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Mutual Funds

Zee Promoter Company Borrows 2,200 Cr. , Has No Cash Flows, Negative Net Worth, Rated A+ on Shares Pledged and Franklin Templeton MF owns 800 cr. of That Debt


Why are we so trusting of rating agencies? The recent drama with Amtek Auto and the restriction on redemptions to 1% by JP Morgan AMC on two of its funds is a glaring example of where rating agencies have failed to identify problems early.
In two more examples, it’s apparent that rating agencies have rated debt very high when they shouldn’t at all be given that kind of rating, at least in my opinion
Take the case of Sprit Textiles Private Limited. This is a promoter company of Zee and Dish TV, and is owned by Subhash Chandra and the promoter group. Let me quote the rating agency, Brickwork, on specific aspects of their rating.

STPL is a part of Essel Group belonging to Mr Subhash Chandra and family. The company primarily acts as a holding company for the group. The Company has two directors on board -Mr. Sanjeev Chaudhary and Mr. Amol Deshmukh who are nominees of the promoters. The Company intends to use the proceeds of the NCD towards General Corporate Purposes as well as for the repayment of the existing debt. For FY13, STPL reported revenue of Rs. 83.5o Cr, loss of Rs. 473.56 Cr, Total Debt of Rs. 2279.23 Cr (Secured & Unsecured) and negative networth of Rs. 0.30 Cr.

Get this. The company has NO OPERATIONAL CASH FLOWS. Means, it really does nothing. And still, it has more than Rs. 2,200 cr. of debt. And a negative net worth!
How does it service that debt? By pledging shares, apparently.

The given rating essentially captures performance of ZEEL and DTIL, since STPL does not have  operational cash flows and the NCD structure involves pledge of ZEEL & DTIL equity shares  provided as security. Security cover of 1.75 times provides cushion to investors.

So exactly how many shares of ZEE and DTIL does Sprit Textiles own? Answer: 300 shares of each. Together, they are worth less than two lakh rupees. See the latest shareholding pattern:
Obviously some of the other promoters of Zee and DTIL has pledged their shares to cover the  loan because Rs. 1 lakh worth of shares cannot be used for crores and crores of debt.
So how is the rating agency providing a rating of “A+” On it? (suffixed with SO, meaning structured obligation). Thisis like the third highest rating that signifies “adequate degree of safety regarding timely servicing of financial obligations”. But how? The company itself owns very few shares, it has nearly no operational cash flows, and is loss making and has negative net worth. The rating is ENTIRELY based on the valuation of Zee and DTIL shares. What if they crash like Amtek Auto tomorrow?
There is no corporate guarantee by the Zee and Dish TV companies themselves, only a promise of further shares to be placed on pledges. But if these shares tank, that is a massive amount of debt that depends on those very share prices!

And there’s another one: Essel Corporate Resources

Again, Brickwork rates them A+ (SO).

ECRPL is a promoter company of Essel Group belonging to Mr. Subhash Chandra and family. The Company has two directors on board — Mr. Sunil Singhal and Mr. Ashok Sanghvi, who are nominees of the promoters. The Company mainly acts as a holding company investing in the group entities. The revenue sources for the company are rental income from owned building and dividend income from investments. For FY13, ECRPL reported revenue of Rs. 32.89 Cr, loss of Rs. 106.12 Cr, Total Debt of Rs. 1355.22 Cr (Secured & Unsecured) and negative networth of Rs. 1096.65 cr. The Debt is majorly in the form of NCD’s, unsecured loans from financial institutions and NBFCs and ICDs from group companies. The source of repayment would be refinancing/ promoter funding.

And Who’s Lending To Them?

