Mumbai: For AA-rated Indian borrowers such as Hindalco Industries Ltd, choosing loans over rupee-denominated bonds is becoming a no-brainer after a drop in lending rates to the cheapest in seven years.
‘‘Today, if we have to raise money, we will prefer loans any day," Alphonso Richard Das, deputy chief financial officer and head of treasury at Mumbai-based Hindalco, said in an interview. “The big-bang improvement in banks’ lending rate post-demonetisation has prompted AA and lower rated corporates to gradually prefer loans over bonds."
While Indian borrowers rated AAA and AA+ still find it cheaper to tap the local debt market, the big cost savings that lower rated firms enjoyed from notes over loans have narrowed so much that Hindalco’s Das says the “arbitrage has shrunk significantly." That’s good news for banks as they grapple with the slowest credit growth in a quarter of a century.
The Reserve Bank of India (RBI) cut interest rates to the lowest since 2010 in August as it sought to resuscitate the economy still suffering from Prime Minister Narendra Modi’s cash ban in November that led to a surge in deposits. Lenders slashed rates based on the marginal costs of funds earlier this year following the clampdown.
“The drop in banks’ lending rate has been much sharper than those on bond yields in the past year, thereby making companies favor loans," said Das. “We expect lending rates to decline further as we see the central bank slashing interest rates by another 50-75 basis points in the medium term."
The switch to loans from bonds is more pronounced in companies rated AA- and lower because the yield spread has contracted significantly in this category rather than AAA, according to IDFC Bank Ltd.
The average yield on AA-rated three-year corporate bonds is at 7.57%, just 38 basis points less than six-month lending rate at the largest lender State Bank of India. That gap was 90 basis points on 8 November, the day demonetisation was announced.
“For companies to choose bonds over loans, bond pricing is expected to be lower by 50 basis points to make it cost effective for giving up of free prepayments on loan reset dates," said Jayen Shah, Mumbai-based head of debt capital markets at IDFC Bank.
Borrowing via loans also means companies are buying themselves the flexibility to prepay. In the case of bonds, which are fixed in tenor and rate, a prepayment is harder to do, said Harsh Shah, chief financial officer at Sterlite Power Transmission Ltd. “People used to choose bonds because of a lower cost and a fixed cost for a longer time," he said. “Now, with liquidity available, banks’ base and savings rates have come down. So, banks can lend at a lower rate."
Bond sales by Indian companies ranked AA or below slumped to Rs9,020 crore ($1.4 billion) this quarter, down 38% from the previous three months and 73% on year, data compiled by Bloomberg show.
To garner business and put liquidity to use, banks price long-term loans on shorter tenor benchmark lending rates such as three-month and six-month, a departure from an earlier convention of using a one-year tenor, said Hindalco’s Das.
This further reduces the borrowing costs by at least 10 basis points for companies and gives them a floating rate loan, which can be re-priced at shorter-intervals.
“The competition for lending to good borrowers or good assets is at its peak because there is liquidity in the market," Sterlite’s Shah said. “The capital markets are still cheaper than bank loans, but the spread has become finer." Bloomberg