Industry pundits concur that the recent regulatory mandate will compel NBFCs to make provisions, given the intricate process of divesting from AIF investments within the stipulated timeframe.
The collective investment in AIFs by entities overseen by the RBI approximates Rs 15,000 crore. Notable participants in this sphere include Piramal Enterprises, Edelweiss, and Indiabulls, as per reliable industry sources. However, the precise extent of ‘doubtful investments’ within AIFs and the consequential provisioning impact on the implicated NBFCs remain elusive.
Unraveling the Impact of RBI’s Stance
Owing to the inherently illiquid nature of Alternative Investment Fund (AIF) structures, the RBI’s recent prohibition on loan evergreening is poised to usher in augmented provisioning and an upswing in non-performing assets for select NBFCs in forthcoming quarters, as per expert projections.
The estimated cumulative investment in AIFs by RBI-regulated entities stands at Rs 15,000 crore, with key players such as Piramal Enterprises, Edelweiss, and Indiabulls at the forefront, according to industry insiders. Nevertheless, the specific details regarding the quantum of AIFs grappling with ‘doubtful investments’ and the subsequent impact on the concerned NBFCs remain speculative.
On December 19, the RBI issued a directive barring regulated entities (REs), including banks and NBFCs, from investing in AIF schemes with downstream investments in debtor companies of the RE, whether direct or indirect.
In essence, the directive aims to curtail the practice of REs transferring loans to AIFs to present a pristine financial facade. Industry sources hint that RE lenders to infrastructure firms often engage in such practices.
Now, the RBI mandates the unwinding of such positions. If an AIF scheme, in which the RE is an existing investor, makes a downstream investment in a debtor company, the RE must divest its investment within 30 days from the said downstream investment, as per the RBI stipulation.
Failure to liquidate investments within the prescribed timeframe will necessitate a 100 percent provision on said investments, according to the regulatory mandate.
Industry experts foresee a higher likelihood of the second scenario unfolding. The challenge lies in the impracticality of liquidating AIF units within a 30-day timeframe, especially considering that many AIFs have predefined lock-in periods.
Mataprasad Pandey, Vice President at ARETE Capital Services, opines, “Liquidating AIF units within 30 days seems impractical, making provisions for such investments more plausible.”
In concurrence, an unnamed AIF official notes the inherent difficulty AIFs face in liquidating units due to the underdeveloped secondary market in this asset class.
Identifying Potential Impact on Lenders
An analysis by IIFL Securities identifies NBFCs such as Piramal Enterprises, Indiabulls Housing Finance, and Edelweiss as particularly exposed to AIF investments. Piramal allocates 20.3 percent of its total investments to AIFs, while Indiabulls Housing has a significant 67.3 percent, and Edelweiss has 11.4 percent.
Piramal Enterprises, in an exchange filing, disclosed an investment of Rs 3,817 crore in AIFs, with only Rs 653 crore exempt from exposure to debtor companies. The company aims to adjust the remaining amount, and inquiries are underway with other NBFCs to gauge the extent of such investments.
In contrast, the impact on banks is anticipated to be minimal, with many REs incorporating AIF units into their regular investment operations, accounting for less than 10 percent of their portfolio.
Mataprasad Pandey raises concerns about concentrated risk when only a few REs hold such investments, emphasizing the potential for a cascading effect.
Unveiling Potential Risks for IIFL
IIFL Securities, which itself has investments in AIFs, holds approximately Rs 1,100 crore (2 percent of AUM) in AIF investments, as per Jefferies’ calculations.
Jefferies suggests that if Piramal and IIFL have to provision against their entire AIF exposure, the potential impact on net worth could be -10 percent and -8 percent, respectively.
AIFs in the Aftermath
While banks and NBFCs brace for potential fallout, AIFs are not exempt from the repercussions, anticipating a shrinkage in their pool of investments.
Expecting regulatory clarification, an unnamed AIF official underscores the potential harm to AIFs if banks and NBFCs become apprehensive about investing in these structures without clear guidance.
Acknowledging the necessity of the notification, Shyamal Karmakar of RV Capital asserts, “It is crucial for fund managers and AIFs to steer clear of conflicts that may jeopardize investor interests. This directive appears to be a step in the right direction to address this issue.”
According to Deepak Shenoy of Capitalmind, the regulation is a commendable move, preventing NBFCs from investing in AIF units to perpetuate loan evergreening. He emphasizes the continued viability of junk bond AIFs, provided NBFCs are excluded as investors.
Decoding the Mechanism of Evergreening
SEBI’s consultation paper in May outlined how NBFCs, in collusion with AIFs, employed the priority distribution method or ‘tranching’ for loan evergreening.
Tranches, reflecting varying degrees of credit risk, prioritize senior investors in proceeds distribution over their junior counterparts. Senior tranches, assuming lower risk, yield lower returns, while junior tranches, absorbing losses first, offer higher yields.
To expunge high-risk loans from their books, lenders subscribe to the junior tranche of an AIF scheme, with the regulated lender’s investment size determined by the anticipated loss on the loan portfolio during structuring. Subsequently, the AIF secures investors for the senior class of units. The AIF then loans the funds to the same high-risk borrower, enabling the lender to present a clean financial record by circumventing NPA recognition. This elucidates how RBI’s rules were circumvented.
In Conclusion
As the regulatory landscape evolves, the ripple effects on NBFCs, banks, and AIFs underscore the need for a nuanced approach to investments and financial practices. While challenges loom, regulatory measures are deemed crucial for maintaining financial integrity and protecting investor interests in India’s dynamic financial ecosystem.
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