Have you heard of Franklin Templeton Mutual Fund?
FT Mutual Fund has bought a very large amount of the debt given by Sprit Textiles. In its latest portfolio it shows over Rs. 800 cr. of bonds bought from Sprit Textiles and Rs. 580 cr. from Essel Corporate Resources Pvt Ltd.
Most holdings are relatively small percentages (3% or so ) of the total portfolios but it still calls to question why these bonds should figure at such a high level of interest.
Now there’s probably a good reason for Franklin Templeton (FT) to buy these bonds, but in then, in funds like Short Term and Ultra Short term funds? If the prices of Zee/Dish TV crash, then these funds have no other assets to claim and recover the money.
And they’re three other fund houses that have invested in Sprit Textiles’ debt: Deutsche, Axis and HDFC. HDFC has larger amounts but for some of the others, this investment is a large percentage of the fund:

What To Do?

This was just an example. Just one company – apparently and implictly backed by the Zee promoters – has garnered over 1000 cr. of debt from mutual funds, with nearly no operations, and with only shares as collateral.
It is your right to demand an explanation of a fund manager – they do not have access to any liquidity and if a fund that is “short term” in nature ever sees investors exiting, you will find redemption gates becoming common; because let’s face it, these above companies and bonds are very illiquid.
There is no indication of any default of any sort by Sprit or Essel or whoever. But as a bond holder, you don’t care about a default – you should only care about whether Zee and Dish TV stock prices are falling – if they fall too much, then this is going to be a dud investment.
If I had the above funds in my portfolio my choice would be to diversify away from them. At this point it makes very little sense to buy a debt instrument that effectively gives me a fixed upside but the downside of a stock.
What’s important though is:

  • Check the portfolio of the funds you own, even those that say they are short term or liquid
  • See if there are companies you don’t recognize or like in there (anything that is government or sovereign is okay, bank CDs are okay for now and large listed companies like Shriram Transport finance etc. are fine)
  • Specifically are there private limited companies there?
  • If so, check the rating document online. If the rating document has flimsy rationale like depending on stocks pledged, then you want to reconsider that fund in the first place.
  • Don’t trust ratings. Credit rating agencies are the worst people to rely on in a crisis, and you should do your own diligence, and demand answers of your fund managers.

Note: There is no credit issue with the above mentioned Zee promoter companies that I know of. So don’t go around thinking there’s a default at all.
But given that all the money they have borrowed is based on sound collateral and there is no real business to speak of, this kind of debt should be rated in the low B’s for risk and should definitely not be held in treasury or ultra-short-term portfolios.

  • Kumar says:

    So CHIT funds through which lots of rural folks earned/saved for their need are RISKY & UNORGANIZED and these Debt MF’s are ORGANIZED 😛

  • Anand says:

    Thank you for the brilliant research and write-up. Especially useful since I am not very familiar with Debt funds.
    These same MFs and the finance industry goes around tom-tomming that Debt funds are ultra-safe etc…

  • Krish says:

    I some how get a feeling that there is a nexus between fund managers and business honchos. Once can see some funds buying unknown small caps, subscribing to FMPs and buying debt instruments issued by anyone etc..
    Suspect these FMs get kick backs for subscription of these dubious instruments and earn more through this route than regular salary via AUM fee.

    • gold bug says:

      Investors should get together and file criminal breach of trust case against Franklin Templeton and arrest all corrupt executives including its criminal in chief Mark Mobius.

    • Now we have no idea if such things are happening, and it’s easy to accuse managers of malice, so I’d be careful of that. In the case of JPM apparently three large investors got their money back but the others didn’t, before they gated the redemptions of the affected funds. There it does appear like one set of investors was favoured over the other. While there may not be any “kickbacks” involved, such favour shown to one set versus another does seem undue.

  • Sreekanth Yelicherla says:

    There is always a vested interest in fund managers and banks. It just proved once again. One of the top rated HDFC mutual fund has in its equity portfolio company like Jai Prakash associates and fund has exited positions completely few weeks ago. It’s a company with almost 15 times more debt than its market cap. Mutual funds investing in IPOs, companies at same time, exiting companies at same time so to avoid any huge fluctuations etc are common observations. That’s why I don’t trust these mutual fund managers. “No one in the world can take care of my money better than myself” is my personal quote. And this article coupled with facts and observations from the author is simple to understand and really outstanding.

