The past three years have seen the banking sector struggling to get its act together. Public sector banks (PSBs) are carrying huge non-performing assets (NPAs) and have also borne the brunt of a record number of corporate debt restructuring (CDR) requests. Each CDR essentially involves a haircut and a large proportion of CDRs turn into NPAs anyway. To make matters worse, credit growth has been at decadal lows. Very stressed balance sheets have not left banks with much room to cut rates. Since 2015, the Reserve Bank of India (RBI) has cut its policy rate multiple times. The central bank has also cut the differential between the repurchase and reverse repurchase rates, (which eases costs for banks). RBI also increased overall liquidity through open market operations. But, little of that has been passed on by banks in lending rate cuts.
If bank credit was the only way to raise debt, India Inc would be in serious trouble because real interest rates are very high. However, there has been a revival of the corporate bond market. In the first half of financial year 2016-17, debentures have seen explosive growth.
About Rs 24,000 crore has been raised through non-convertible debentures (NCD), according to the Securities and Exchange Board of India (Sebi). This is the highest ever recorded. Ten NCDs were issued in the first half of 2016-17, compared to only four in the same period of 2015-16. Companies received a total of Rs 33,812 crore from 20 issues in 2015-16; while in 2014-15, NCDS raised Rs 9,713 crore through 25 issues. Most major NCD issues of 2016-17 were highly subscribed. This indicates investors are seeking higher returns at one level and also that corporates have worked out good marketing mechanisms.
The rationale for corporates taking the NCD route is simple. Banks have been offering 7-7.25 per cent for one-year fixed deposits. Treasury bills have been going for yields of about 6.5 per cent after the latest rate cut.
So, lenders seek to beat those rates, without much increase in risks.
A corporate with reasonable reputation can place NCDs for 8.5 per cent to 9.5 per cent, which is considerably cheaper than the rates it is likely to be charged by a bank. Such an NCD offers investors a solid 1.5 per cent premium over bank FDs (fixed deposits), and maybe three per cent premium over government securities. Hence, there is enough of a spread to make this a win-win proposition for corporates and debt investors.
In theory, an NCD is legally secured and guaranteed. In practice, any investor is relying on the good reputation of the corporate. If a corporate refuses to pay its debts, there is very little that can be done about it. It doesn't matter whether it's legally bound to pay or not. Given the tardy nature of the Indian legal processes, it would take many years to collect via legal action. It is also perfectly possible that a defaulter will not have the resources to pay, even if its assets are taken over and auctioned.
The NCD (or any legally secured bond, including a convertible debenture) differs from basic debt in one key respect. If there is an active secondary market in the instrument, there is much less fear of an asset-liability mismatch. The instrument could be very long-tenure. But, an investor can buy it, take the dividend, and then sell it on, whenever convenient. This makes bonds ideal instruments for infrastructure developers with long-gestation projects.
In practice, however, the Indian secondary market for corporate paper is not very liquid and an investor usually assumes any investment might need to be held till maturity. Note that Rs 24,000 crore is not a large amount in relative terms, where bank debt is concerned. But, it is a lot for the corporate bond market and could indicate an improvement in liquidity of the secondary segment. That would be a healthy signal.
The action in NCDs also indicates something else. Most Indian households, especially those with pensioners, are seeking "safe returns" from debt. Most debt investors are not smart enough, or nimble enough, to book capital gains by investing in debt mutual funds, which will gain as interest rates fall. Most households are therefore, hurt by rate cuts. The political dimensions of such financial preferences are far-reaching. But, exploring those will take us far afield.
If bank credit was the only way to raise debt, India Inc would be in serious trouble because real interest rates are very high. However, there has been a revival of the corporate bond market. In the first half of financial year 2016-17, debentures have seen explosive growth.
About Rs 24,000 crore has been raised through non-convertible debentures (NCD), according to the Securities and Exchange Board of India (Sebi). This is the highest ever recorded. Ten NCDs were issued in the first half of 2016-17, compared to only four in the same period of 2015-16. Companies received a total of Rs 33,812 crore from 20 issues in 2015-16; while in 2014-15, NCDS raised Rs 9,713 crore through 25 issues. Most major NCD issues of 2016-17 were highly subscribed. This indicates investors are seeking higher returns at one level and also that corporates have worked out good marketing mechanisms.
The rationale for corporates taking the NCD route is simple. Banks have been offering 7-7.25 per cent for one-year fixed deposits. Treasury bills have been going for yields of about 6.5 per cent after the latest rate cut.
So, lenders seek to beat those rates, without much increase in risks.
A corporate with reasonable reputation can place NCDs for 8.5 per cent to 9.5 per cent, which is considerably cheaper than the rates it is likely to be charged by a bank. Such an NCD offers investors a solid 1.5 per cent premium over bank FDs (fixed deposits), and maybe three per cent premium over government securities. Hence, there is enough of a spread to make this a win-win proposition for corporates and debt investors.
In theory, an NCD is legally secured and guaranteed. In practice, any investor is relying on the good reputation of the corporate. If a corporate refuses to pay its debts, there is very little that can be done about it. It doesn't matter whether it's legally bound to pay or not. Given the tardy nature of the Indian legal processes, it would take many years to collect via legal action. It is also perfectly possible that a defaulter will not have the resources to pay, even if its assets are taken over and auctioned.
The NCD (or any legally secured bond, including a convertible debenture) differs from basic debt in one key respect. If there is an active secondary market in the instrument, there is much less fear of an asset-liability mismatch. The instrument could be very long-tenure. But, an investor can buy it, take the dividend, and then sell it on, whenever convenient. This makes bonds ideal instruments for infrastructure developers with long-gestation projects.
In practice, however, the Indian secondary market for corporate paper is not very liquid and an investor usually assumes any investment might need to be held till maturity. Note that Rs 24,000 crore is not a large amount in relative terms, where bank debt is concerned. But, it is a lot for the corporate bond market and could indicate an improvement in liquidity of the secondary segment. That would be a healthy signal.
The action in NCDs also indicates something else. Most Indian households, especially those with pensioners, are seeking "safe returns" from debt. Most debt investors are not smart enough, or nimble enough, to book capital gains by investing in debt mutual funds, which will gain as interest rates fall. Most households are therefore, hurt by rate cuts. The political dimensions of such financial preferences are far-reaching. But, exploring those will take us far afield.