Icd Markets Grow Up

A more mature market for inter corporate deposits is re-emerging.

Over the past year, rates in the inter-corporate deposit market have dropped 400 basis point across the board for all categories of borrowers. This would have been good news were it not for the fact that there are fewer lenders as well. The number of deals in the ICD market has dropped by 20 per cent over the past six months, treasury officials at Lloyds Finance complain.

Brokers are so desperate to attract AAA-rated companies that commissions have plunged the 0.25-0.1 per cent depths from last years high of 1 per cent. This despite the fact that there is no official ceiling on brokers commission.

At one level, this is considered a healthy sign. It indicates that this short-term money market instrument, which has recently been edged out by other competing products, is being increasingly dictated by market forces rather than gut-feel and psychology. And this could presage a rejuvenation. This level of maturity is helping the speedy revival of the ICD market, says KaushikModak, associate vice-president, treasury, Kotak Mahindra Finance.

Evidence of this is clear from growing volumes. This cyclical market, which had touched the Rs 7000-8000 crore figure in 1994-95, and then tapered off after a series of defaults, like the default involving liquor major Shaw Wallace, has once again inched up to Rs 4000-crore levels.

At another level, however, this could be a problem. Corporate treasurers point out that the current pick-up is the result of a surfeit of small intermediaries, who operate from their houses or small offices. With low overheads, they have been able to cut their commissions and work on wafer-thin margins. But the few deals that they do are enough to skew the market and this makes the scenario all the more confusing for the established players, says Modak.

The ICD market has been a casualty of sorts in the money markets over the past six months for several reasons. For one, its unsecured and unregulated nature, which made it popular in the strictly regulated era of the eighties, has become something of a liability. Says Modak, The two main reasons for the present lull in the ICD market are a change in borrowers credit perceptions and the tremendous fall in the fund requirements coupled with increased liquidity.

Changes in the nature and flexibility in domestic financial markets have made Indian corporations increasingly aware of less risky instruments as gilts and bank fixed deposits. Also, the new-found freedom to invest in markets and securities abroad means that companies prefer to assume government risk over corporate risk.

This increasing consciousness of the Indian industry towards credit indicates that it seems to be coming of age pretty fast. But the optimistic attitude is belied by the fact that the Indian industry has become highly risk averse, risk taking being an essential attribute of all matured markets.

This risk averse attitude is very prominent in the ICD market. This is because Inter-Corporate deposit market is essentially an unsecured market, point out treasury officials in Apple Finance. And with a strong precedence of defaults in this unsecured and essentially an unregulated market, no wonder the players, especially the lenders, have become very cautious and are not prepared to lend to anyone except the AAA rated corporates.

The interest differentials highlight the point. For top-rated companies, funds are now available at 10 - 12.5 per cent compared to 16 per cent a few months ago. For a AA rated company, interest rates are 14 - 16 per cent, and for single A-rated corporates they are in the 17 - 18 per cent range.

So if the ICD market has become a borrowers market for blue-chips, the going is far tougher for less-pedigreed companies. Concurs Ulhas Yargop, treasurer, Mahindra & Mahindra, Companies other than AAA-rated ones are finding it extremely difficult to raise funds from the ICD market, even at higher rates, despite the availability of funds. This is also because stringent requirements on provisioning for bad and doubtful debts are making banks reluctant to lend as well, even though they are flush with funds.

The frequent downgrading of companies by credit rating agencies has also made lenders in the ICD market both nervous and selective. Ulhas feels that in the present scenario, safe parking of funds (ofcourse at lesser interest rates) gets prominence over profiting from high risk investments in, say, the ICD market.

For all practical purposes, therefore, companies have stopped relying blindly on ratings by the credit rating agencies, though CRISIL ratings are still very highly valued by the industry. Some even insist on collateral (like post dated cheques or shares), often for amounts higher than what is being lent. This, of course, contradicts the basic definition of an unsecured market but speaks volumes for the fear and uncertainty gripping the market.

Modak agrees and says, Companies rely heavily on information about prospective borrowers gathered from the informal channels because in this market, bad news travels really fast, which means a defaulting company becomes untouchable almost instantaneously.

An indication of the slackness in the ICD market is the southward movement in interest rates as a consequence of announcements in the credit policy and the fact that the demand has reduced not only on account of economic slowdown hitting the industry, but also because the number of eligible borrowers have gone down (players consider only those corporates eligible for borrowing in the ICD market who have sound ratings).

ICD markets were also losing out to funds-flush, increasingly risk-averse banks, which are showing a preference for commercial paper (CP) from AAA-rated companies. With another avenue for cheap, short-term funds open, ICDs were being given the go by.

The current fall in commissions and spreads indicates that market fundamentals are

increasingly taking care of the inherent drawbacks of ICDs. This is a healthy sign since it indicates the fact that operations in this market are strongly dictated by market forces. This level of maturity is helping in the speedy revival of the ICD market, feels Modak.

This is because unlike many other short term instruments, ICD operations are not screen based operations and because of the low levels of regulatory controls, there is no effective control over the intermediaries or the end-use of the funds - only the market fundamentals take care of these drawbacks.

ICD is meant to offer an uncontrolled and free route for lending and borrowing of funds, says Ulhas, and offers the borrowers much greater flexibility vis-a-vis other routes of short-term borrowings, like bill discounting and cash credit.

But as far as the end use of the ICD funds is concerned, Modak is critical of industry practices. ICD funds should ideally have been taken for the short-term working capital needs. But many companies utilised it for non-operational and high-risk purposes, including stockmarket investments. This resulted in a number of defaults, he says

The only remedy for this is that the Inter-Corporate deposit market matures quickly, and realises that short-term funds require high liquidity and are best invested in those areas which give short-term returns. The players in the market are just as optimistic as they were two years ago, since with each trough following large scale defaults, the ICD market has emerged more mature and stronger.

Prudential accounting norms are one of the most significant regulations on the borrowing and lending corporates in the ICD market. For example, non-banking finance companies like Kotak Mahindra Finance, which is into equipment leasing, can borrow a maximum of twice their NOF (net owned funds) from the ICD market. Also, among other regulations, the more prominent ones are those given in the Companys Act. Section 293 (1d) of the Act requires passing of a board regulation for the borrowings, while section 310 prohibits lending more than 30 per cent of net worth.

Also, this years slack season credit policy has stipulated that surplus short-term funds can be used in money-market instruments, but investments should only be out of surpluses and not out of bank finance.

These regulations and their experiences in the ICD market have helped the players to gather sufficient expertise to play safer i.e. to discourage them from lending wantonly, without analysing the credentials of the corporates, and also from using the short-term funds drawn from the ICD markets into stocks or other non-operational uses. The ICD market may never reach the peaks of the early nineties. But it will definitely emerge older and wiser.

The increasing consciousness of the Indian industry towards credit indicates that it seems to be coming of age pretty fast.

For top-rated companies, funds are now available at 10 - 12.5 per cent compared to 16 per cent a few months ago.