It's back to the drawing board as commercial paper market sees hiccups

Strict enforcement on end-use of proceeds and risk aversion will raise barriers for commercial papers

It’s unlikely that anybody is going to get an easy pass into the commercial paper (CP) market going ahead. Not many will go on record to tell you what class or kind of issuers are going to be hit, but it will involve more than the usual suspects: non-banking financial companies (NBFCs) and realty firms. And this is despite the Reserve Bank of India (RBI) offering a lifeline to ease liquidity concerns last fortnight. So, what’s in store?

Mint Road is to insist that its CP regulations issued on February 1, 2017 — but papered over in the din that’s currently on — are to be followed in letter and spirit; it will shut this route for many. It was made explicit back then that issuers must disclose the end-use of proceeds, which can be used to finance only the current assets and operating expenses of a firm. It is reasonable to assume that a few issuers have used the proceeds in contravention of these norms.

It’s also not going to be a smooth passage from the drawing board to the issuance stage for CPs because the RBI circular had also insisted that, to ensure the system is not blind-sided, all lenders to the firm issuing the CPs from whom it had secured loans too, are be informed about the details. Simply put, adherence to this, with multiple checks due to the current money market jitters, will eat into the lead-time for issuances.

Another barrier is the ground rule that the CP issuer should get at least two ratings (from a credit rating agency) and assign the lower of them to the issue. It’s been rendered almost worthless after Infrastructure Leasing & Financial Services blew up in everybody’s face, going from investment grade to junk status within a fortnight. In effect, this means that multiple ratings by themselves will not aid buoyancy to a CP issue.

The long and short of it

“We believe Rs 1.5 trillion (55 per cent of outstanding) of CPs of financial companies will be up for maturity this month. In December, the maturity quantum reduces to Rs 758 billion (28 per cent of the outstanding),” said Kunal Shah of Edelweiss Securities.

As for NBFCs and housing finance companies that are in the spotlight, he feels that given the support from banks for buy-out or onward lending, inflow into liquid funds, and the RBI’s open market operations, “it’s safe to assume that the risk-related to them is likely to wane over the next 20 days”.

It still does not answer the question: where does all this leave non-financial companies as far as CPs are concerned?

It would be illustrative to look at the RBI’s Report on Trend and Progress of Banking in India (2016-17), which says CP issuances almost doubled to Rs 1 trillion in 2016-17.

This should be seen in a larger context – the flow of resources from non-bank sources filled the gap opened by dwindling bank credit to India Inc which fell to 34.9 per cent during 2016-17, down from 50 per cent in 2015-16. Within non-banks, private placements of both corporate bonds and CPs made up 21 per cent of their total funding needs.

“The question is who is going to provide the liquidity. For some time now, mutual funds were the biggest providers of it,” said Romesh Sobti, managing director and chief executive officer of IndusInd Bank.

“If issuing CPs becomes an issue for some, they have to fall back on their cash-credit limits with banks, but then pricing will be higher.” Again, the unknown variable here is whether the banks will generously open the cash-credit purse as the CP mart turns tight.

It’s also not clear if issuers have unused bank credits to back the CPs. “Some may have borrowed some amount through standalone CPs not backed by unused bank credits, or the share of CP per borrowing may be higher than prudent limits, especially intra-quarter,” said Kailash Baheti, chief financial officer of Magma Fincorp. It brings into play another Mint Road norm, namely that the CP issuing entity has a sanctioned working capital limit by banks — and the account is classified as a standard asset.

The bottom line: it will be red lights till the commercial kicks into CPs.

Rocky road ahead

• Pricing set to move up significantly to pre-IL&FS crisis level of 15.7 at the upper end, or up by 200 bps
• Flight to safety will result in a whole universe of issuers getting squeezed out
• Good credit rating alone may not save the day for some
• Investors will play by the book and stress on the RBI circular that proceeds from CPs be used to finance only current assets and operating expenses