Ratings downgradeShares of Reliance Capital, Anil Ambani-led group’s financial services flagship, closed 11-12% down and Reliance Home Finance closed about 4% down (depending on the stock exchange) on Monday after at least two rating agencies cut their credit ratings for the firms. The rating action has been called ‘completely unjustifiable and inappropriate’ by Reliance Capital and Reliance Home Finance, but stock market investors through their reaction have shown signs of stress and worry. The spotlight is now on the mutual fund industry’s exposure to Reliance Capital and Reliance Home Finance. Read on to know more.

Rating actions

Reliance Capital – CARE Ratings (CARE) has revised its rating to A (credit watch with developing implications) for long-term debt programme, market-linked debentures and subordinated debt of the company. The earlier rating was A+. CARE has stated this action is primarily due to the extension of timeline for progress of planned divestments in various companies.

Reliance Capital said it considers the above rating action completely unjustified and inappropriate. There has not been any adverse change in the company’s operational parameters from the time of the last rating action, just five weeks ago. This development is linked to Reliance Capital’s process of monetising its entire 42.88% stake in Reliance Nippon Life Asset Management that is currently valued at over Rs 5,000 crore. There is also a plan to monetise a 49% stake in Reliance General Insurance which has filed for IPO. Reliance Capital claims that when the deals happen it expects to realise minimum proceeds of over Rs 10,000 crore. This would then cut its loan pile by more than 50%.

On its part, CARE while downgrading the rating said that: “The revision in the ratings of Reliance Capital Ltd (RCL) factors in extension of timeline for progress of planned divestments in various companies leading to depletion of liquidity and increasing refinancing risk.”

The ratings remain under credit watch with developing implications as CARE would closely monitor the progress of the sale of group assets/investments as per the timelines stated by RCL in order to reduce its debt levels. Further, the ratings continue to take into account RCL’s sizeable exposure to group companies in the non-financial business segments having weak financial profiles and requiring continued support from RCL. While some of these group entities have been identified by RCL for divestment, timely exit from these investments will be critical for reducing its leverage.

“The ratings continue to factor in strength from RCL’s experienced management and established business franchise of subsidiaries/associates in financial services segments including Asset Management, Life Insurance, General Insurance, Health Insurance, Broking, Commercial and Housing Finance businesses. Going forward, RCL’s ability to maintain liquidity levels and divest group exposures as envisaged and unlock value in a timely manner thereby reducing leverage will act as key rating sensitivities,” CARE said.

Similarly, Brickwork Ratings (Brickwork) has revised rating to A+ (credit watch with negative implications) for long-term debt program, market-linked debentures and subordinated debt of the company. Brickwork has stated this action is primarily due to the extension of timeline for progress of planned disinvestments in various companies. Like in case of CARE Ratings, Brickwork’s action also met with a similar response from Reliance Capital.

Reliance Home Finance – Brickwork Ratings has revised rating to A+ (credit watch with negative implications) for the company’s long-term debt programme, market-linked debentures, subordinated debt, and non-convertible debentures (NCDs) public issue and to A (credit watch with negative implications) for upper Tier-II NCDs, inter-alia, due to revision of rating of the parent company, Reliance Capital Limited.

The company said it considers the above rating action completely unjustified and inappropriate. There has not been any adverse change in the company’s operational parameters from the time of the last rating action, just eight weeks ago, it said.

CARE Ratings (CARE) has revised its rating to BBB+ (credit watch with developing implications) for company’s long-term debt programme, market linked debentures, subordinated debt, and non-convertible debentures (NCDs) public issue and to BBB (credit watch with developing implications) for upper Tier-II NCDs. CARE has stated this action is primarily due to a revision of rating of the parent company, Reliance Capital Limited.

Reliance Home Finance came out with a similar statement against CARE Ratings’ action.

Mutual fund exposure

In terms of equity MF exposure, Reliance Capital is not a major risk for most equity schemes. As per data, Reliance Tax Saver ELSS had the biggest exposure to Reliance Capital but that is limited 0.5% of net asset. Reliance Value Fund also has some exposure but that too is limited at 0.22% net asset. There are a total of just five schemes with Reliance Capital in their portfolio.

Reliance Home Finance too is not a really big bet for any MF equity scheme. As a percentage of net asset, Reliance Home Finance is 2.12% of Aditya Birla Sun Life Emerging Leaders Fund – Series 7. Aditya Birla Sun Life Small Cap Fund also has 0.94% net asset exposure to Reliance Home Finance. There are a total of just 5 schemes with Reliance Home Finance in their portfolio.

