Remember June 4 when debt funds posted up to 53% one-day drop in net asset value (NAV)? Yes, that was the day when housing loan firm Dewan Housing Finance Ltd (DHFL) missed over Rs 900 crore in interest payments. On June 11, DHFL announced that it has made the requisite payment towards interest payable on those debt securities.
However, the NAV of debt mutual funds on June 11 evening show only a marginal rise in NAV. When we say it’s marginal, it’s less than 5%. So, what is happening? Why are your debt fund NAVs not recovering fully? It turns out that repaying the interest back is not going to really help NAV recover if the rating on those debt securities stays at ‘D – Default’. Read on to know more
Explaining the NAV fall
Debt funds holding DHFL debt securities were in for a rude shock when the NBFC failed to pay the interest to non-convertible debenture (NCD) holders on June 4. DHFL kept on saying that there is a delay in interest payment and it had a 7-day window to pay up. But, not being able to pay up on June 4 was not taken lightly. When a debt issuer is unable to honour its interest payment commitment on a scheduled date, it is taken as a default.
Non-payment of interest payments is technically considered as a default, and so mutual funds were forced to take a straight 75% haircut i.e. reduced the value of DHFL debt securities in their portfolio. This led to a sharp drop in net asset value of debt funds. Over the next few days, credit rating agencies marked DHFL debt securities to ‘Default’ rating and some fund-houses took extra pre-caution by fully writing down the value of DHFL debt.
Some of the debt funds had sizeable exposure to DHFL debt. So when they had to write down the value of DHFL debt, the effect on NAV was substantial. For example, DHFL Pramerica Medium Term Fund had 37% exposure to DHFL debt. This fund’s NAV fell by 52.99% on June 4. The NAV of Tata Corporate Bond Fund, whose 28% money was in DHFL debt, fell by 29%. The 21% exposure of Baroda Treasury Advantage Fund led to a 17% drop in NAV. Similarly, NAV of Principal Low Duration Fund, whose 19% money was in DHFL, fell by 16.5%. The 15% exposure of Edelweiss Corporate Bond fund led to a 13.4% drop in NAV.
Rating agencies reacted the next day i.e. June 5. CRISIL downgraded its rating on the Rs 850 crore worth commercial paper (CP) of DHFL to ‘CRISIL D’ from ‘CRISIL A4+’. The bigger hit came from CARE Ratings. CARE downgraded debt securities worth Rs 1,02,563 crore to ‘D’ (Default) from BB- or BBB- ratings. The ratings were for Rs 17,655 crore worth NCDs, Rs 29,000 crore public issue of NCDs, over Rs 42,000 crore worth long term bank facilities, etc.
Later, UTI MF increased the markdown to DHFL debt securities from 75% to 100% in the schemes which have an exposure. Tata MF announced ‘side-pocket’ for 3 affected schemes. Fresh investments into many of the debt funds, across AMCs, have been temporarily suspended.
The fund-houses really had no option: there was no secondary market for such debt securities, which meant they were stuck with virtually dead wood.
The NAV rise is not going to be easy
On June 11, DHFL announced that it has made a full payment towards interest payable on Secured Redeemable NCDs issued by way of the public issue within the cure period of seven working days. The company said it has made interest payments in lieu of Rs 961 crore as committed to its debenture holders. With this tranche, the company confirms full payment and will seek rating upgrades from agencies.
This announcement means that the original problem of delayed interest payment is no longer there. So, we checked the NAV of the affected funds on June 11 evening to see the recovery in NAV. There was very little uptick compared to the drop on June 4.
For instance, DHFL Pramerica Medium Term Fund NAV rose 4.6% on June 11 (over June 10). Its NAV is at Rs 7.25 (regular growth plan), still long away from June 3 NAV of Rs 14.72. Tata Corporate Bond Fund NAV rose by 0.01% only. Baroda Treasury Advantage Fund NAV rose by 0.25%. The NAV of Principal Low Duration Fund rose by 1.27% only. The NAV rise was 0.98% in the case of Edelweiss Corporate Bond Fund. The NAV of BNP Paribas Medium Term Fund has risen by 2.05%.
Why are the fund NAVs not going back up? The answer is a bit complicated.
Even though DHFL has paid the interest, the NAVs will not immediately go back up. Fund houses will do NAV markup only for the interest component. This means the increase in NAV will only be limited to the interest received. The NAV fall on June 4 was so sharp because the entire assets i.e. principal was marked down.
The problem is that the ratings of DHFL NCDs are now rated ‘D’. This rating downgrade is the main reason why NAVs are not going back up. The NAV will go back up when the rating changes back to what it was, or the principal is paid on maturity of NCDs.
While DHFL plans to seek a rating upgrade, nobody feels the revision will happen in a hurry. This is because there is some cooling period from rating agencies for rating changes. This means rating agencies cannot just downgrade a security one day, and revise it back up on the next day.
But as the NCDs mature, fund houses can definitely mark up on those bonds and also the interest component. When are NCDs maturing? DHFL NCDs worth about Rs 3,500 crore are maturing on September 9, 2019. A smaller tranche of over Rs 1,000 crore will mature on August 16, 2019. Before that i.e. between June 18 and August 6, a small tranche of Rs 28-30 crore of NCDs will also nature.
As per rating agencies, DHFL is envisaging cumulative cash inflows of around Rs 6,600 crore from June’19 to Aug’19 as against scheduled cumulative cash outflows of around Rs 10,780 crore during the same period. So, there is a negative cumulative mismatch of around Rs 4,180 crore. If DHFL is able to plug this mismatch, things will be back to normal. If the projected negative mismatch becomes reality, there will be more trouble.
Disclaimer: The article is only for informational purposes. Investors are requested to consult their financial, tax and other advisors before taking any investment decision.