Banking & Finance: Relaxed AIF regulations - positive for some lenders

In Dec-23 the RBI had clamped down on AIF investments by the lenders to curb evergreening of stressed loans. To address some of the collateral damage concerns of various stakeholders, the RBI has partially relaxed/clarified a few regulations that are incrementally positive for the lenders. Analysts of IIFL Securities believe some lenders ala PEL, RBL, HDFC and Axis who had conservatively provided on their entire AIF exposure (5-550 bps of loans) in Q3FY24, might be able to write-back some of these provisions. Analysts of IIFL Securities elaborate the four key relaxations from the RBI and its implications on the industry below.

Change in definition of ‘downstream investments’ made by the AIFs: The December circular did not clearly define the nature of downstream investments made by the AIFs, and it was expected to include investments via both bonds and equity route. However, it is now clarified that the downstream investments by the AIFs shall exclude investments in the equity shares of the debtor company, but shall include all other investments, including investment in hybrid instruments. Implications: The exclusion of equity shares from the definition of downstream investments works only for investments in listed companies, and will likely thus benefit a few lenders. However, it seems to fail to account for the Private Equity and Venture Capital investments, which are mainly in the form of compulsory convertible instruments such as CCPS and CCDs. The AIF industry may therefore have to evaluate whether they would need to convert all their hybrid secured to equity to allow lenders to stay invested in their funds.

Provisioning required only on the overlapping downstream investment, and not entire investment amount of the lender. As per the latest directions, RBI now requires banks to only set aside provisions to the extent of their investment in the AIF scheme, which is further invested by the AIF in the debtor company, and not on the lender's entire investment in the AIF scheme. Implications: This can potentially result in a reversal of the provisions made by the lenders, who had conservatively provided on entire investments in Q3FY24. Select banks and NBFCs had made AIF provisions to the tune of 2- 550 bps of loans (not annualised) in Q3FY24 (refer to Fig. 1). There is a possibility that some lenders ala PEL, RBL, HDFC and Axis may write-back some part of the provisions already recognised in Q3FY24. However, some lenders may also consider to defer writing-back of these provisions to the time when these investments come for redemption, or even consider carrying them as a contingency buffer for future potential haircuts, if any.

Capital hit due to investments in the subordinated units of any scheme with a ’priority distribution model’ should be split equally between Tier-1 and Tier-2 capital. There are three key changes: (1) the RBI has clarified that if there is any downstream investment by the AIF in a common debtor, then the lender will have to create a provision on this exposure, rather than deducting from capital directly; (2) in cases other than point 1, the capital deduction will take place equally from both Tier-1 and Tier-2 capital; and (3) it is applicable for all subordinate investments, including in the form of sponsor units. Implications: The drag on Tier 1 ratio of some lenders ala IIFL Home Finance can potentially be lower than earlier expected. However, no relaxation has been provided to the lenders whose exposure to these scheme is in the form of sponsors.

AIF investments through fund of funds or mutual funds is excluded from the scope of this circular. The RBI has clarified that investments by REs in AIFs through intermediaries such as fund of funds (FoFs) and mutual funds is outside the scope of this circular. Implications: This shall likely result in the exclusion of FoFs like NABARD and SIDBI, which form a reasonably sizeable part of AIF investments by the banks. Axis Bank had mentioned that 46% of their AIF investments are in AIFs that are directly or indirectly government-owned or from sponsoring entities like NIIF, NABFID and NABARD. With such AIF investments outside the purview of circular, the banks which have already made a provision on them may see write-backs.