Balasubramanian is the CEO of Aditya Birla Sun Life AMC and has been with the organization since 1994. He shares his views on the current issues the debt market is grappling with, specifically in the shadow banking space.
The NBFC issue had its origins as a liquidity issue that has rapidly progressed into a solvency issue. Do you agree?
The solvency issue has always been a question mark.
Initially, it was a pressure on ALM.
It then progressed into a de-growing issue; de-grow the business because the money market has become tight. Naturally, their repayment obligations remained.
Then comes the rotation of money. Once the confidence level goes down refinancing becomes tough.
It’s a cycle. So, it is only natural that solvency will creep in as an issue.
Having said that, it is worth noting that all have assets backing them.
Then what do you mean by pressure on ALM?
I meant that it is not an issue of assets vs. liabilities, per se. It is a mismatch on long-term assets and short-term liabilities. And that is the crux of the issue.
Right now, they are identifying assets that can be sold. And they are selling assets. Often the sale of assets takes times – sometimes a few months, up to 5 months. Yet, it is happening.
Once, and if, the rotation stops, things could deteriorate rapidly. Then it could turn into a full-blown solvency issue.
Isn’t that what happened with IL&FS, the rotation stopped?
Indeed.
The financial market works on refinancing. Borrowing would happen for 1 year to finance a 2-year project. Or borrowing would happen for 3 years, to finance a 5-year project.
Once the rotation stopped, IL&FS had to resort to alternative financing. They were borrowing traditionally from one segment of the market – banks. But there are various types of banks; generically you can say good and bad banks. Now the moment, the regulator put certain banks under Prompt Corrective Action, or PCA, it hit their lending capabilities and prevented them from expanding.
The other segments in the financial space won’t grow that significantly in a short time frame to cover the gap. Neither does it have that sort of risk appetite.
Some banks focus only on retail, others only wholesale, while still others will work on a combination of both. Within wholesale, some may focus only on corporate lending and avoid real estate altogether. Others may avoid NBFCs. Some players like HDFC Bank will reach the customer directly because their business model has no need to dabble with NBFCs as intermediaries.
IL&FS brought in innovative financing when it came to infrastructure. It was dedicated to financing the infrastructure of the country. While its assets are good, the cost of building those assets is what is the issue. Some were built at high cost.
Liquidity is no longer the issue. But do you think that there are issues on the asset side as loans were often given on the higher end of the risk curve?
What is wrong with loans being on the higher end of the risk curve? Loans have to be given, right?
There are different types of borrowers, and the lower rung of the companies also need financing. Borrowers have different credit profiles. Someone has to lend to the segment with weaker credit, after all they are part of the economic system. We will never have a GDP of 6-7% if this segment is ignored.
If everyone decides to be a safe lender who will fund them?
But where the issue is, is whether the credit was priced properly. At what rate were they lending to make it worthwhile to carry that risk? Was the risk adequately compensated with higher rates?
How do you see it panning out?
Shakeouts happen due to fundamentals or regulatory tightness or modifications. And it is good for the system to move to the next level.
NBFCs which are highly leveraged and with a higher number of NPAs will be forced to shutdown.
Years ago, it was just institutional lending – IDBI, ICICI etc. Then came in the banks. Then the NBFCs and HFCs. Now private equity and alternate financials.
In 2008, the size of the mutual fund industry was Rs 3 lakh crore of debt and Rs 1 lakh crore of equity. Now it is Rs 15 lakh crore of debt and Rs 10 lakh crore of equity.
The fund industry has played a big role in the development of the bond market. We can lend at market-driven rates. Banks have capital adequacy needs, SLR, CRR, deposit rates – all this keeps their cost of lending high. The mutual fund model is a good one when it comes to the role of financial intermediaries.
Talking of the fund industry, how about your exposure to IL&FS, DHFL and the Essel Group?
Our investment in DHFL was returned last year.
In the case of IL&FS, the default of the parent company had a cascading effect. Our investments were into the Special Purpose Vehicles, or SPVs, of IL&FS. They were in the road assets which earned us annuity receivables from the Jharkhand government. We have exposure to power assets in Chennai, collections from the Tamil Nadu government is escrowed. There was a ring fencing mechanism in place. But once IL&FS, the parent, came under moratorium, the entire entity got hit.
The Essel Group exposure is fully secured with reasonably good margin. However the whole industry had exposure to this group.
But why did ABSL face this situation since you have a credit risk team in place?
We do have a sound team in place.
As a fund house, we focus on three market segments.
- The pure liquid fund is on the lower end of the curve.
- Duration risk is based on broad macro variables and we take interest rate calls.
- And then we have a presence in the credit market.
In case of the latter, we built a 5-member team; 4 analysts and a legal expert. This is to enable us to make the right credit calls. So it is a strong team that has built the right structure and are cognizant is risk.
So what went wrong?
Check the investments where we are stuck. Nowhere our investment covenants have been compromised. The very fact that we are still confident of our investments coming back, is coming from the fact that our structures are well constructed in the best interest of investors. Market volatility at times do challenge these assumptions. However, well-crafted structures on the basis of our credit team expertise is the one that ultimately protects us. Believe me I am very confident on this.
As an AMC what was the lesson learnt?
Our exposure was higher than what we could have ideally taken. That was because we estimated our fund growth to be high. But when IL&FS happened, our growth assumption got hit and this exposure inadvertently took dominance. That is where we erred. For the slightly higher return, we took a higher exposure. We should have stuck to a 3-4% exposure instead of 7%.
We went through pain but we are confident that no investor will be disappointed.
