TROUBLE BREWING

Unrecognised distressed debt will add substantially to the woes of banks

Until now, the banking system faced the brunt of default from India Inc., but that is changing fast. Crisil Rat- ings indicates that India Inc.’s overall credit health in 2016/17 continues to remain fragile, and India Ratings expects 50 per cent (`15 lakh crore) of the total corporate debt, including non-bank debt to remain vulnerable (default on its debt repayment). It’s a consequence of weak asset quality and stressed cash flow. There are concerns that any untoward incident, from currency depreciation to global and domestic event risk, could create a huge dent in the portfolio of investors who have been making record investments in corporate debt. After all, non-bank debt stands approximately at 25 per cent of the total corporate debt of `30 lakh crore.

“We are asking investors to avoid funds that are chasing returns by taking higher credit risk. We ask investors with less than two years of investment horizon to stick to funds with lower average maturity and lower credit risk. We advise investors to stick to funds that are buying quality papers, which are triple A-rated in ultra short-term category and AA plus in the short-term category,” says Bala. Meanwhile, Securities and Exchange Board of India Chairman Ajay Tyagi has warned mutual funds from adding bad debt to their portfolio. Besides following the ratings of credit agencies, they should do their homework as well before investing in debt instruments, Tyagi said on June 29, 2017, at AMFI’s first ever mutual fund summit in Mumbai.

But with interest rates falling, generating returns have become difficult for fund managers. To generate high yields, they tend to look at high-risk debt papers. According to Fundsindia.com, in the short-term bond fund category, papers below AA plus ratings are finding more weightage in portfolios. On an average, holding below AA plus rating in a short-term debt fund’s portfolio is 16 per cent compared to 10-12 per cent two years ago. In some of the funds, investment in paper with below AA plus rating is as high as 80 per cent. Similarly, in the ultra short-term fund

“SECTORS LIKE INFRASTRUCTURE HAVE A NEGATIVE OUTLOOK AND COULD POTENTIALLY ADD TO THE CHALLENGES OF THE BANKING AND FINANCIAL SYSTEM” RAKESH VALECHA/ Senior Director/ India Ratings

category, two years ago there were no holdings with A rating, but it now constitutes 3-4 per cent of the portfolio. Then, on an average, papers below AAA rating have gone up to 25 per cent now, compared to around 20 per cent two years ago, in the ultra short-term fund category. This clearly indicates that fund managers are chasing returns at the cost of safety. “We have told investors to stick at the shorter end of the curve and not to time the market. Second, we have been investing with the large fund houses as even in case of default investors interest is safeguarded,” says Hemant Rustagi, CEO, Wiseinvest Advisors. He is hinting at the JSPL fiasco where Franklin Templeton took the hit on its own balance sheet taking care of investors. Similarly, ICICI Prudential managed to throw its weight and get the interest payment from the company.

While Rahul Bhuskute, Head of Structured Investment & Credit at ICICI Prudential AMC, agrees that mutual funds have been taking credit risk with an aim to generate better returns, he feels there isn’t much risk to the overall portfolio if one diversifies and makes small investments. “Taking small exposure in a diversified portfolio may not have an impact on the portfolio even in an adverse event. In the last three years, while there hasn’t been a single default in triple A-rated paper, the probability of default in three year double A is at 0.77 per cent as per CRISIL data, which is negligible when considering to the return one makes from investing in double A-rated paper as compared to triple A,” says Bhuskute. “Second, the amount of default is minuscule to the overall investment in the bond market.”

As on April 30, 2017, NCDs and corporate bond investment by mutual funds is at an all-time high of `5.5 lakh crore, compared to `1.7 lakh crore on May 31, 2014. There has been huge interest in the last few months from FIIs as well. Their holding in corporate bonds has gone up to `2.13 lakh crore on June 16, 2017, up from `1.78 lakh crore on March 31, 2017. FIIs can buy corporate bonds up