Mumbai: If you have bitten a bullet, you better chew it too.

Fund houses that have financed Yes Bank co-founder Rana Kapoor are finding it hard to do this.

Enticed by returns during good times, fund managers had entered into a layered deal that uses Kapoor’s Yes Bank shares as collateral for a loan. The loan is unsecured since the shares were unencumbered. Simply put, investors can’t force Kapoor to sell his share to make good a repayment. Since good times seldom trigger prudence, fund houses were too happy to overlook.

But what can you expect if capricious equity is collateral for a debt instrument that demands disciplined repayment?

Yes Bank shares fell 5.6% today, making the lender the biggest loser on the Nifty in the first hour of trade. The stock has dropped a massive 75% in the last five months and needless to say has spooked everyone, including Kapoor.

Kapoor’s vehicles are Morgan Credits Pvt Ltd and Yes Capital through which he owns shares in Yes Bank. Both are in a bind now.

Care Ratings downgraded Morgan Credits bonds to BBB- from A- on Tuesday even though fund houses had forced Kapoor to secure the loan through pledging shares last week. Of course, this meant that the collateral value can be lowered. In February, when Care Ratings had given A- to the bonds, the collateral to loan ratio was 2.0. Since then Yes Bank shares have dropped 63%, resulting in the downgrade.

In the case of Yes Capital, however, the value of shares has to be 2.25 times that of the loan because there is no pledge. As of August, the outstanding bonds of Yes Capital rated by Care Ratings was 207 crore, against Yes Bank stake of 2.97%. The fall in the bank’s shares has brought down the cover to 2.37 times from as high as 4 times three months ago.

“So far, the cover is comfortable. But if Yes Bank shares were to fall sharply again, then the investors will just have to take the hit,” said an analyst requesting anonymity.

While Kapoor can’t be forced to sell, investors can ask him to make good the shortfall in collateral value.

Indeed, media reports suggested that Morgan Credits would repay investor Reliance Nippon Asset Management Co as Kapoor looks to monetise stakes in other companies. He also owns 3.92% stake directly in Yes Bank.

Meanwhile, the bank’s shares were down over 1% on Wednesday, perhaps in expectations of Kapoor selling off shares to pay back investors.

The capital markets regulator has mandated mutual funds to ensure a collateral cover of four times the loan size, but no timeline has been indicated.

According to J.N. Gupta, a former executive at Securities Exchange Board of India (Sebi), the best recourse for investors is to invoke pledges. Where it is not possible, unfortunately, they may end up taking the hit. “MFs did not anticipate these things when investments were made in innovative structures. Now they will have to face the reality,” he said.

The rating downgrade of the shares-backed bonds will force fund managers to side- pocket their investments, as well as demand Kapoor make good the shortfall in value.

Perhaps Kapoor’s turnaround to a willing seller of Yes Bank shares from someone who considered them diamonds forever was driven partly because of the probability of pledges being invoked.

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