    • DJ says:

      One other point: some are assuming that the fund manager went by the public rating. I would guess that he probably didn’t, or at least its common and expected for fund managers to do their own analysis and in-fact try to get ahead of rating upgrades/downgrades and/or take advantage of discrepancies. Until we know what the fund manager relied upon, its hard to lay any importance to the credit rating. Default case should be that the fund manager made a honest mistake.

  • Nitin N Karwa says:

    Generals corporate purposes here could well have different meanings. Need to check what exactly these cos or their promoters doing with this debt. Surely money is being out to use somewhere or the other 😉

  • gold bug says:

    My stomach is churning. I am redeeming tomorrow. Thank you Mark Mobius, Sukumar and other fundsters. When the tide goes down you know how many are corrupt. If they have guts they should sell the shares in the market immediately. Further all so called SO appearing in their fund portfolio holding should be also redeemed. Mark Mobius CIC of the Fund should immediately order enquiry and sack the management of these funds and institute criminal proceedings against them if collusion between them and the Management of the Invested Companies are found.

  • Nutts says:

    Dude u r out of ur minds. Do some research before publishing and misguiding.
    1.75x is coverage but according to shareholding u provided there are not enough shares to pledge.
    U have assumed it’s a fraud and ur esteemed research has found one.
    Use ur brains and tell me how this is possible. If u can’t figure out I will teach u.

    • The company itself doesn’t have enough shares. The shares pledged belong to someone else. That’s what is clearly mentioned.
      The point is – if the company has no cash flows, no operational income (not serious at least) then all that this mega loan depends on is the share price (and the collateral). There’s no other guarantee. Loans are based on capacity, creditworthiness and collateral. There is no capacity. Creditworthiness is probably basd on that of group cos, but there is no cross guarantee provided at all for comfort, so this part is iffy. So it’s all about collateral. In that case, the rating should be much lower, like B or BB, since all that matters is the share price.

      • ajay jain says:

        you are right deepak in your overall conclusion that the fund houses have no reason to invest in such debt. the problem is that they are all chasing yield in order to garner more AUM. This leads to a cosy arrangement between the distributors, fund house, borrower and rating agencies. Since each one of them are lightly regulated they all wink at each other and go on fattening their own paychecks at the cost of retail investor. when this arrangement breaks because there is only so much that you can stretch a rubber band the losers are only the retail investors like we saw in case of JP morgan debt fund.

  • Nh says:

    These are smart moves. Look at all the companies to which they lend, they are largely ethical management. Lending at holding company level is the smartest thing anyone can do. It’s not only about cash flows but it’s about underlying assets. It’s unfortunate you don’t see that.

  • Nh says:

    Well not all management is ethical ” (they have lent to dlf and others) but the structure of the deals is advantageous to templeton in most cases. I see a smart bunch of people running the fund…

  • Gandhian says:

    I don’t think this article makes much sense but is rather being quite sensational. 1.75x cover with highly liquid shares with strict top up requirements is a reasonably safe instrument. You can’t get higher yield without taking more risk. Therefore if one wants 100% safety best to invest in government papers. I would be happy to hold the zee credit.

  • Sudip says:

    Being from a rating agency background I can tell you that brickworks and care ratings are not to be trusted. Crisil, icra to an extent fitch are the standard bearers of credit rating industry in India. Any ratings from the other two are to be taken with many pinches of salt.

  • Chaitanya Patel says:

    Dear Deepak
    Thank you for eye opening article. I have one suggestion. As the fund houses and schemes mentioned are very popular (at least on the ratings / peer comparison point of view) can you also provide alternative funds for investment or switching ?

  • Bekxy Kuriakose says:

    Hi Deepak
    Its time someone raises a flag on the way rating agencies rate papers and I am glad your post has done the same. In case of Amtek after maintaing a stable outlook the rating agency suddenly downgrades by six notches!!
    While MFs are being blamed by all and sundry, why is noone taking the rating agencies to task (the regulators or the media)?

