25 mutual funds with Rs 2,700 crore of IL&FS bonds take a hit

Net asset values of at least 25 mutual fund schemes have been hit after credit rating agencies downgraded the ratings of debt securities issued  by  Infrastructure Leasing and Financial Services (IL&FS) and its subsidiary IL&FS Financial Services.

The downgrades follow the companies defaulting on interest payments on their bonds.

These mutual fund schemes hold Rs 2,700 crore of bonds and commercial papers issued by IL&FS and its subsidiaries, according to mutual fund’s monthly portfolio disclosures.

Fourteen of these schemes, as on August 31, had two percent or more of their assets invested in the debt securities of IL&FS and its group companies.

The market is concerned that the bonds issued by other IL&FS subsidiaries like  IL&FS Transportation, IL&FS Tamilnadu Power, IL&FS Energy Development and  IL&FS Security Services could be downgraded in the near future.

On September 10, rating agencies ICRA and CARE downgraded non-convertible debentures of IL&FS to BB from AA+. ICRA said the downgrade reflects "rising pressure on liquidity at the group level due to sizeable repayment obligations".

ICRA also downgraded the short-term rating for a 40-bln-rupee commercial paper programme of IL&FS Financial Services, a subsidiary of IL&FS, to 'A4' from 'A1+'.

Last week, IL&FS Financial had informed exchanges that the company would not be able to issue any commercial papers till February 28, as it had defaulted on payments on two papers, which were due to mature on August 28 and August 30.

Tata Short Term Bond Fund had a Rs 170 crore exposure to commercial papers of Infrastructure Leasing & Financial Services, amounting to 3.2 percent of its assets, while Tata Money Market Fund had  exposure worth Rs 49 crore, amounting to 2.3 percent of its total assets.

BOI AXA Credit Risk Fund had Rs 100 crore investment in the company's commercial paper and it made up for 6.1 percent of its total assets. Principal Mutual Fund had collective exposure worth Rs 73.51 crore in its portfolio.

In fact, Principal Mutual Fund suspended investments in four of its schemes with exposure to IL&FS Financial Services commercial papers.

According to the addendum on the fund house’s website, subscriptions, switch-ins, systematic investment plans and other investments in Principal Cash Management Fund, Principal Ultra Short Term Fund, Principal Low Duration Fund, Principal Arbitrage Fund, have been temporarily suspended “to protect the interest of the unit holders”

The net asset value of the above-mentioned schemes fell by 1-3 percent on Sep 10. A few schemes also had exposure to debentures issued by the group companies which also took a hit on the scheme’s NAV.

Six schemes of DSP Mutual Fund had a collective exposure of Rs 380 crore to non-convertible debentures of IL&FS Transportation Networks Ltd.

DSP Credit Risk Fund had an exposure of Rs 220 crore to IL&FS Transportation Networks as of August 31 and it made up for 3.2 percent of the scheme's assets. DSP Regular Savings Fund had 4.6 percent of its assets invested in it, while DSP FMP Series 195 36M Fund had nearly a tenth of its assets invested in IL&FS Transportation.

How does a downgrade or default impact investors?

Such instances impact the net asset value or NAV of the scheme. The impact on NAV can be on two occasions – downgrade and default.

In case of downgrade, the impact gets reflected in NAV immediately as post-downgrade, the bond yields are marked up and prices fall.

In the past, downgrades of Amtek Auto, Jindal Steel & Power and Ballarpur Industries had badly hit the portfolios of some mutual funds.

What are fund managers saying?

DSP Mutual Fund has total exposure worth Rs 253 crore IL&FS Energy Development Company Limited (IEDCL) maturing on June 2019.

A note sent to DSP Mutual Fund’s investors and distributors stated:

"The current liquidity situation is temporary, based on the following updates received from the company:

• The board of IL&FS Ltd has approved a Rs 4,500 crore rights issue to shore up capital in the board meeting dated August 29, 2018 and the rights issue would be completed by October 30, 2018. The company has also approached shareholders for liquidity support to the extent of Rs 5,000 crore.
• IEDCL has already started initiatives to divest its stake in operational SPVs like ONGC Tripura Power Company Limited and wind energy assets, which is expected to generate Rs 1,400 crore of liquidity by March, 2019 compared to repayments of Rs 800 crore till June, 2019. Hence, even without IL&FS Ltd. support, IEDCL can meet debt repayment obligations till June, 2019 (when our NCD matures) through the divestment proceeds.
• The major shareholders of IL&FS Ltd are strong institutions like LIC (25 percent), Orix Corporation of Japan (23.5 percent), Abu Dhabi Investment Authority (12.6 percent), State Bank of India (6.42 percent) and HDFC (9.02 percent). These marquee investors provide added comfort that the entity will receive the adequate support.

Birla Sun Life Mutual Fund has exposure to IL&FS Tamil Nadu Power Co Ltd (ITPCL) across its five schemes. The fund house, in a note to investors, said:

“ITPCL, being the thermal power generating subsidiary of IEDCL, is an independent cash flow generating company through the distribution and sale of power. Hence, our lending is secured against the expected cash flows from this thermal power plant. Our investments continue to remain investment grade with no mark downs or haircuts.”

What next?

The board of Infrastructure Leasing & Financial Services Ltd (IL&FS) has decided to again on September 15 to seek approval for Rs 3,000 crore loan from LIC and SBI.

Mutual fund experts say except liquid fund investors, retail investors who have invested in credit risk funds and other bond funds can remain invested if the fund house assures communicates ability to recover the principal and interest income.

However, if recovery looks difficult, investors can exit the scheme where exposures are very high and which will be ultimately written off if the company defaults. Investors in schemes where exposure is over 4 percent and above are at risk of losing more and may take a call to exit such schemes.