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Posted on 19-Apr-2019 Comments  0

HDFC FMPs

Should investors roll over FMPs or just redeem it at a discount?

Fixed maturity plans (FMPs) came under a cloud in the last few weeks after leading AMCs admitted to their inability to honor their FMP commitments. The reason was a huge exposure to the Essel Group, which is owned by Subhash Chandra of the Zee Group. The Essel group had made some disastrous investments in infrastructure and most of it was irrecoverable. Chandra had sought time from the fund managers to redeem these bonds.

How did this come about?

The first signs of a crisis in FMPs were there when the stock of Zee group companies tanked sharply in a span of just 2-3 days. That was the time Chandra admitted that the group had made some illiquid investments to the tune of Rs.10,000 crore that was almost irrecoverable. That was not the issue. The real problem was that private group companies had raised promoter funding from mutual funds by pledging the shares of the promoter. Chandra has promised to make good the bonds by selling his stake in the Zee group to a foreign investor. In short, if the stake is sold then the promoter will realize the funds and repay the mutual funds which will be used to redeem the FMPs. Therein lies the Catch-22. The sale of stake will not happen at the current price and the price will have to fall to find a buyer. But that would mean the FMPs with shares pledged against them will run a huge risk of value erosion.

Should you roll over the FMP?

What should you do as an investor in an FMP of any of these funds that is caught in this mess of the Essel Group? The only merit in rolling over is that you will not only get the indicative return on your FMP but also additional returns for the 1 year holding period. Of course, this comes with no guarantee of getting your money but looks to be the best bet if you are not keen to lose returns. However, you may discover at the end of 1 year that the Zee money is not recoverable and, most likely, by then the stock would hardly be worth anything. Should you take that risk?

Known devil or unknown angel?

Your choice is between a known devil and an unknown angel. In a best case scenario, you can wait for a year and perhaps get you money back with handsome returns. What happens if you choose to redeem. The non-Essel portion will be redeemed at the yield indicated but the Essel portion may be paid to you at a discount to NAV. If the share of Essel exposure is 20% and you take even a 50% cut, you lose 10% of your value. With the normal returns on the balance 80% portfolio, you may just about end up getting back your principal. You should just take it and forget about this FMP. For all you know, these toxic assets may stretch much beyond Zee group. As well redeem the money and invest it elsewhere!

Jet Airways

It is definitely the beginning of the end for Jet Airways 

Just around midnight on the 16th of April Jet announced temporary suspension of all its flights. That was a euphemism for a shutdown in operations due to paucity of funds with the airline.  When the airline sent an SOS for an infusion of Rs.1000 crore and the bankers refused, it was clear that Jet Airways would have no option but to shut down.

How not to sell an airline

How did Jet come to this pass? An ex airline official once said that at a point it just becomes so unprofitable to run an airline that the returns can never match up to the risk of flying. When you reach that point, most promoters will just leave the airlines to die a natural death. That appears to be the case with Jet also. When SBI had taken a majority stake in the business, they should have realized that funding the operations till the closure of the deal was its job. By refusing a line of credit to Jet at this point of time, it has acted more like a banker than an airline CEO. The problem is that when you own more than 50% of the shares of a company, you got to think like the CEO of that company. By refusing to give Jet the funding support, SBI has virtually paved the way for the eventual liquidation of the airline. That may not happen right away but eventually there will be little choice. This may not be the end but it is surely the beginning of the end of Jet Airways as we know it. Let us understand why it is so?

Piecemeal sale will not work

The SBI approach seems to be to keep all its options open. While SBI is looking to find a global investor to buy the Jet stake, it is also simultaneously trying to evaluate what it can recover through a piecemeal sale of Jet Airways. For example, the bank is also negotiating with other Indian airlines to take over the fleet of Jet Airways. Already, other airlines have expressed interest in the landing rights and parking slots of Jet Airways. The only question is that if all these assets are sold, then what is left of Jet Airways. Actually, nothing will be left. Already most of the employees of Jet have started shifting to other airlines and in another month or so Jet would be incapable of flying even if other problems are resolved. It is hard to fathom if SBI did not think about these consequences or whether they deliberately allowed Jet to fold up.

Endgame for Jet

At this point, it is estimated that banks may get around 20% of their loans and operational creditors will get nothing. That was always the dilemma. Jet had no real assets so they could not go to NCLT and outside of NCLT; it was always going to be a case of fleeting assets vanishing overnight. SBI would have done better to negotiate a deal with Goyal and let Jet fly. Now it clearly looks like the beginning of the end for Jet. It is just that nobody cares!

RBI Dilemma

Should RBI cut rates further; MPC minutes show a clear divide

The minutes of the Monetary Policy Committee (MPC) published during the week give a clear idea about the discussions within the MPC before the rate cut decision was taken. The MPC minutes document detailed discussions among the 6 members of the MPC and the logic for arriving at the rate decision which is communicated through the policy announcement. 

Some differences within

Clearly, some differences have come out between the key members of the MPC before the decision was taken. For example, Dr. Viral Acharya was very skeptical about cutting rates this time around considering that rates had been cut in February. Dr. Acharya had some reservations about 2 consecutive rate cuts in two policies. Dr. Acharya was also concerned about the absence of transmission to the final borrowers. However, the RBI governor had a more flexible view on growth. Das was of the view that another rate cut would only restore the status quo as of June 2018. Also considering the weak IIP growth and the much weaker manufacturing numbers, Das felt that the time to cut rates was ripe. In fact, the governor has also hinted at being flexible about a series of rate cuts in the coming months as to spur growth. Dr. Acharya had expressed worries about core inflation remaining elevated around the 5.5% mark, although the RBI had shifted focus to headline inflation.

Acharya model may not work

Dr. Viral Acharya had focused on a more calibrated approach to rates at a time when the core inflation was sticky. However, a status quo would not really have worked for three reasons. Firstly, transmission is an issue but that will automatically happen as liquidity and cost of funds become favorable. We saw that in the post demonetization period. Secondly, Indian real interest rates at above 4% are among the highest in the EMs. That is making Indian industry almost non-competitive. The only way to rectify the situation is to cut rates aggressively. Thirdly, corporates have seen cost of funds going up by nearly 100-125 basis points even for blue chip borrowers. That is hardly sustainable!

Das model may work better

The RBI governor has talked about a combination of 3 things. There has to be rate cuts to cut cost of funds. Then there has to be liquidity infusion to depress rates at the short term and enable transmission. That is being done through OMOs and the dollar swap auctions. Thirdly, Das has also talked about mixing monetary and fiscal measures to be really effective. That may actually be the crux. Debating over rates may not be really productive. The  bottom line is that real rates have to come down substantially. Of course the big missing link will be fiscal stimulus. That could complete the circle!

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