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Sebi: Sebi questions ‘premium-base’ fund transactions by non-bank lenders

Mumbai: The cozy deals finance firms cut with private equity (PE) homes to eliminate risky loans for builders and lessen the impact on bottom-line profits of the financial market managers question a fund structure involving ‘senior-junior’ investors.

Over the past two years, several large non-banking finance companies (NBFCs) have transferred real estate and other wholesale loans at the first sign of stress for new alternative investment funds (AIFs) that they set up in partnership with Production Specialists and property managers.

The transaction works in such a way that the NBFC takes the money and the PE cleans up the old person’s loan book, while the PE earns a better return.

Mind is better than money



What attracts a PE fund to enter into such an arrangement is the unique ‘senior-stage’ arrangement: while both PE and NBFC invest in AIF, PE has a ‘premium’ status – like regulated profit from AIF. the first investments are paid to PE. Only after the PE is paid does the AIF distribute the balance to the NBFC (base stage, second lien).

Securities & Exchange Commission of India (Sebi), in a recent communication with several funds, questioned the senior-subordinate mechanism, three people familiar with the development told ET.

The regulator, said one fund manager (who requested anonymity), classified in its letters that only investment managers or funders could bear higher losses. However, in most AIF structures involving PE-NBFC, PE is the sponsor but NBFC is the investor in the fund which can suffer losses and lower returns. Sebi, the person said, has also stalled the proposal to set up an AIF (structured along high-level branches) by a major Mumbai-based NBFC and a global asset manager.

According to one senior banker, such transactions become ‘step-by-step lending’ – the apparent fact of lending more to save an existing loan to a struggling borrower in need. on the verge of default.

KICKING THE CAN DOWN

Here’s how an NBFC-PE transaction works: Suppose, an NBFC invests ₹300 crore while a PE invests ₹700 crore in the newly formed AIF, which issues units to both investors.

The AIF then lent the ₹1,000 it received (from PE and NBFC) to a group of NBFC stressed borrowers by registering to debit the issues these borrowers issued. The borrowers (as part of the whole deal) then repay the NBFC. Posting such an agreement, NBFC has no contact with these borrowers; instead, it keeps AIF units in its investment book. The result: the finance company’s loan book looks cleaner and it avoids making higher provisions in the event of default. Loss from brand-name accounting in the market of the units is much lower than the provisioning for debts converted into bad assets.

As a result, the NBFC uses the money to refinance (or even restructure) its loans through the AIF acting as an intermediary.

Such deals have also caught the attention of the RBI, according to a senior fund industry source. “The NBFC is simply starting to fail. The central bank may want to know if the NBFC has made adequate provisioning and what are the terms of such transactions.”

Sebi Question 'Senior-Junior' Fund Transaction by Non-Banking Lenders

GENUINE SUBJECTS MAY BE AFFECTED

However, according to Tejesh Chitlangi, senior partner at IC Universal Legal, the senior-junior stage is an important structural aspect for some AIFs, especially for funds that invest in debt securities. .

Many of these transactions are driven by commercial reasons – with a group of senior investors in the AIF, paying higher fees, receiving their periodic payments (such as principal as well as a barrier). /return rate) takes precedence over other junior investors paying lower fees.

“This can be considered a wise decision by all investors as higher risk yields better returns and vice versa without violating Sebi’s blind group principle requiring commensurate participation. However, Sebi does not appear to favor such structures for a variety of reasons, although there is no explicit prohibition in the restrictive AIF Regulations. such structures, but the regulatory stance seems to favor allowing similar structures only in the base case or in some cases of the first type of loss, Chitlangi said.

“It appears that the stance discourages certain internal debt investment transactions conducted by a few AIFs. But, this would limit the conventional commercial structures implemented by many AIFs. Chitlangi said. .

Sebi’s opposition to these structures comes after at least four major NBFCs have refinanced nearly 10,000 yen loans through them over the past two years.

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