  • rohitms says:

    Good work. Not a default yet but very high business risk .

  • Dinesh Nagpal says:

    Brilliant investigative stuff. Reminds one not to judge a book merely by its cover!

  • Biplob says:

    “See if there are companies you don’t recognize or like in there”
    That gives the impression that people shouldn’t invest in unknown small-caps. There are many which have good business (model) with Ok (atleast) corporate governance.

  • Varun says:

    What’s new about this structure? promoter is pledging some of his shares for his other ventures…big deal
    Look around and see…there are so many transactions which have been done, and are there in market.
    Comparing Amtek with any other transaction is futile.
    Before even generalising and comparing, you should first analyse the Amtek Annual Report, and see where the cash has gone.

  • Parul says:

    Hi Deepak,
    Really good insight. Thanks for the same. Was also wondering what would happen to Dish TV incase of any eventuality and where and how these funds raised would have peen utilized?

  • Nilesh Trivedi says:

    Rating agencies know who their real customers are.:)

  • DJ says:

    I don’t understand why people are so critical of Franklin Templeton (or JPM in that other case, although that was a bit more egregious due to a high percentage of the portfolio in one company, so there was some rationale, although if even that is visible to investors, then I’m unsure what the fuss is about). Its pretty basic to check the portfolio before investing in a fund. I’m extremely exasperated when I see comments like the above.
    I am also completely flabbergasted by the point in the article about the fund being short term, so they should not have invested in speculative debt? Hello, there are various kinds of short term funds! How do you think these FT funds have been outperforming other short term funds for many. many years now? As an investor, you have control over how much you put into risky short term paper, you have the choice of gilt funds, and other funds with various levels of allocation to gilts – 30% to 60% even within Franklin Templeton. What more do you want? It was your responsibility to choose a fund with more (or all) short term gilts in them, if you wanted relatively more protection.
    I think you are doing a major disservice by propagating the falsehood that a short term debt fund cannot be expected to hold speculative debt ever.
    The truth is that commenters were greedy due to past returns showing outperformance vs gilts, and did not understand or care to understand the risk, inspite of the literature of each fund saying clearly what they are investing in…. I am also willing to bet that the commenters here showing outrage haven’t read or understood your article and are just angry that they might lose some money. Meh… its so ridiculous.
    Why does anyone assume that a portfolio of debt will never have any defaults just because it is Franklin Templeton? The nature of the fund matters too. Most speculative debt funds factor in a default percentage. And, yes those defaults will be lumpy. And, if you don’t know that, please stay away and stay in gilt funds, even when you see speculative debt funds outperforming because you clearly don’t have a clue that they might suffer defaults when the cycle turns.

    • I think a panic reaction is not justified, but the popular belief is that short term or ultra short term funds need to be taking little risk. The reason they get spooked is because they hadn’t really seen that there was risky paper in there.
      I understand you’re flabbergasted about short term funds and speculative debt but this is a fund that’s supposed to invest in A grade or above debt – which is probably why the discomfort with more risky bet was. I certainly believe that we should have high risk short term funds, if marked so.

      • Gaurav says:

        Hi DJ and Deepak,
        I think that the major concerns are twofold:
        1. About the risk – even when the scheme document mentions something like this (Franklin):
        Franklin India Short-Term Income Plan Income Builder Account is an open end income scheme intended
        to provide stable returns by investing in fixed income securities.
        then one would assume that stable returns does NOT mean a hit of 3.5% odd in one day. I know – it hasn’t happened yet with FT, but the quality of papers does seem to be at odds with what the fund prospectus says
        2. The main point – the damn gates could be enforced! If my investment gets gated then pretty much the whole purpose of investing in fixed income is lost.
        Finally, the portfolio can and will change. If the fund manager wants to go down the credit ladder I’m fine, but he should know what he’s doing. After all, isn’t that what they get paid for?

