Market correction: Banks develop cold feet while lending against MF units

Allirajan M

When Rishi Raj Arya, a 34-year-old  from Vadodara in Gujarat and working in an MNC, wanted to raise a loan against the investments he had in equity mutual fund (MF) schemes to meet his emergency financial requirements during the lockdown, he was in for a shock.

While he was able to get an overdraft facility for his equity schemes in fund houses serviced by CAMS (Computer Age Management Services; one of India’s largest registrar and transfer agents), he couldn’t get the same for his other holdings. Worse still, he was initially told by his bank that they do not provide such a facility for investments in Franklin Templeton MF, which had announced the winding up of six of its debt MF schemes. Rishi had investments in Franklin Templeton’s equity schemes.

Banks reluctant to lend against MFs

HDFC Bank (where he has an account) has finally agreed to lend against his investments in Franklin Templeton MFs after two months of follow-ups and exchange of mails. But it has refused to do the same for his holdings in Sundaram MF and Mirae MF without assigning any reasons. Though they are not among the larger fund houses, their schemes have delivered good returns and compare well with the ones managed by leading firms.

With equity markets remaining volatile and illiquidity in lower-rated debt securities hitting investors hard, banks are increasingly playing it safe when it comes to lending against MF investments. “I needed funds urgently to meet certain payment obligations. Since a good part of my investments was in Franklin Templeton, I wanted to raise a loan,” Rishi says. And although just the six debt schemes of Franklin Templeton have come under the scanner, and not its equity funds, Rishi was originally denied a loan. HDFC Bank did not respond to our queries.

Moneycontrol also reached out to the likes of ICICI Bank, Axis Bank and Kotak Mahindra Bank, but they too refused to share the decision-process they follow for providing such loans. An e-mail questionnaire sent to these banks and SBI (State Bank of India) on the eligibility and reasons for refusing loans against MF investments made with certain fund houses did not get any response till the time of writing this article.

Swarup Mohanty, chief executive officer (CEO), Mirae Asset India mutual fund says, “This is a common occurrence and has happened in the past.” He said that if banks do not recommend certain fund houses to their customers, then the branches also don’t give loans against such funds.

“The liquidity crisis in the fixed-income part of the MF industry is a first-of-its-kind that has brought to the fore a new risk in the eyes of a prudential lender. The lender is now looking at what can go wrong and is trying to minimise losses,” says Sunil Subramaniam, managing director, Sundaram MF. He says that the criterion for such loans is the scheme type and not fund house specific. For instance, the lender would look at small-cap funds of a MF with caution, as the risks are higher.

A lower proportion only made available

Some private banks explicitly state that they would lend only against MF holdings with CAMS as the transfer agent. Banks offer an LTV (loan-to-value) of 50-60 per cent against equity MF investments and 80-85 per cent for debt MF investments, but are quite choosy when it comes lending now. HDFC Bank also told Rishi that the loan against the MF schemes in his portfolio belonging to fund houses that are managed by KFintech would take longer than those taken care of by CAMS for processing. In simple words, Rishi was told that loans would be given at a faster pace against CAMS-managed schemes vis-à-vis those under the purview of KFintech.

“Loan against mutual funds happens instantly when an investor approaches a lending agency with whom we have a tie-up,” says Sreekanth Nadella, CEO, KFintech. “For other lenders, the process takes 3-4 working days,” he says. KFintech says that it has not come across instances of undue delay in processing such loans.

Banks charge 9.75-12.75 per cent a year for loans against equity and debt MFs. For raising a loan, the borrower has to submit the relevant KYC (know-your-customer) documents, latest statement of holdings, pledge form for the creation of pledge and a guarantor form, which is mandatory in case of a joint holding. Some banks demand IT (Income Tax) returns for the preceding two years and bank statement of the latest three months.

Banks evaluate your portfolio on a weekly basis. They conduct an interim revaluation if there is a sharp fall in the prices of the securities, or net asset values of mutual funds, pledged as collateral. If the equity markets fall, you would be asked to offer more units in lien. The minimum and maximum loan amounts for equity MF investments vary, but most banks have kept it at Rs 25,000-50,000 with the maximum going up to Rs 20 lakh.

For debt MFs, the minimum and maximum loan amounts are higher and could go up to Rs 5 crore. Since these loans are typically in the form of an overdraft, they do not have a fixed tenure. However, you have to renew the loan once a year.

Moneycontrol’s take

With equity markets falling and debt markets being spooked by liquidity related issues, taking loans against MFs is a good idea, as they offer a window to realise the full potential of the investments on a sunny day later. But with banks increasingly turning selective, you may not get enough money for your requirements. Also, you may have to provide more units as lien on a regular basis as markets have turned volatile with a negative bias consistently in the past few months.