks can buy these corporate instruments and negotiate on a bilateral basis with the issuer for an extension, he said.
Lakshmi Iyer, chief investment officer (debt and head products) at Kotak Mutual Fund, however, said that if mutual funds face problems with PTCs, they can take part in longer-term refinancing operations—where banks will be made to buy corporate bonds.
The fund executive quoted earlier said PTCs as instruments may not find any takers due to credit quality or concerns regarding the solvency of the issuer. Mutual funds then will have to side-pocket PTCs if they are classified as ‘default’ by the rating agencies, he said.
As the moratorium ends on May 31, there could be concerns about debt coming up for repayment in June. Businesses will have to ensure they start generating cash accruals to service debt.
According to Brickwork, 55-60 percent of the borrowings are from banks and can be easily restructured under the moratorium. Another 20 percent are bilateral agreements and may not trigger any issue if the borrower is able to convince the counter-party. The problem, it said, may be with the remaining 20 percent.
This remaining 20 percent includes debt investments of mutual funds, insurers, portfolio managers and other investment funds. This issue can aggravate if these instruments are owned by foreign investors through custodians. If they refuse to extend the tenure of these instruments, the borrower may end up at the National Company Law Tribunal.
In such a scenario, all credit rating agencies will have to downgrade the instruments as ‘default’, said Bahl.