Reports have emerged that Infrastructure Leasing and Finance (IL&FS) Ltd, a large infrastructure development company, has failed to repay debt, triggering concerns of a financial crisis in the company. This has wider ramifications for not just the finance providers but also the debt mutual funds which hold IL&FS papers.
IL&FS has not been able to pay more than three-fourths of a deposit of Rs 250 crore which it owed to Small Industries and Development Bank of India (SIDBI). In addition, on August 28th IL&FS Financial Services, a subsidiary of IL&FS, committed a default on its debt, repaying the money after its due date.
Now all of this may have caused mutual funds holding the debt of IL&FS group entities to downgrade their holdings.
Reports indicate that DSP Credit Risk Fund, which has a substantial holding of IL&FS group debt, did this type of markdown on Friday. The fund’s Net Asset Value (NAV) plunged from 29.06 to 28.83 in a single day, a drop of 0.8%.
Such a fall may not be unusual for equity funds but is steep for debt funds. Therefore, defaults or delayed payment of debt by companies like IL&FS is likely to dent the confidence of investors in money market funds.
It brings to mind the more dramatic episode by the erstwhile JP Morgan Mutual Fund with a default in Amtek Auto debt and by Franklin Templeton Mutual Fund with a default in JSPL.
It is unclear at this point how much further the fund’s NAV will fall. Within its top holdings, DSP Credit Risk Funds holds 3.21% as a structured obligation issued by IL&FS Transport Networks and roughly 3.3% in debt issued by IL&FS Energy. It is also unclear which other mutual funds own IL&FS debt.
The one year return on DSP Credit Risk Fund has plunged to 3.3%, lower than the category average of 4.9%. The three-year CAGR for the category stands much higher at 8%.
Credit Risk funds hold more than 65% of their assets in low rated debt. More specifically they hold 65% of their assets in debt rated below AA+. In return, they get higher interest rates on such paper. However, the threat of defaults and downgrades looms large on them.
These funds have only been formally defined as a category after the SEBI reclassification of October 2017. Prior to this, defaults have affected debt funds of all categories. Amtek Auto defaulted on its debt in August 2015, forcing drops of 3.4% in JP Morgan Short Term Fund and 1.7% in JP Morgan Treasury Fund. The fund house also restricted redemptions in the two funds.
In February 2016, Jindal Steel and Power (JSPL) debt was downgraded by ratings agencies causing hits to the funds of Franklin Templeton such as Franklin Templeton Short Term Income Fund and Franklin Templeton Credit Opportunities Fund. The AMC subsequently took the debt off the books of the concerned funds and on to its own books and their NAV gradually recovered. However, fund investors did suffer from the loss caused by the downgrade.
Meanwhile, IL&FS is holding discussions with its shareholders LIC and SBI for an immediate loan of Rs 3,000 crore, besides expediting the Rs 4,500 crore rights issue which is slated for November.
Watch this space for more updates on this development.