Franklin AMC bought JSPL papers from its schemes

Debentures bought at around 27% discount in two tranches

The mystery buyer of Jindal Steel and Power's (JSPL’s) non-convertible debentures (NCDs) in Franklin Templeton’s mutual fund schemes in February-March 2016 is, finally, out. And it is none other than Franklin Templeton Asset Management Company, itself, which bought these papers from its six schemes, according to the fund house’s annual report.   
 

The debentures were valued at around Rs 1,700 crore before credit rating agencies downgraded the instrument in January 2016. Franklin Templeton's asset management company bought the debentures for an aggregate value of Rs 1,240 crore, a 27 per cent discount.   
 

A Franklin Templeton spokesperson said: “Franklin Templeton Asset Management India (FTAMIL) was the counterparty for JSPL securities transactions in February and March 2016. The transactions were effected keeping in mind the interest of unit holders and the challenges that could be faced while holding non-investment grade securities in an open-end fund structure.” 
 

According to the spokesperson, JSPL's securities had been purchased across its corporate bond fund range in December 2014 when the long-term rating for JSPL was AA- by rating agency CRISIL, and in March 2015 when these securities were rated AA by CARE, another rating firm.  
 

However, things changed dramatically in January 2016 when CRISIL downgraded JSPL's NCDs to BB+ and then to D by March; Franklin Templeton was caught on the wrong foot because of its high exposure. Six of its schemes had exposures of two-seven per cent of their corpus in JSPL debt papers. The total value of the holdings was around Rs 1,700 crore — the highest exposure to the company in the mutual fund industry.  
 

According to industry players, after the news of JSPL's downgrade came out, there was a lot of redemption pressure on the fund house. To resolve the situation, the fund house sold JSPL papers at a discount in two tranches, at Rs 72.50 and Rs 67.50 (face value Rs 100) on February 29 and March 10, respectively, to the AMC. 
 

“While the downgrade saw the scheme’s net asset value (NAV) fall, the sale led to a further loss for investors,” said a distributor. ICICI Prudential Mutual Fund also had exposure to JSPL. However, it did not sell the papers. 
 

“FTAMIL purchased JSPL securities in two tranches due to the size of the transaction. The first tranche was purchased on February 29, 2016, when the security was rated BB+ which is below investment grade. However, we had to arrange for funding to purchase the balance, which took normal procedural time. The second tranche was therefore purchased on March 10, 2016. In the interim, the rating agency downgraded JSPL’s long-term debt rating from BB+ to Default (D),” said the fund house’s spokesperson. 
 

Fund experts have raised questions on whether the fund house took the decision in haste as JSPL had not defaulted till then and the NCDs would start maturing only from 2018. 
 

Another question that they ask is if the NCDs were valued correctly. According to the fund house’s spokesperson, the securities were valued in accordance with regulations and fair valuation principles and were purchased by FTAMIL at the price at which they were held in the funds. All necessary disclosures about these transactions were made to the relevant authorities. Industry players say that though other fund houses did not sell the papers, their valuation was similar. 
 

As far as Sebi guidelines go, a fund can classify an underlying asset as a non-performing asset (NPA) only three months after a default on interest and principal payments. And in case of interest payment defaults, the fund needs to write off the security's underlying value in phases, every quarter, starting six months from the default date, or three months from the NPA classification date. The fund needs to write off the value in five tranches —10 per cent, 20 per cent, 20 per cent, 25 per cent, and finally 25 per cent.
 

The good news is that Franklin’s investment hasn’t gone waste. The company has recorded interest income of Rs 99.7 crore on this investment already and has created provision for another Rs 14.5 crore.  
 

Dhirendra Kumar, CEO, Value Research, said: “This was a Catch-22 situation for the fund house. Ideally, in such situations, the Securities and Exchange Board of India should allow fund houses to stop redemption. But it does not happen easily. Therefore, the fund house has little option. This does lead to a conflict of interest.”
 

However, the larger issue, according to Kumar, is that while investors get full liquidity in open-ended schemes, the underlying assets are not completely liquid. “This mismatch leads to such situations,” Kumar said.