Even as credit growth of banks languished under 6 per cent and larger companies seemed disinterested in taking on additional loans, corporate bond issuances recorded a sharp increase in 2020-21. Companies seemed to have turned to bond market to refinance existing loans and to reduce their loan burden during the pandemic.
The heightened activity is to a large extent due to RBI’s liquidity injection to fight the slowdown and yield curve management. Corporate bond yields fell to multi-year lows over the past year, making finance available at lower cost to industry.z
According to SEBI, the role played by bond market is almost equal to bank credit in recent years. But the inherent problems in Indian corporate bond market is resulting in these benign conditions primarily benefiting larger companies.
Issuances surge in FY21
In 2020-21, even as economic activity contracted and companies postponed new capex projects, corporate bond issuances were robust at ₹7.82-lakh crore. This was 13 per cent higher than the issuances in 2019-20. Surprisingly, fund raising by companies from equity markets was more subdued, down 25 per cent last fiscal year. This was mainly due to preferential equity allotments, declining sharply.
In corporate bond market, private placement continued to be the preferred route with 98 per cent of the funds raised. According to the RBI, corporates have used the lower rates prevailing in the bond market to deleverage or to switch from high cost loans.
The action in the first two months of FY22 is however quite tepid, with private placement of bonds down 61 per cent compared to the same period last year. Lower demand from investors, given the heightened risk perception due to the second wave, may have dampened issuances. It is to be seen if issuances revive again from the second quarter, as activity revives.
Benign conditions
Higher appetite for corporate bonds in FY21 is mainly due to lower cost of borrowing compared to bank loans. According to RBI, weighted average lending rate of outstanding rupee loans was around 10 per cent in January 2020 and declined only slightly to 9.16 per cent by May 2021. There was a sharper decline in WALR of fresh rupee loans from around 9.5 per cent to 7.81 per cent.
Yields of corporate bonds are however, very attractive now, compared to the bank interest rates. While yields have hardened in some maturities in recent months due to inflation fears, they have reduced sharply over the past year, featuring close to multi-year lows. Yield curve of FIMMDA AAA rated 5-year corporate bonds currently trade at 6.06 per cent, down almost 240 basis points since February 2019.
Similarly, FIMMDA AA rated 5-year bond yield index is trading at 6.86, 220 basis points lower. It’s the only lower rated bonds which are priced higher. For instance, the FIMMDA BBB rated 5-year bonds yields are trading at 8.6 per cent, but the yield is down 250 basis points since February 2019. Almost the entire policy rate cut of 250 basis points seems to have been transmitted to the bond market.
This is mainly due to the liquidity injection by the Central banks in a bid to create conducive monetary conditions through targeted long-term repo operations (TLTRO), open market operations, operation twist and G-SAP programs. Net LAF (liquidity adjustment facility) absorption has stayed elevated between ₹4-lakh crore to ₹6.4-lakh crore since last April. With credit growth slowing, banks have been parking their surpluses in the reverse repo window.
This surplus liquidity, as well as the RBI’s stated objective to manage sovereign yields in a bid to lower borrowing cost in the economy, seems to be bearing results. Spreads (difference between G-sec yield of similar maturity and corporate bond yield) of AAA rated 5-year corporate bonds have narrowed considerably to 15 bps by June 2021, after hitting a high of 101 bps in April 2020. Spreads on AA rated bonds are also down almost 70 basis points since last April.
Helps larger companies
While the lower spreads have offered a lucrative opportunity to bring down borrowing cost, not all companies have been able to benefit. This is because the issuances in the corporate bond market are skewed towards the stronger businesses which are rated AAA by rating agencies, appetite for lower rated paper has been much lower in FY21.
According to SEBI, there were 1,337 corporate bond issuances in 2020-21, which raised ₹28,28,259 crore. Of this, ₹23,82,411 crore was raised by borrowers with AAA rating; they accounted for 84 per cent of the funds raised. Another 12 per cent of the funds were raised by the borrower in the next rung of risk category – rated AA. These borrowers raised ₹3,33,349 crore. Borrowers with lower ratings (A to non-investment grade) jointly accounted for only 4 per cent of the value of issuances.
Appetite for securities of lower rated borrowers have always been lower in Indian corporate bond market. This would have shrunk further during the pandemic as companies already under stress would have faced greater uncertainty in the economic contraction due to Covid-19. Further, mutual fund appetite for lower rated paper has reduced significantly since the IL&FS issue.
Foreign portfolio investors have also been wary about Indian corporate bonds of late. They have utilised only 22 per cent of the limit available to them in July 2021, holding ₹1,26,208 crore, compared to utilisation of 57.4 per cent in February 2020.
Trading turnover in bond market also remains quite low, making it difficult for retail investors to actively participate in these. Predominance of private placements in bond issuances, to larger borrowers, is hampering liquidity in the market.