Brave new world

Cheap credit and regulatory reforms are luring Indian companies to the revived domestic bond market, taking market share from the capital-constrained banking sector.

Declining bond yields are luring more Indian companies to the bond markets, in an early sign that efforts to wean corporate borrowers off bank loans may finally be paying off.

Major companies such as Tata Steel or Mahindra & Mahindra are returning to the bond market after years of absence, and first-time issuers are joining them, thanks to a combination of cheap credit, better economic fundamentals and strong investor demand.

The corporate bond revival comes after the Reserve Bank of India in August unveiled a series of major reforms aimed at deepening the market. As well as widening investment criteria to boost demand, it simultaneously stoked supply by announcing limits on banks’ exposure to corporate borrowers to prevent systemic risks.

Low yields

Bond yields had remained relatively high until recently despite the fall in inflation. Once they started receding in the past few months, with the 10-year government benchmark dropping to a near seven-year low of 6.85%, bonds became an attractive funding source for companies.

“Issuers are tapping the bond route because the gap has widened between the bond rates and loan rates in recent times,” said Shameek Ray, head of debt capital markets at ICICI Securities Primary Dealership. “The cuts in RBI policy rates following the drop in consumer price inflation and the increase in system liquidity have led to a sharp decline in bond yields.”

“Issuers are tapping the bond route because the gap has widened between the bond rates and loan rates in recent times.”

Bond markets continued to rally in October after the RBI, under new governor Urjit Patel, cut interest rates by 25bp in a surprise move and left further room for easing.

“Corporates are not only borrowing more from the bond markets but are also borrowing for longer tenors,” Ray said.

Stressed banks

Cautious bank lending is another reason why corporate borrowers have turned to bonds.

Indian banks are under tremendous stress due to the huge pile of bad loans on their books and the recent demand from the RBI that they recognise non-performing assets and provision against them.

Stressed loans in India’s banking sector crossed US$138bn in June, according to RBI data, an increase of nearly 15% in just six months. This suggests that a state clean-up effort will take longer and cost more than expected.

So far, the funds raised through bonds are mostly for refinancing.

Mahindra & Mahindra came back to the bond markets because it had an external commercial borrowing to refinance. Meanwhile, capital-hungry companies like Tata Steel are benefiting from a more favourable economic backdrop.

“The commodity cycle is recovering; therefore companies like Tata Steel are able to issue bonds at this juncture and see proper demand for their paper,” said Leong Lin-Jing, fixed income investment manager at Aberdeen Asset Management.

In a further sign of growing maturity, some companies are now turning to the bond market to fund acquisitions. Household products manufacturer Nirma in September raised Rs40bn to fund the purchase of Lafarge India in the largest local M&A bond to date.

One investment banker who was not on the deal called it a “paradigm shift” for corporate financing. “Companies can now tap the bond market to fund acquisitions. That is what is done in the mature markets,” he said.

Bank buying

As issuance has picked up, banks have been raising their investments in bonds.

Lenders are replacing loans with investment in bonds and commercial paper because they do not want to lose their existing corporate clients. Banks also find it easier to sell bonds when needed, DCM bankers said.

Bank loans have lost around five percentage points in market share to the bond market over the last two years, according to an Ambit Research note published earlier this year.

Deal volumes are expected to grow further on the debt market following the adoption of the bankruptcy code passed by the upper house in May.

“The market is expecting lower-rated companies to tap the bond market with the implementation of the bankruptcy law, which will protect investors in case of default,” said another DCM banker.

The RBI’s reform of corporate bond repos will further boost liquidity, and an expected pick-up in corporate capex will also benefit the debt market.

On the buyside, the pool of investors in corporate bonds is growing.

“Retail and high-net-worth investors are increasingly looking for alternatives to bank fixed deposits through mutual funds. Further, yields have dropped on tax free bonds as these issuances (which were distorting markets earlier) have been stopped,” I-Sec PD’s Ray said.

“We are also seeing the foreign portfolio investor pool becoming deeper and more diverse,” he said.

Public issues of bonds have also gathered steam this year as companies look for larger and longer financings.

Housing finance companies Dewan Housing Finance and Indiabulls Housing Finance raised more than Rs200bn between them from public bond issues in September alone.