The Indian rupee bond market has done well to become a viable alternative for capital- starved corporates looking for new funding avenues with the closure of offshore debt markets. Issuance volumes have been strong this year and the issuer base has widened significantly. However, this growth phase is set to be stunted amid a continuing lack of depth because of a limited investor base and tight regulations.
Until July 2009, issuance touched Rs992bn (US$20.3bn) from 334 issues versus 787 rupee debt issues totalling Rs1.61trn in the whole of 2008, according to Prime Database. With the current issuance momentum, bankers are expecting 2009 volumes to overtake easily that of 2008 for a new record.
“The reason behind the robust onshore volumes is simple,” said Kaustubh Kulkarni, director (capital markets), Standard Chartered Bank. “Indian issuers were hungry for capital, but they had no choice but to look to deals at home rather than overseas. Offshore markets, with the advent of a global recessionary phase and a near meltdown in the financial sector, had turned risk averse. International banks and institutional investors were ready to take on Indian debt exposure only if they were paid a huge risk premium.”
In light of this changed lending or investing mindset, Indian corporates looking to fund working capital requirements or refinance debt had to approach their domestic relationships and pay coupon levels that were more amenable for the Indian institutional investor base.
At first, such an option proved to be expensive compared to what corporates had gotten used to paying for offshore debt. For example, when Reliance Industries – after a six-year absence from the domestic market – publicly issued Rs10bn of five-year non-convertible debentures via Axis Bank in November 2008, it paid an annualised coupon of 11.45% for the rupee debt – a huge premium over a syndicated five-year US$1.2bn bullet loan it had done just recently offshore.
The loan then paid 151bp over Libor, and the fully hedged rupee cost of that loan worked out to roughly 7%. Simply put, the company had then paid a huge 445bp premium over its offshore loan. Issuers always paid a spread for onshore funding vis-à-vis offshore debt, but that spread used to be comfortably within the 50bp–100bp range.
But top Indian corporate names had no choice. They had to pay up to raise funds from the local debt markets. At the time, corporates explored a variety of funding modes including rupee loans, commercial paper and medium to long-tenor rupee bonds.
Thanks to regulatory measures in early 2009 that injected significant liquidity into the system, interest rates eased and the onshore debt markets started looking less expensive. Immediately the rush of Indian corporate paper issuance intensified and many, which had not visited the rupee debt markets for years, returned. The question then was only whether they should look at rupee debt or the local bank market for funds. The bond markets saw more action backed by some fundamental reasons in its favour.
“As corporate borrowers are becoming larger and building sophisticated treasuries, they are better utilising the bond versus loan trade-off – the bond usually achieves cheaper pricing, diversifies investor base, is easier to hedge using interest rate derivatives while it does not allow prepayments and has “negative carry” (a loan can be tied up today for disbursement after six months when the funds are actually required whereas the bond has to be borrowed as soon as terms are finalised),” said Shameek Ray, director at ICICI Securities.
The surge in issuance volumes saw the emergence of some innovative issuance. In May, Tata Motors used a bank-guaranteed bond to refinance a US$3bn 12-month acquisition bridge. The automaker raised Rs42bn through a multi-tranche rupee bond that came bundled with a credit enhancement in the form of a standby letter of credit from the State Bank of India (SBI). Tata Motors certainly benefited from the SBI-guaranteed bond.
The company raised much-needed cash just ahead of a US$2bn refinancing of its bridge loan that funded the acquisition of Jaguar/Land Rover. The deal launched on May 20 and closed on May 21. Citigroup and Tata Capital were the lead arrangers on the bond, while SBI was joint lead.
The bond was split into four tranches: a Rs8bn 23-month tranche yielding 6.75%; a Rs3.5bn 47-month tranche yielding 8.4%; a Rs18bn 59-month tranche yielding 8.45% and a Rs12.5bn 83-month tranche yielding and marketed at 10.03%.
The pricing translated to spreads of 48bp, 90bp, 75bp and 173bp, respectively, over Triple A public sector credits. By comparison, a rupee loan then would have come at 12.5% at least. A rupee bond from the borrower, without a guarantee, would have been near impossible and certainly much more expensive than a loan, and would not have been as flexible as the structured bond.
The Tata Motors bond paid a 2% coupon plus a redemption premium. The weighted average yield-to-maturity is around 9%. Add another 1% in terms of the cost of the SBLC guarantee, and Tata Motors achieved a cost of funding of around 10%.
At this point of time, the acceptance of rupee debt was not just among the top- rated corporates. Even lower-rated issuers began finding interest among investors for their debt issuance. Some issuers even rated AA found interest for their rupee debt for the first time in many years.
But there is clearly a limit to how much the market could absorb or was willing to absorb.
Investors, despite being keen to invest, were saying “no” to issuers who were rated AA– or below, reflecting a lack of depth in appetite.
Despite regulators’ best efforts to develop the domestic bond market, the investor base in rupee debt markets is quite narrow with banks and mutual funds dabbling occasionally, depending on the liquidity situation. Insurance companies and pension funds make up the bulk of the investor base, but they are reluctant to take exposure to credits rated below Double A.
The participation of foreign institutional investors (FIIs) could be a welcome development. However, FIIs have largely remained on the sidelines despite being allowed to invest up to US$15bn on a cumulative basis in Indian corporate debt. No single FII can hold Indian domestic debt of more than US$300m.
Adding to all that are Indian regulators, who are not keen to allow innovative instruments if they had even the bleakest potential of causing systemic risk.
Just eight days after the Tata-guaranteed deal, the Reserve Bank of India banned Indian banks from guaranteeing corporate bonds. The move frustrated issuers and bankers who argued that local companies and debt markets need as much help as they can get and that the structure could have allowed corporates rated AA and below to access the market.
The RBI said banks should not guarantee bonds or debt instruments of any kind, and that allowing such a practice could have “significant systemic implications and impede the development of a genuine corporate debt market”.
Constant regulatory intervention and the fact that the local corporate bond market does not have a variety of investors could stem the current momentum, according to bankers.
“If you look at it objectively and compare the market today to last year, nothing new has happened,” said one banker. “The secondary market volumes are still bad, the investor base has not widened and the market has not got used to paper rated AA and below. . .so in terms of evolution, this market has not gone anywhere.”
Still there are attempts, nudged along by regulators and some exuberant market forces, to achieve something different that will push the bond market into a fresh new direction.
In early August, Indian mortgage lender HDFC ventured into uncharted territory when it wrapped up a Rs43.01bn non-convertible debenture-with-warrants issue. The groundbreaking transaction – the country’s first – had many positives but it was too tightly priced and carried with it the possibility of killing future investor interest for the product if they made losses on this trade. The deal came after the Securities and Exchange Board of India in December 2008 laid the platform for issuance under the bonds-with-warrants instrument.
There is no doubt that Indian issuers now had another viable fundraising option. For an Indian issuer, the bonds-plus-warrants instrument does not pose currency risks as seen on a foreign currency borrowing. Moreover, there is no approval required from regulators unlike offshore CBs. An offshore CB features the option to convert a bond into equity and typically the equity option is detached synthetically via a CDS.
The NCD-with-warrants instrument, on the other hand, is an unstapled instrument with the options sold separately at the time of the issue. Moreover, it is regulated under the QIP rules, which allow for easy and speedy issuance.
But without a further deepening of the rupee bond markets, the NCD-with-warrants product could be utilised by a very few. NCDs require ratings of Double A or above, which limits the liquidity available for such issues. Then there is also the question of liquidity for warrants, which means that lesser credits than HDFC might not get the same price advantage from the warrants options.
Shankar Ramakrishnan