    • Gold Bug says:

      Thanks for your stupid lectures. I suspect you are from Franklin Templeton. You are well versed with subprime securities in US.
      Probably you don’t have investment in the above funds, so you can talk bullshit.
      Instead of blaming investors for being greedy or else (rubbing salt over wound) it would be wise to ask the Fund House if they fetl any threat to the portfolio constituent in any fund they should switch to safer Gilt funds and not the investor. They have the mandate to do so.

      • DJ says:

        You suspect wrong.
        I am not from FT and I own some Franklin Income Builder, yet this is my opinion. I invested in it knowing full well what the risk of doing so is. I went out of Franklin Low Duration and Franklin STIP last year into gilts, so my remaining Franklin Income Builder position doesn’t hurt as much.
        And, how do we know whether or not the fund has reduced or gotten out of this investment? Its possible that they might have done so. The portfolio composition above is presumably from an earlier date…

        • On the first point there is no “hurt” that has happened or is even likely right now considering Zee shares are hale and hearty. And you’ve done a good job diversifying so if there’s any impact it will be very tiny.
          The portfolio was as of August 31, and it’s unlikely they have sold the investment in the last few days (at least I haven’t seen it reported in the OTC deals, but that market can be opaque. Even then, getting rid of Rs. 800 cr. debt is not going to be possible in a hurry…

        • DJ says:

          well, its unclear if it was a good job because these funds might still outperform gilts despite some bumps along the road… 🙂 Most likely, I will be regretting the switch and chasing yield as usual when I see my returns at the end of the year! 🙂 Any who, the point was that I have no self-interest in defending FT or anyone else in the finance industry. Unless you consider opposing unjustified emotional outrage in society as a matter of self-interest…

        • I don’t think you’re wrong at all mate. I also think panic reactions are silly and one should consider risk from a non myopic view; but I also understand that people feel betrayed when they are given the impression of lower risk but it turns out to be higher.
          I don’t mind chasing high yield at high risk but getting 12.5% in a debt instrument from a sprit corporate resources isn’t exactly that – you get far higher returns from operating companies 🙂

  • Kamal Garg says:

    This is completely shocking. Great pedigree mutual funds like Franklin Templeton and other great MFs like Axis, and even HDFC have such large exposure in these companies which have almost zero networth and no means to service the debt and repay it. I think SEBI should take these kind of news items as ‘suo motto’ complaints by investors and initiate a probe into it. How make Amtek Auto we will have in India. Even great global pedigree MF like J P Morgan has failed in having solid internal control systems for risk assessment and mitigation, then, what to think about other MFs. They all collect money from public and therefore are accountable
    SEBI must initiate an enquiry into it.

  • S says:

    Expressing one’s professional opinion, as long as it based on facts and figures and not merely an uncontrolled response to a singular episode unfolding currently, is acceptable. One must remember that financial investing does not come without risk of default and with every default, all participants (including credit rating agencies and investment managers) become smarter, knowledgeable and more prudent in their decision making. However some disparaging comments alluding to nexus between fund managers and business honchos were most distasteful as they were expressed without proof of any wrongdoing. To the author of the article and uninformed commentators, let us criticize, only if and where there is a need. And when you do, do so responsibly, please.

    • I can’t speak for the others – and I think needless allegations are worthless and undesirable too. But nothing in the article I wrote is not “irresponsible” – it is built around a very specific company and a very specific situation, for which there is a concern about the rating agency and the mutual fund that has lent Rs. 800 crores out of Rs. 2200 cr. to a company, with no incoming cash flows of serious sorts, or assets for a positive net worth. This is a concern but it’s mentioned multiple times that this is not a default situation, and that people that own the fund might consider not to concentrate investments in these funds.
      It is however irresponsible for the fund to just point us to the rating document when they recently released a “rationale” of their investments, with explanations for other companies but not for Sprit.
      Also note this, since I’m reasonably sure you can relay this to the fund team – the interest on that 2200 cr. borrowed is coming from somewhere isn’t it? It’s not from the company’s cash flows. So who’s paying? It can’t be dish tv or Zee TV, this would show up in their ARs. At some point, this is a loan on which interest is paid by taking on more debt (which is precisely the purpose of some of the NCDs taken earlier) When interest on current debt (and principal) is paid for by taking on new debt you have to sit up and wonder when the turkey will be seeing that thanksgiving day.

