Large borrowers will find it hard to tap bond market from April: Here's why

Greek mythology has it that a reluctant Atlas was tricked by Hercules into holding up the heavens after having briefly taken up the burden when the titan went to fetch the golden apples.
 

The Securities and Exchange Board of India’s (Sebi’s) life-breath to get borrowers tap the bond mart for a quarter of their fresh long-term funding over Rs 100 crore from April 1, 2019 may well see the Atlas-Hercules narrative play out again. 

A key driver behind the mandatory shift to tap bonds is the inability of banks to fuel India Inc’s appetite for funds given their capital concerns and the provisioning for dud-loans. It’s also desirable on its own as a measure — banks being the only lenders in town is an archaic notion; in our case, the corpus of corporate bonds as a proportion of our GDP is just 16 per cent. It compares poorly with Malaysia’s 46 per cent, Korea’s 73 per cent; and a staggering 120 per cent in the US. 

The bond-window rings in other benefits too — better financial discipline as they have to be marked-to-market, more so when read along with the new one-day default norm in servicing debt; and an immediate transmission of changes in policy rates though this can cut deep too — hikes will be passed on the double.

Aiming high; firing low

Says Gurpreet Chatwal, President at CRISIL Ratings: “Our analysis shows approximately 450 companies had an aggregate rated long-term debt of Rs 45 trillion at the end of FY18 in this category — or a third of the outstanding credit.” And about half of them have sourced at least a quarter of their funding through bonds. “So, the remaining would be the ones driving incremental issuances. At present, they hold only Rs 6 trillion of rated, long-term debt. We believe another Rs 10-13 trillion of long term-debt outstanding over the medium-term would have been eligible under Sebi’s framework had it included A-rated papers and unlisted corporates.” It’s a big stumbling block.

Sebi’s consultative paper in July 2018 had noted that given the current stage of the bond market, any mandatory requirement would need to be light-touch in nature; it would also need to provide enough leeway to issuers. But its notification on November 26 last year was explicit that those unable to comply with are to offer an explanation to the bourses. A sticking point is the one-day default norm. 

Vimal Bhandari, Executive Vice-Chairman of Kirloskar Capital

Says Vimal Bhandari, executive vice-chairman of Kirloskar Capital: “One-day default is difficult to monitor in large companies especially where cash inflows are dependent on government payments like in the case of road projects or power companies and delays have been noticed. It puts companies under undue stress.” Then again, trends of recent can be misleading.

While FY17 was an inflection point — the share of funds raised through bonds overtook that of bank financing to move up to 51:49, from the 41:59 in FY16 (and 37:63 in FY13) — the technical reason for this was the 175-basis points slash in key rates by Mint Road being fully passed on during the monetary policy’s accommodative phase from the dawn of 2015. 

Besides, a surfeit of liquidity in the post-demonetisation (due to a surge in deposits) and the enhanced flow of household savings into mutual funds, insurance firms and pension funds stoked their appetite for bonds. But these trends can see a reversal on an economic recovery or a rise in interest rates -- the bonanza the better-rated firms availed of by hooking into bank-credit substitutes (riding on low yields) will vaporise. It will then be back to equilibrium position — reliance on bank loans which was sought to be cut in the first instance. The blowout at Infrastructure Leasing & Financial Services and doubts over the veracity of ratings has also messed up the plot of late.

In FY18, around 87 per cent of the private debt placements was of double-A rated paper and above. 

“The existing threshold criteria for investments (double-A) is cited as one of the key reasons for lack of participation in bonds by insurance companies and retirement funds. Sebi’s framework is a critical supply-side initiative, but it needs to be matched by commensurate demand side reforms,” says B Prasanna, group executive and head of global markets at 

ICICI Bank.

You also see another skew. In FY18, around 72 per cent of private placements (debt) was from the financial sector — banks, financial institutions and NBFCs. 
 

“Given that most of these entities are in the higher rating categories (double-A and above) and actively rely on non-bank financing (since most of them end up competing with banks), it’s natural for them to rely heavily on bond markets and hence, they contribute to the higher issuance volumes,” adds Prasanna.
 

Sushil Agarwal, Group CFO at Aditya Birla Group

Notes Sushil Agarwal, Group-CFO at Aditya Birla Group: “Since this is a new way of borrowing, gradual introduction is better. I feel that the threshold criteria of double-A is fine. One should watch out as to how the market adjusts to the new scenario and gradually extends this for lower-rated corporates. In any case in the current scenario, insurance companies and retirement funds look at better rated companies when committing to long-dated papers.” This flight to safety will hit power firms the hardest.

 Madan Sabnavis, chief economist at CARE Ratings, says: “Despite the large funding requirement, it is onerous for power companies to enter the bond market on account of low credit quality. Getting banks to take on a contingent liability in the form of providing a credit enhancement would be a way out for some projects.” 

Devil in the detail

One reason for non-financial players being cornered on bonds is the debenture redemption reserve (DRR), given they have to set aside a part of their profits (25 per cent of the value of the debentures) towards it; plus they have to park at least 15 per cent of the debentures maturing during the year in bank deposits and government securities. 

Bhandari says, “It (DRR) increases the cost of using bonds. This needs to be re-thought given it reduces the distributable surplus of companies impacting equity holders. As the DRR is not invested as a sinking fund, it has no impact on liquidity of companies. It is desirable to rethink this move to make bond issuances more issuer-friendly.” 

Agarwal seconds it: “One can look at a relaxation in the DRR criteria to make the market more efficient.”

Going down the food chain would mean issuances will have to be backed by credit enhancements.

Banks can provide partial credit enhancement of up to 50 per cent of the issue size, as a non-funded facility, in the form of an irrevocable contingent line of credit. But the restriction on individual banks to 20 per cent of the issue size and capital charge on the entire bond quantum, instead of the partial guarantee amount, has resulted in this option being a still-born. 

 “It (enhancements) will come at a price; it will push up the cost of borrowings,” says Romesh Sobti, managing director and CEO of IndusInd Bank. 

To the extent such leg-ups will mean an exposure on the party that issues the credit enhancement to the bond issuer, yet another variable kicks in. 

“Banks’ exposure to a single entity and a group is to be capped at no more than 20 per cent and 25 per cent of tier-1 capital, respectively, from current levels of 15 per cent and 40 per cent, starting next fiscal. If banks are to subscribe to these bonds, this (exposure caps) is another element which needs to be borne in mind,” adds Sobti.

 

The bottom line: Atlas-Hercules was a myth; so too will be a deeper and wider bond mart for India Inc for some time to come.