Coming to the debt MF picture, Reliance Capital is a Rs 187 crore exposure for fixed income schemes. The Rs 2,000-crore Reliance Hybrid Bond Fund has Rs 75 crore (3.7% net asset) worth of Reliance Capital debt. Another scheme, the Rs 1900-crore Reliance Equity Savings Fund has about 4% net asset or Rs 77 crore of Reliance Capital exposure. In terms of highest net asset percentage, LIC MF Dual Adv FTP-2 has the highest at 16.5% and LIC MF Dual Adv FTP-3 has about 4.9% in Reliance Capital exposure.

Mutual funds’s exposure to Reliance Home Finance debt is much bigger. At last count, Reliance Home Finance debt worth Rs 1,900 crore was with mutual funds. In terms of highest value, Reliance Credit Risk Fund, SBI DAF-XXII, Reliance Strategic Debt Fund, Reliance Equity Hybrid Fund, Reliance Ultra Short Duration Fund, SBI Credit Risk Fund and SBI DAF-XXIII held the most (Rs 120 crore to Rs 370 crore).

Scheme Name Instrument Name Net asset %
UTI FTIF-XXVII-IX(1160D)(G) Reliance Home Finance Ltd. SR-B 62 (15-Sep-20) 9.73
UTI FTIF-XXVII-VI(1113D)(G) Reliance Home Finance Ltd. SR-B 62 (15-Sep-20) 9.53
UTI FTIF-XXVIII-I(1230D)(G) Reliance Home Finance Ltd. SR-B-64 (06-Apr-21) 9.37
UTI FTIF-XXVIII-VII(1169D)(G) Reliance Home Finance Ltd. SR-B 66 (15-Apr-21) 9.22
UTI FTIF-XXVIII-II(1210D)(G) Reliance Home Finance Ltd. SR-B-64 (06-Apr-21) 8.85
SBI DAF-XVIII-Reg(G) Reliance Home Finance Ltd. SR-I CAT III & IV 8.90% (03-Jan-20) 8.44
UTI FTIF-XXVIII-V(1190D)(G) Reliance Home Finance Ltd. SR-B 66 (15-Apr-21) 8.39
Reliance FHF-XXXII-10-1151D(G) Reliance Home Finance Ltd. SR-I CAT I & II 8.70% (03-Jan-20) 8.34
Reliance FHF-XXXII-7-1376D(G) Reliance Home Finance Ltd. SR-B-57 08.64% (25-May-20) 8.22
Reliance FHF-XXXIII-9-1265D(G) Reliance Home Finance Ltd. SR-B-57 08.64% (25-May-20) 8.17

In terms of net asset percentage, UTI FTIF-XXVII-IX(1160D), UTI FTIF-XXVII-VI(1113D), UTI FTIF-XXVIII-I(1230D), UTI FTIF-XXVIII-VII(1169D), and UTI FTIF-XXVIII-II(1210D) from UTI MF stable are most exposed with each holding Reliance Home Finance debt security of 8.85-9.7%.

Reliance MF schemes like Reliance FHF-XXXII-10-1151D, Reliance FHF-XXXII-7-1376D, Reliance FHF-XXXIII-9-1265D, Reliance FHF-XXXIV-8-1191D and Reliance FHF-XXXIV-10-1174D held 8-8.34% of Reliance Home Finance debt exposure each.

Do remember that a debt instrument is downgraded, at least theoretically, when the risk of non-payment is enhanced. This downgrade results in a mark down in NAV (Net Asset Value) and the impact is high or low depending on the quantum of a rating downgrade and the proportion of the scheme’s holding in the paper.

For example, a rating downgrade from AA+ to AA- may be just 2 notches while a fall from AA+ to BBB would be 6 notches. Similarly having a 1% exposure to an instrument causes less pain compared with say a 5% exposure.

Debt fund takeaways

We do not know what the future holds for Reliance Home Finance and Reliance Capital. But over the past few months, there are some simple lessons that debt MF investors have learned. Let us remind you of them.

1) Be cautious of debt funds with a concentrated portfolio – Always avoid a debt fund where the assets are concentrated to a few holdings. In a credit event, due to the lack of diversification, such portfolios can be the worst affected. A well-diversified portfolio where the exposure is limited to 4-5% towards single security, will weather any storm much more easily.

2) Avoid debt funds with high exposure to low rated assets – Many credit risk funds are sold on the pitch that they can generate 3-% more than bank FDs. The truth is that if you want higher returns, be prepared for a higher risk as well. Risk does not only mean volatility in NAV/returns, but it can also result in a significant loss of capital. That is why it is best to avoid funds that allocate a high proportion of their assets rated AA or lower.

Author
Kumar Shankar Roy

Kumar Shankar Roy is contributing editor with RupeeIQ. He can be contacted on contact@rupeeiq.com