October 10, 2019

Observations On The Essel Mess

Guest post by Norman Evan

Remember the 30 September deadline for some FMPs and other debt funds to have got back the money they’d invested in Essel group companies?  That date has come and gone, and things haven’t played out the way some mutual fund managers thought, or led investors to believe.

If you don’t remember or haven’t been following the story, it involved limited purpose, private companies linked to the Zee promoters.  Sprit Textiles, renamed as Sprit Infrapower and Multiventures.  Edisons Utility Works, renamed as Edisons Infrapower and Multiventures.  Continental Drug Company, renamed as Konti Infrapower and Multiventures.  There are more, but you get the idea.  If you lifted their corporate masks (or veils, if you like), I guess all these companies would look pretty much the same.

These companies had borrowed money from various mutual funds.  The borrowing was on largely similar terms. Most of the NCDs that were created, ticked all the boxes that would unnerve a risk-averse bond investor.  Zero coupon bond.  Check.  Backed by shares.  Check.  Rating by Brickworks.  Check.

As we’ve seen time and again, the mutual fund managers were either suckers for a good yield or had their own interests or agenda.  These NCDs had no place in mutual fund portfolios.  Certainly not in FMP portfolios where a lot of them landed.

Then, some months ago, there were the first signs of dark clouds looming.  It looked like the Zee promoters wouldn’t be able to pay back some of the money on time.  But if everyone went about selling the shares which backed the NCDs, they’d  get much less than what they hoped for.  So they all sat down and hatched up a plan.  They decided to give the Zee promoters time till 30 September to come up with the money.

So what happened?

One, not all companies paid up.  Why?  I guess only the Zee promoters or their associates can tell us that.  Konti paid back in full.  Edisons and Sprit paid back some of the money but there’s a fair bit still left to be paid back.

Two, the repayment has been pretty arbitrary. Kotak MF got paid back all that they were owed.  But Birla MF and HDFC MF have a lot less to smile about.  And while Kotak MF might brag about how their decision to give time to the Zee promoters has been vindicated, I’d say they got lucky.  Unless they arm twisted their way to get the payment. 

Talking about arbitrary repayments, this is becoming quite the thing.  Back in June, FT got fast track payments for their investments with the DHFL promoters.  Other mutual fund managers whose DHFL investments were more investment-worthy and repayment-worthy than that of FT, have been left holding a lemon. 

Three, there’s the mystery of dual ratings.  Brickworks, in its infinite wisdom, has downgraded some Sprit and Edisons NCDs to a D rating while it has downgraded other NCDs from the same companies to BB-.  Why?  It would seem that wherever payment was due, but didn’t happen, they did a downgrade to D.  But where payment was not yet due, they decided that those NCDs weren’t yet ripe for a complete downgrade.  Is this what happened with IL&FS or DHFL? No.  So why did this happen in this instance?  Read this rating rationale for the Sprit downgrade and see if you can figure that out.  I can’t.

To continue with Sprit as an example, it had NCDs outstanding to the extent of 1064 cr or so.  Of this, 211 cr was due as on September end.  The company paid back 100 cr- fine.  The 111 cr that it didn’t pay back was downgraded to D.  But the 853 cr which isn’t yet due, was only downgraded to BB-.  And that’s what makes my head explode.  Sort of.  These guys couldn’t pay back 111 cr but the rating agency seems more optimistic that they’ll pay back the 853 cr.  It just takes my breath away.

Could it be- could it just be- that this may have something to do with the impact it has on scheme NAVs?  A D downgrade would mean writing off 100% of the investment value while a BB- means writing off just 25% of the value.  You have to admit- AMCs do have a rather cozy relationship with rating agencies.

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