NBFCs predict tighter RBI rules for IPO financing

RBI likely to tighten the noose around IPO financing by NBFCs.

Non-banking finance companies expect the Reserve Bank of Bank of India to tighten rules for financing of initial public offerings in the coming days, industry sources told Moneycontrol. A standard minimum upfront margin is likely to be in place that customers would have to deposit with NBFCs while borrowing funds to apply in IPOs.

In case of loan against shares, NBFCs cannot fund more than 50 percent of the value of the shares pledged as collateral. In the case of IPO financing, they cannot lend more than Rs 1 crore per borrower. But the NBFC has the discretion on how much money it wants to collect from its IPO funding customer as upfront margin. The amount would vary depending on the customer’s creditworthiness, the amount of business earned from him, the length of the relationship and the number of times the IPO is likely to be subscribed.

Last week, the RBI had asked JM Financial to stop financing IPOs and non-convertible debenture offerings. The central bank’s review of JM’s processes found that the process of assessing creditworthiness was shallow and that financing was done against meagre margins.

“NBFCs are so far comfortable financing IPOs on thin (upfront) margins because the arrangement with their (IPO funding) customers allows them access to their bank accounts as well as demat accounts,” said an official at one of the NBFCs quite active in the IPO financing and loan against shares segment.

So, even if the stock debuts at a discount to the issue price, the NBFC can recover the interest costs and any potential decline in value of the stock from the upfront margin.

NBFCs charge up to 13 percent for financing IPOs, a juicy stream of revenue given the low risk involved.

Another key factor driving the IPO funding frenzy has been the massive oversubscription in majority of the issues. This means that often the value of the shares allotted is equal to, less than, or not much higher than the money collected as margin.

For instance, if a client has put Rs 2 lakh as upfront margin, and has been allotted shares worth Rs 3 lakh, that is still good enough for the NBFC to recover its entire loan and interest charges, even if the stock lists at a 30 percent discount to the issue price.

According to industry sources, the problem could arise if the value of the shares allotted are substantially higher than the upfront margin deposited by the customer.

“Technically, there are three days to go from the time the shares are allotted till the time they list on the exchanges,” said the person. “So, if you have collected Rs 1 lakh as margin and the client is allotted Rs 3 lakh of shares, you are technically giving a loan in excess of the collateral. This could be a source of risk if market sentiment changes dramatically.”

If there is a clearly defined limit for loan against shares, it is only logical that there will shortly be something similar for IPO financing as well now that regulators are looking at this route of financing closely, according to the person.

The other cause for concern for regulators is the number of bids for IPOs being inflated using a legitimate cover. Sebi has already flagged it off in its order on JM Financial in the NCD offerings case.

“Sebi is also separately examining an issue in the SME segment of NSE where it was observed that certain entities placed huge bids under the HNI category and subsequently also placed bids under the retail category. This resulted in the issue being oversubscribed but the bids were rejected as multiple applications were made from the same PAN,” the market regulator said.

Market sources said this practice is rampant in the case of small and micro cap IPOs, and that it also happens in some of the mainboard IPOs.

In a bid to boost the subscriptions, merchant bankers are said to be funding clients and asking them to bid from both the non-institutional investor (NII) category as well as retail category. If somebody bids in both categories through the same PAN account, both bids get disqualified.

At the close of the bidding process, these bids will reflect as valid bids, giving the impression that the issue has been massively oversubscribed. But less highlighted is the number of duplicate bids that are rejected.

“This can cause a problem for NBFCs at some point if all the merchant bankers in the  same issue follow this trick, as the number of shares allotted will go up sharply,” said another NBFC official. “In such an event, the NBFC’s margin of safety will go down considerably. Because issues have not listed at steep discounts it does not mean they cannot happen in future.”