  • DJ says:

    “popular belief “… “supposed to”… “they hadn’t really seen that..”
    A 1 min check of the FT funds on Valueresearchonline’s portfolio compositions page shows that they have 30-50% A-or-below rated paper.
    The value research fund style graphic for the following funds:
    Franklin India Short Term Income Plan, Franklin India Dynamic Accrual Fund, Franklin India Low Duration Fund
    shows the portfolio credit quality to be “Low”, (bottom third of the spectrum).
    What more marking or knowledge does any investor need beyond this? How can anyone say they didn’t know?
    I don’t know about popular belief, but I can’t imagine anyone looking at these fund profiles properly and concluding that they do not have credit risk. And, when talk about rising NPAs is all over the place, I don’t know why anyone should be surprised.
    The fact is that investors don’t look at or understand portfolio composition, or even the simple fund style graphic. They look at returns and go for the highest one, in which case they can’t complain and need to look in the mirror (or at the fund style graphic and beat their heads against it).
    There seems to be a weird notion that a reputed fund manager like FT should not have had speculative debt in its portfolio. When it is perfectly fine for that to happen as long as the fund style is widely advertised, as is the case in these instances (refer valueresearchonline fund style graphic).
    Furthermore, you can’t even make the liquidity argument because some of these funds have 1 year exit loads, so they are not meant to be used as liquid funds or for short term investments. The short term label only refers to the duration of instruments and nothing else….

    • All this is hindsight right now. The funds get pitched as safe, and I’m not a big fan of just saying caveat emptor and getting on with it. This is a problem, period, and misselling happens all the time, so its very easy to shrug and say “but you should have read all the rating documents!” but honestly people just don’t do this. In fact this is the point at which people should realize that if they don’t do this kind of effort mutual funds are not for them.
      Liquidity arguments apply to many of these funds – the treasury ones for instance have no exit loads, and teh ultra short terms have very little loads beyond say 90 days. Maturity profiles aren’t 90 days (much higher in many) and MFs cannot borrow for intermediate liquidity so the exit load + terms aren’t matching so the liquidity argument remains. (It is not the duration of instruments like you said)

  • Vallabh says:

    Hi Deepak,
    I have 1 cr rupee loan no income no savings n I pledge my 1 kg gold to get more loan. My net worth in negative . But I will still get loan n I will b AAA rated in bank books as they can sell gold if I don’t pay. Isn’t above situation similar …

  • vamsy says:

    I really appreciate your guts and stir up a Hornet’s nest. Since the beginning of times where money is involved, there is a scope for frauds, conflict of interests and self serving interests. What bothers me during the past few years is the way people stopped publishing information about these kinds of things. Our mainstream media has become the most despicable ensemble of institutions which works in a way not to offend the masters and chooses to keep people in the dark. People (like you) who come up with research and provide honest opinions are pestered by harsh criticisms and despite the fact that you were being professional and putting facts as is, is being looked upon as malice intention to defame these Institutions.
    You are doing great service to your readers, please continue with your job and publish great articles.

  • Sanjeev B says:

    Deepak, thanks for not only putting the spotlight on these deals, but also in how well you put it in words.
    For this deal, isn’t this just a ‘benami’ loan? Sprit borrows and covers previous interest obligations, but it could also be giving part of the loan to the generous souls who pledged their shares for Sprit to get the loan in the first place. Now if Sprit defaults, it gets chased, killed and buried (well almost). But the ‘generous souls’ may be using some of the money borrowed, and they continue to enjoy impeccable credit rating and financial track record.