Covered bond issuances increase to Rs 2,200 cr in FY21: ICRA report

Domestic covered bond issuances have witnessed a sharp increase to about Rs 2,220 crore in FY2021 as against the issuances of Rs 400 crore seen in the preceding fiscal, said a report by ICRA Ratings.

These bonds have been issued so far by non-banking financial corporations (NBFCs), nine in FY2021 compared to two in FY2020.

"The covered bonds have seen improved acceptance in the Indian market mainly in H2 FY2021 as it provides a 'dual recourse' benefit to the investor, i.e. the repayment obligation has to be met by the entity and in case of failure to do so, by a pool of assets assigned to a trust," the rating agency said.

It said that given the uncertainty on collections due to the pandemic, the protection available to an investor of a covered bond improves when compared with the conventional securitisation of the pool of assets.

The domestic market for covered bonds is still in the nascent stages with the first issuance seen in FY2019.

This structured product, however, has been a well-accepted financing tool in the western markets, especially in Europe, for many decades and has also seen a growing popularity in some Asian countries such as Singapore and Japan.

"We have seen 12 NBFCs issue covered bonds in the domestic market so far with about 75 per cent of such issuances done by entities having their credit ratings in the single A category," the agency's Vice-President and Group Head (Structured Finance Ratings) Abhishek Dafria said.

Through the covered bond structures, the entities are able to reduce the risks for the investors by providing an exclusive cover pool of assets assigned to a trust thereby helping them improve the credit rating on such covered bonds to double A or triple A rating categories, he said.

Dafria said issuers have benefitted from lower coupon rates on the covered bond issuances due to the higher rating with coupon reduction seen in the range of 0.5-1.25 per cent.

However, the coupon rates still remain higher than the benchmark yield for the enhanced rating category due to the new nature of the product and limited market size, he said.

"We expect the premiums to gradually decline with increase in the size of the covered bond market through better stakeholder awareness and wider investor participation," he added.

The agency said almost two-thirds of the covered bond issuances have been in the form of market-linked debentures (MLDs) so far. High networth individuals (HNIs) and family wealth offices have invested in many of the issuances.

Covered bonds backed by a security pool of gold loans and vehicle loans have found favour with investors, primarily due to the secured nature of the underlying loans, it said.

"For the covered bond market to witness any material increase, participation of other categories of investors would remain critical, such as mutual funds and insurance companies, who have the capacity to participate in large-size issuances," the agency's Assistant Vice-President and Sector Head (Structured Finance Ratings) Rachit Mehta said.

Covered bonds at present form a very small share of the total borrowings of the respective entities, he said.

However, if the issuances were to increase in the future such that covered bonds formed a meaningful share of the total borrowings, then the company's ability to maintain the required security cover would remain important, he said.

Failure to meet the security cover would result in a step-up on the coupon rate thereby negatively impacting the financial profile of the entity, Mehta added.