Market participants spent months seeking easier liquidity conditions from the Reserve Bank of India. The liquidity deficit, many believed, was keeping funding costs high and worsening the credit crisis.
Liquidity in the system finally turned surplus in June and has remained so for the last eleven weeks. The surplus has risen to as high as Rs 2 lakh crore on days.
Despite this, funding costs for corporations, even AAA-rated corporates and non-bank lenders, have not eased significantly. While government bond yields fell as liquidity turned surplus, the spreads (or additional interest) demanded by investors over and above government bond yields remain high.
Despite surplus liquidity coming into the system, spreads on AAA corporate bonds have not come down and trading in the bond markets continues to be skewed, said Dwijendra Srivastava, chief investment officer-debt, Sundaram Asset Management Company Ltd. “This is because of two reasons: either investors do not expect liquidity at the system level will continue to be in surplus going forward or that they are not convinced about individual companies and individual sectors.”
Wide Spreads; Greater Differentiation
Infrastructure Leasing and Financial Services Ltd., which collapsed in September 2018, was rated AAA until just about a month before default. The experience left investors demanding more to compensate for credit risk.
That remains the case even a year later, particularly for non-bank lenders.
Bond issuances of eight large NBFCs analysed by BloombergQuint show higher costs across the board. Notably, the differentiation between individual firms, even within the AAA-rated category, has also increased.
Tata Capital Financial Services Ltd., for instance, paid a spread of more than 200 basis points over the comparable government security when it raised 5-year money in June. The last time it had raised capital for this duration, in September 2018, it had paid only about 72 basis points above the benchmark.
Mahindra and Mahindra Financial Services Ltd. paid nearly 189 basis points over government bonds to raise 3-year bonds in February this year. In April 2018, the last time it raised money for this duration, the spread was just 85 basis points.
In contrast, the two HDFC Group firms have seen the smallest increase in spreads. HDFC Ltd. paid 128 basis points above government bonds to raise 10-year bonds in August, marginally more than the 118 basis points is paid in October 2018.
For the analysis, BloombergQuint compared the most recent security issued, for which there was a comparable bond issue in 2018.
According to Kavita Chacko, senior economist at CARE Ratings Ltd., investors are pricing in credit-risk of companies across rating categories. Though there is a surplus of banking liquidity there is a general risk-aversion, she said.
Specific to non-bank lenders, Srivastava said that a contraction in the balance sheets of large NBFCs and continued credit rating downgrades has left investors scared about hidden risks.
“There is an overall risk aversion in the corporate bond market after the default from two big NBFCs during last year. The situation does not seem to be coming to an end. Barring a few large well run NBFCs, most of the other companies are unable to raise funds, due to risk aversion,” said Sampath Reddy, chief investment officer of Bajaj Allianz Life Insurance Co. Ltd.. The current risk aversion and liquidity squeeze in the corporate bond market may cause a further slowdown, he added.
Fund raising conditions for AA-rated NBFCs are even tougher.
JM Financial Asset Reconstruction Co. Ltd. raised three-year funds at a spread of 638 basis points over government securities. When it raised funds for this duration in 2018, the spread was 243 basis points.
Cholamandalam Investment and Finance Co. Ltd, paid 219 basis points over three-year government securities this year, compared to 69 basis points last year.
Lakshmi Iyer, chief investment officer-debt at Kotak Asset Management Co. said there are multiple layers of uncertainty right now. “The government bond market needs to stabilise first. This has to be coupled with a return of investor confidence. Till then, it may be difficult for these spreads to compress anytime soon,” she said.
Iyer said that funds are buying short-term paper (3 month to 1 year) and are averse to investing in illiquid corporate bond issuers. “The secondary market for corporate bonds is illiquid, however there is some sporadic trading activity taking place in the AAA-rated bond segment. Mutual funds currently are not participating much in non AAA-rated corporate bonds hence the trading in the secondary market is tepid,” she said.
A fixed-income fund manager, who spoke on condition of anonymity, told BloombergQuint that price-discovery remains tough for many corporate bond issuers. The top blue-chip firms continue to get as much money as they want, but there is no secondary market of trades in other AAA-rated and AA-rated companies, he said.
It is very hard to discover the right price for a bond because spreads between a AAA-rated NBFC and a AA-rated NBFC have also widened because the price discovery mechanism of the secondary-market is largely broken, this person added.
Investors are being choosy even while buying debt of non-financial companies. Here, the differentiation is based more on industry. Segments of manufacturing, such as automobile companies, and real estate firms are being forced to cough up more to raise money.
Joyville Shapoorji Housing Pvt. Ltd. paid 374 basis points above the 10-year government bond while raising funds this year. Last year, it had paid 216 basis points above government bonds.
Piramal Enterprises Ltd. is paying 346 basis points above government bonds now compared to 275 basis points last year.
The trend is not entirely surprising, said Arvind Chari, head of fixed-income and alternatives at Quantum Advisors Pvt. Ltd. When a central bank commences a rate-cutting cycle, spreads rise in the bond markets, particularly when policy rates are cut to address a slowing economy, said. The availability of investment pools is currently constrained as mutual funds, leading to higher funding costs, Chari added.
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