Business Today
Defaults in corporate bonds: Tip of the iceberg
Some questions need to be answered on the functioning of rating agencies that overnight stopped rating a debt paper. At the same time, some overnight changed a debt rating of the Amtek Auto paper from low credit risk to very high risk of defaulting.
Defaults in corporate bonds: Tip of the iceberg

Defaults in corporate bonds: Tip of the iceberg

title=/

Mahesh Nayak, senior associate editor, Business Today


The default of Amtek Auto's non convertible debentures (NCD) has raised concerns about the role of mutual fund managers, rating agencies and regulators. The big question is: how safe are debt investments, especially in mutual funds?

Some questions need to be answered on the functioning of rating agencies that overnight stopped rating a debt paper. At the same time, some overnight changed a debt rating of the Amtek Auto paper from low credit risk to very high risk of defaulting.

The Amtek Auto default also raises concerns on the selection criteria of the debt paper by Asset Management Company (AMC) and the role of regulators. Role of analysts have also to be questioned as the JP Morgan AMC's scheme - JP Morgan India Short  Term Income Fund - was among the top 50 schemes for making investment in debt funds.

One could say that JP Morgan AMC followed the book, so going by regulation they didn't do anything wrong. But it still raises the question of why it bought Amtek Auto's paper when no one else in the mutual fund industry was willing. That, too, JP Morgan AMC bought the paper of Amtek Auto from the secondary market from Axis Bank in January 2015. According to market grapevine, the AMC is said to have acted against the advice of its own in-house research team. Yes, "high risk is high returns", then if an AMC takes a wrong step, it will also have to bear the negative results. After all globally JP Morgan AMC manages money that is bigger than the size of the Indian economy. The company did not reply to a questionnaire sent by BT.

There is no need to give any sort of concessions to the AMC that miscalculated its investment in Amtek Auto, as a majority of the money deployed in debt funds are institutional and from high net worth investors, who are considered informed investors. But the problem is: for the past couple of years debt funds have been sold to retail investors as safe products. This is the big cause of concern for the regulator, as this episode is seen as just tip of the iceberg.

The reason why the regulator is worried is because it's no more a Rs 200-odd crore issue, but a Rs 60,000 to 75,000 crore of investment in corporate bond paper below Triple A. Concerns are investments by mutual funds in these corporate bonds can today follow the Amtek Auto way. In fact of the total Rs 12.55 lakh crore assets under management (AUM) of the mutual fund industry, over 65 per cent of the money is invested in debt funds including income funds, liquid, money market and government securities funds.

Sources says already there are talks of default in the interest payment of a Triple A rated steel company and the urgency seems to have hit in the regulator's camp that is working together with mutual funds, rating agencies and banks to avoid a mishap in the market. Concerns are if the default comes out in the open, it will have a huge impact on the overall mutual fund industry because the paper of the steel company is held by many mutual funds.

What is being heard on the street is: regulators and banks are trying hard to ensure that the tap doesn't dry and companies do not default on their commitments on bonds.

The problem of default in corporate bonds can have a contagion impact that can bring down the entire mutual fund industry like a pack of cards. During the global financial crisis in 2008 we have seen a glimpse of what can go wrong when panic strikes as investors line up for redemption and there have been instances then of AMC closing shop.

India is cheered for its strong regulators -be they banks or capital market -but the default in corporate bonds can spark a huge fire that will not only bring a bad name to the Indian mutual fund industry, but the magnitude of the crisis could also have a huge negative sentiment towards India, which is today emerging as a safe haven among its peer countries as a strong investment destination.

Get latest news & live updates on the go on your phone with our News App. Download The Business Today news app on your device
More from OPINION