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Redemption blues for liquid, debt funds

By Ranju Sarkar in Mumbai
October 14, 2008 09:48 IST
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Liquidity crunch and fear are driving redemptions by companies in liquid and debt funds. With banks tightening working capital loans and refusing to discount letters of credit beyond 60 days, companies are trying to tide over the crunch by redeeming some of their investments in debt and liquid funds of mutual funds.

The redemptions are also driven by concerns on the quality of the portfolio: debts funds' exposure to illiquid, pass-through certificates and the fixed maturity plans exposure to real estate companies, who many fear could default.

"There has been some amount of redemptions in debt funds,'' said Murthy Nagarajan, head, fixed income, Mirae Asset Management. "The PTC portfolios are illiquid. People don't want to be there. They are saying why should I keep my money in a mutual fund; I am better off with cash," added a fund manager.

Like in the US, banks in India have securitised a part of their retail loan book to pass-through vehicles, which have issued PTCs to mutual funds. For instance, a bank with Rs 1,000-crore (Rs 10 billion) loan book, decides to securitize a part of it, say Rs 100 crore, which allows it to grow its loan book and meet the capital adequacy norms.

For mutual funds, the PTCs offer a return which is 200 basis points higher than the more-safer certificate of deposits banks issue, said a fund manager.

The originating bank would go to a credit rating agency and seek a rating. The rating agency looks at the likely default rate on such loans (say 10 per cent), for which the originator stands guarantee. Based on this guarantee, the agency provides a rating which is higher than otherwise possible on such securities.

"Market conditions have completely changed. The default rates on such loans could be higher today. These instruments are not listed; so it's difficult to value them. Even if you want to do a bilateral transaction (a bank could sell to a fund, or one fund to another), there's no liquidity," said a CFO in Mumbai.

"It's both the liquidity crunch and concerns on safety that's driving companies to redeem. There are concerns on the underlying debt of mid-rated companies that mutual funds bought, some of whom could default," said the CFO with a leading corporate in Mumbai, which has trimmed its liquid funds portfolio by a quarter.

"Fear is driving fear here," said a mutual fund analyst. Funds have been trying to dispel the same. "We have 50-odd FMPs. There has been no delay or default on any of our investments in last ten years of FMP's history," said Nilesh Shah, deputy managing director, ICICI Prudential.

Analysts said funds have been trying to meet redemption pressures by selling the commercial papers and certificate of deposits to some banks, who expect things to change in the next 2-3 days but that calls for some government intervention.

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Ranju Sarkar in Mumbai
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