Sweetheart deals that finance companies cut with private equity (PE) houses to dispose off risky builder loans soften the hit on bottom lines are under the scanner of market regulators which are questioning a popular fund structure involving ‘senior-junior’ investors, reported The Economic Times.
Over the past two years, some of the large non-banking finance companies (NBFCs) have transferred real estate and other wholesale loan exposures at the first hint of stress to new alternative investment funds (AIFs) that they set up in partnership with PEs and asset managers.
In such deals, the money is invested in by the NBFC and the PE goes in cleaning up the former’s loan book, while the PE earns a better return.
What lures a PE fund to walk into such a deal is the unique ‘senior-junior tranche’ arrangement: while both the PE and the NBFC invest in the AIF, the PE has a ‘senior’ status — as the stipulated returns from the AIF’s investments are first paid to the PE. Only after the PE is paid, the AIF distributes the balance to NBFC (the junior tranche, having a second lien).
In a recent communication to several funds, the SEBI has questioned the senior-junior mechanism, three persons aware of the development said, ET reported.
Sebi, said the person, has also stalled a proposal to set up an AIF (structured in senior-junior tranches) by a large Mumbai-based NBFC and a global asset manager.
According to a senior banker, such deals boil down to ‘loan evergreening’ — a sharp practice of giving more loans to salvage an existing loan to a troubled borrower who is on the verge of default.
Such deals have also drawn the RBI’s attention. The NBFC simply kicks the can down the road. The central bank would probably like to know whether the NBFC is making adequate provisioning and what the terms of such transactions are, wrote ET.