HDFC to issue masala bonds this week

Mumbai: Housing Development Finance Corp. Ltd (HDFC) will launch the first sale of so-called masala bonds by an Indian entity this week, seeking to raise at least ₹ 2,000 crore, the mortgage lender said on Monday.

HDFC will have the option of raising ₹ 1,000 crore more from the sale in case of excess demand. The sale will likely be officially launched on Tuesday and close on Friday.

A masala bond is a rupee-denominated bond sold overseas. Such bonds allow an issuer to raise funds in the overseas market without taking on the currency risk typically associated with foreign-currency denominated bonds or loans.

“The corporation is the first Indian public issuer of synthetic rupee notes. The synthetic rupee notes are in the nature of rupee denominated bonds as per applicable Reserve Bank of India (RBI) guidelines. The bonds will bear a fixed coupon and will have a tenor of 3 years and 1 month,” HDFC said in the statement.

The concept of masala bonds was first spelt out by RBI in April 2015, following which the central bank issued guidelines for the securities in September.

The idea was to allow Indian companies to raise money through an overseas debt instrument where the currency risk lies with the investor rather than the issuer. A number of countries do this. China, for instance, issues local-currency offshore bonds known as “dim sum” bonds.

Since last year, when the guidelines for masala bonds were unveiled, a number of companies have tested the waters. The list includes HDFC itself, Indian Railway Finance Corp. Ltd, NTPC Ltd, Shriram Transport Finance Co. Ltd and Dewan Housing Finance Corp. Ltd.

These entities and their bankers have not closed the deals because investors demanded considerably higher interest rates than those on offer in the domestic market. Higher rates were being sought to compensate for the currency risk, because the Indian rupee was expected to depreciate.

While the view on the rupee has not changed much, liquidity in the market has improved, said a person familiar with the deal, explaining HDFC’s decision to go ahead with the issue.

“The company has been watching the market for sometime now. An improvement in global liquidity conditions and the recent rally in the bond markets makes this a good time to go to market,” added this person, who asked not to be identified.

Excluding tax, the rate at which HDFC expects to raise funds through this issue will be comparable to the cost of raising funds in the domestic bond markets, the person added. However, the mortgage lender will also have to bear an additional cost of the withholding tax of 5% that is levied on offshore bonds, which will push up the cost beyond that of funds it raises locally.

On 17 June, HDFC sold three-year bonds in India carrying a rate of 8.46%.

While the cost of raising money through the masala bonds will be slightly higher, HDFC will get the benefit of diversifying its source of funds.

“HDFC is keen to diversify its borrowing profile by tapping global investors through this issue of rupee denominated bonds. This milestone issuance, the first of its kind, should validate the attractiveness of the instrument and set a good benchmark,” said HDFC chairman Deepak Parekh in the company’s statement. The bonds will be listed on the London Stock Exchange.

If successful, HDFC’s issue may allow other companies to follow suit. So far, only the International Finance Corporation (IFC), an arm of The World Bank, has raised about ₹ 11,000 crore through masala bonds.

The IFC first raised ₹ 1,000 crore through masala bonds in November 2014 to help develop a market for such securities. Apart from IFC, British Columbia, a province of Canada, said it intends to raise funds through masala bonds earlier this year.

“Masala bonds, once they pick up, will allow investors to diversify their source of funds and also reduce the currency risk associated with overseas funding,” said Pawan Agrawal, chief analytical officer, Crisil Ratings. China has done that, he added, and, over the year, developed a market for dim sum bonds.

While investors may initially be interested in companies with a high credit rating, over time, even relatively lower rated firms may get access to the masala bond market, added Agrawal.

HDFC has a AAA rating (the highest) in the Indian market.

“If you look at the foreign currency bond market, a reasonably wide range of issuers have access to these markets. Typically, investors would want to start with the higher rated issuers but then, as confidence builds, other issuers should be able to tap the market as well,” Agrawal said.

According to RBI’s September 2015 guidelines, companies can raise money through masala bonds for most purposes, other than funding real estate transactions, investing in capital markets, and on-lending to other entities for such activities.

To make masala bonds more attractive, in April, RBI reduced the minimum tenure of such bonds to three years from the previous five years.

RBI and the government, however, have not yielded to the demand that the 5% withholding tax on offshore bonds be waived in the case of masala bonds.

This continues to be an irritant and may mean that fund raising through such bonds will remain marginally more expensive than domestic fundraising.