MF distributors’ body to RBI: Set up SPV to buy illiquid bonds directly from fund houses

The liquidity crisis that debt funds, particularly credit risk schemes, had been facing throughout March 2020 due to the ongoing COVID-19 crisis, peaked on April 23 when Franklin Templeton wound up six of its debt funds. Due to the redemption pressures that Franklin Templeton had been facing, it had already sold its most liquid securities, exhausted its borrowing limits that each MF scheme is entitled to (20 percent of the corpus) and had even approached SEBI to increase the limits. Although SEBI did increase the limit to 40 percent in some of its schemes, Templeton stopped borrowing after a point. “This, coupled with the inability to liquidate securities in the portfolio in the current market environment, led us to believe that it is not prudent for the schemes to borrow increasing amounts of money for meeting redemption obligations,” said a Franklin Templeton spokesperson over email.

Banks' risk aversion

Although RBI has nudged banks to lend, they have not been lending to non-AAA rated securities. Within the Targeted Long-Term Repo Operations (TLTRO)-2 that the RBI announced on April 17, a sum of Rs 50,000 crore was made available to banks to lend to non-banking finance companies (NBFCs), with at least 50 percent of the total amount earmarked for small and mid-sized NBFCs and micro-finance institutions. But only Rs 12,850 crore was lent by banks. The first TLTRO announced on March 27 had made Rs 1 trillion available to banks, for lending against investment grade corporate securities. All securities with a credit rating of BBB and above are investment grade.

As banks still did not lend to such lower-rated entities, the RBI announced TLTRO-2, which too didn’t help much.

Meanwhile, fund houses, saddled with non-AAA-rated investment grade securities, continued to face a liquidity crisis. When Franklin Templeton finally wound up six of its debt funds, RBI announced a special liquidity window. A senior fund official who did not wish to be named said that even if fund houses borrow from banks under the special window, they would still need to repay at a later date. Plus, after paying back the loans, the onus of selling those collaterised securities would still fall on mutual funds. “What if liquidity doesn’t come back for months,” he wonders.

“The root cause is risk-aversion. Banks have TLTRO 2, special liquidity window for MFs, but not availing it because of the risk in NBFCs, particularly the lesser ones. There should be help either with the Government guaranteeing a portion of NBFC loans / bonds through a contingency fund or ultimately RBI buying directly. If banks get the confidence, they will not be saddled with bad loans / bonds, with support from RBI / Government or an SPV for guaranteeing these loans / bonds, the wheels would start moving,” says Joydeep Sen, founder, wiseinvestor.in.

FIFA has suggested that the RBI set up an SPV that would buy these non-AAA rated investment grade securities, outright, from fund houses. This method, says Dhruv Mehta, chairman of FIFA, will also help Franklin Templeton offload some of its securities faster and pay off its investors ahead of the schedule it has formally laid out. Some of the six Templeton funds could, as per the fund house’s conservative estimates, take as long as three to four years to repay the money back to investors. In early April, the US Federal Reserve launched a program called the Main Street Lending program wherein it will give money to small and mid-sized companies by buying their bonds directly. “The buyback program is not unheard of. The SPV can buy such bonds from mutual funds and then subsequently liquidate them or hold to maturity with the portfolios currently having double-digit yield to maturities,” says Dhruv.