Tata Motors’ CDS spread widens

Tata Motors’ CDS spread widens

Mumbai: The spread on Tata Motors Ltd’s credit default swaps (CDS) has been widening in the past one month, indicating worsening investor perception about the firm’s ability to service its debt, even as the UK unit JaguarLand Rover (JLR) helped India’s largest auto maker by revenue post strong earnings for fiscal 2011.

The instrument is insurance bought by bond investors. In case the issuer defaults on payments, the insurer pays the investor. The insurance premium, known as spread, is independently traded in the market. Globally, the outstanding CDS being traded is close to $70 trillion (Rs 3,122 trillion).

An increase in CDS spreads is “not representative of a rise in international investors’ risk perception about Tata Motors", company spokesperson Debasis Ray said in an email to Mint.

Tata Motors’ CDS are not traded on the exchanges and thus do not have enough volume, making them vulnerable to demand-supply mismatches and the widening of spreads, Ray added.

In addition to this, liquidity may have been stretched for Tata Motors because debt-holders have been converting foreign currency convertible bonds (FCCBs) into equity, he said.

“Tata Motors’ FCCB holders have converted bonds worth $257.60 million of 4% FCCB 2014 and $69.47 million of 1% FCCB 2011 into equity since November 2010," Ray said. “This, we believe, has significantly affected the supply of Tata Motors’ paper and has led to a rise in the CDS spreads."

Ray pointed out that Tata Motors’ rating at BB- (stable) and Ba3 (stable) by Standard and Poor’s and Moody’s, respectively, has remained unchanged since December. It has, in fact, improved from B (negative outlook) and B3 (stable) in September 2009, he said.

Fitch has a BB rating on the bonds.

The sudden widening of the spread on Tata Motors’ CDS, both on 10-year and five-year bonds, comes as the spread of all other companies from the so-called BRIC countries— Brazil, Russia, India and China—have remained stable. In the case of some of them, it has even shrunk on improved risk perception. All of them, except Severstal OAO of Russia, have a higher rating than Tata Motors and their CDS spreads are narrowing.

Even the CDS spreads of entities from the troubled parts of Europe have been stable in most cases.

Tata Motors’ CDS spread on the 10-year bond is now at 426.27 basis points (bps), after reaching its peak of 426.74 bps on Tuesday, the highest since June 2010, according to Bloomberg data. One basis point is one-hundredth of a percentage point.

The CDS spread fell to a low of 196.86 bps in December and till 6 May, was at around 250 bps.

The rise has been especially sharp in the past fortnight. For instance, on 18 May, the spread was 284.46 bps and jumped to 413.46 bps the next day.

Analysts who track Tata Motors are baffled as the company posted good earnings for fiscal 2011 (FY11), even though March quarter results did not meet Street expectations.

On the back of robust volume expansion at JLR, consolidated net profit at Tata Motors in FY11 rose to 9,274 crore from 2,571 crore in the previous year.

For the quarter ended March, operating margins at JLR fell to 15% from 17.4% inthe preceding quarter, while those at its India operations remained flat.

The Tata Motors stock has lost 11.51% since earnings were announced on 27 May, while the Sensex has gained 1.94%.

On Wednesday, Tata Motors rose 0.14% to close at 1,028.40 on the Bombay Stock Exchange even as the Sensex fell 0.55%.

Currently, there are two Tata group companies with CDS being traded—Tata Motors and Tata Power Co. Ltd.

No similar trend has been observed in the CDS of other Indian companies, including that of Reliance Industries Ltd and State Bank of India, in the last one year. Tata Power’s spread has fallen 47.23 bps in the year-to-date period.

Analysts tracking the company are surprised by the increase in the spread. Mint spoke to half a dozen of them and none of them was able to fully explain the reason. One of them said JLR may not be able to sustain volumes with the financial crisis in Europe deepening. He spoke on condition of anonymity.

In an 8 June report, analysts Chirag Shah and Siddhartha Bera of brokerage Emkay Global Financial Services Ltd said new car registration in the UK had declined 1.7% to 150,431 units in May over the year earlier, while sales of JLR had contracted 15% to 3,525 units. Shah refused to comment on the reasons behind the CDS spread widening.

An analyst at a domestic brokerage, who also declined to be named, said the CDS should shrink and not increase, considering that Tata Motors has been able to deleverage the balance sheet and boasts a healthy debt to equity ratio of 0.7.

“Tata Motors’ consolidated net automotive (excluding the company’s vehicle finance business) debt equity as of 31 March has significantly come down to 0.68:1; and Jaguar Land Rover bond offering of £1 billion (Rs 7,330 crore today) equivalent senior notes in May was significantly oversubscribed," Ray said, adding that these indicate a positive perception of overseas investors about Tata Motors.

Of the £1 billion raised, JLR used £250 million to repay its parent Tata Motors.

According to the analyst with the domestic brokerage, the increase in the spread could be on account of the high capital expenditure outlined by the company for JLR operations.

JLR will spend £1.5 billion annually to meet product development and other expenses, the company said on 27 May. The expenditure, the analyst said, is almost on par with cash generation at the UK-based firm.

This means there will be no reduction of Tata Motors’ consolidated debt of 15,000 crore, making it vulnerable to defaults.

The movement of Tata Motors’ spread over a year is somewhat similar to that of Hellenic Republic, the sovereign debt issued by the government of Greece, which has widened by 219 bps over a year. The spread of Hellenic Republic is, however, at 1,086.95 bps, way more than that of Tata Motors.