Riding The Yield Curve, But Far From Winning

Updated: Jul 29 2002, 05:30am hrs
What would explain the fact that there are hardly any floating-rate debt issuances in the market. Again, not a day goes by without a corporate house claiming that it has raised monies at “the finest ever rate” or at “record pricing.”

But all these are at fixed-rates. And here are the names of some recent issuers of floating rate papers: Whirlpool of India Ltd, Rural Electrification Corporation (REC), Hero Cycles Ltd, Ranbaxy Laboratories. The subscriber profile has just one bank — Central Bank of India to REC. The rest are all mutual funds, and in one instance, the National Housing Bank (to REC again).

Now juxtapose the above with last Friday’s statement by Housing Finance Development Corporation of India chairman Deepak Parekh, at the company’s annual general meeting that he expects interest rates to dip by another 100 basis points (bps) this fiscal. Statements made by the Reserve Bank of India (RBI) governor Bimal Jalan and deputy governor YV Reddy over the course of this fiscal have all supported such a view: Not lower by 100 bps or anything of that sort, but that the lower interest party will continue.

While some critical commentators may point out that the RBI is also the merchant banker to the Centre — the argument here is that is why such statements are made! — many like IL&FS Mutual Fund chief investment officer K Ramgopal are categorical: “Floating rate issuances will only pick up in the days ahead. It has taken sometime for this market to develop.”

Seconds Rabo India Finance Pvt Ltd senior manager (treasury) Rajat Monga: “Floating rate borrowings make eminent sense for long-term borrowers, especially those with a higher degree of operating leverage (share of fixed costs). Such borrowings lend stability of the earnings of the company by reducing interest cost during down turns and vice-versa.”

And Mr Monga’s outfit, Rabo India, raised monies through this route last week: Rs 60 crore through a five-year debenture with the coupon rate to reset semi-annually. The benchmark was The Credit Rating and Information Services of India’s (Crisil) Bond Valuation matrix for the applicable credit-rating of the issuer. The transaction protects investors from interest-rate and credit-migration risks, and offers cost effective long-tenor funds to the issuer. The issue, rated triple-A by Crisil, has a ‘put’ and ‘call’ at the end of three years.

“This structure enables us to access long-term funding at low carrying cost without taking interest rate risk or locking in the credit-spread for long tenors. This is because the debentures get re-priced at the time of coupon reset at the then prevailing government security rates and the credit spreads for triple-A rated issuers,” says Mr Monga.

Let us now get some perspective on this floating rate interest business. The economy broke free from an administered interest rate structure in the mid-90s. The concept of a prime lending (PLR) for banks was first articulated in the credit policy of October 1994 by then RBI governor C Rangarajan. Several measures have since been taken with banks being allowed to quote short-, medium- and long-term PLRs.

But the next stage — floating rates — has not happened really. This is despite the RBI having nudged the market. The floating rate bond 2006, was issued in November 2001 for Rs 2,000 crore. The interest rate on the bond was set at a mark-up over and above the variable base-rate. The variable base-rate for payment of interest was to be the average rate of the implicit yields at cut-off prices of the last six auctions of 364-day T-bills.

And just see how the Centre has won. On May 18, the RBI notified that the interest rate on floating rate bond 2006, for the half-year ending November 21, 2002, will be at 6.23 per cent per annum. This is as against an interest rate of 7.01 per cent for the period November 22, 2001-May 21, 2002.

Why is the Centre doing this Unlike corporates, the Centre will not be able to retire loans like corporates, say like a Reliance. Since the mid-80s, the weighted average interest rate on dated-stock is ranged at 11-13.75 per cent levels. Now look at redemption numbers in 2002-2003. The bulk of loans amounting to Rs 27,419 crore this fiscal fall in the 11-13.7 per cent bracket.

But before that: Have yields really bottomed out for now Explains Mr Ramgopal: “I will take it (bottoming out views) with a pinch of salt. If monsoons are a problem, it does not augur well for credit offtake. Yields will not go up. This song of a hike in rate in the US is over. I will not say this will lead to a reduction here if that happens, but it is, indeed, an enabling factor.” But all this still leaves a lot unexplained.

So why is there no deluge in floating rates notes There has to be deeper reasons.

Credence Analytics director Shefali Sachdev has this to say on why corporates would opt for floating rates, given the prevailing view in some quarters that interest rates have bottomed out: “Most banks do believe that interest rates have bottomed out. And they are uncomfortable about investing in longer-term paper, and would prefer instruments that will give them a share of the upside. As a result, issuers are able to price floating rate papers at far more attractive spreads over the relevant gilt.”

Ms Sachdev then qualifies this view with the observation that this does not necessarily mean that the issuer has a view that interest rates will fall further. “Even if the issuer feels that rates will remain flat or rise somewhat (but less than the improved spread it has to pay on the floating rate issuance as compared to fixed rate over the tenure), it would still makes sense for them to issue a floating rate instrument.”

Yet, few issuers take the floating rate route. Explains Mr Monga: “There is a need for development of newer benchmarks, those that closely track interest rates in the economy and not liquidity in the system. These benchmarks should be the basis of cash transactions and should minimise basis risk for the issuer. Issuers, investors and regulators alike need to invest in facilitating such benchmarks. Though one recognises that balance-sheet needs of Indian investors and lack of faith in available benchmarks mandates investments in fixed rate paper, the move towards floating rates of return on various savings instruments should go a long way in developing the floating rate market in India. On our part, we are experiencing increased demand of floating rate loan products from our customers and it is only a matter of time that such demand would manifest itself in the corporate bond markets as well.”

But before we start singing paeans in praise of floating rates, read what JM Morgan Stanley’s head (fixed-income) Sanjay Bhasin says: “Most of these banks who invest in floating rate issues are looking at it from a balance-sheet management point of view. There is money to be given... but what I feel disturbing is that there are several corporates who are going to the shorter end of the spectrum. Asset-liability mismatch is not just an issue with banks, but with borrowers as well. Further to the extent that you write in a ‘call’ option, what are we talking about”

A clearer articulation of Mr Bhasin’s view can be seen in Ms Sachdev’s observation: “Banks are largely of the view that that yields on gilts have bottomed out. With huge cash surpluses, they feel that corporates with higher spreads are attractive as investment avenues. Investing in a floating rate bond means that the risk of interest rates over the tenure of the bond is taken care of.”

And here comes the critical part. “Additionally, since a large part of the liabilities are, in effect floating as depositors can withdraw funds when interest rates rise regardless of the fact that the actual form of the deposit is a fixed-rate deposit, banks look at floating rate instruments as an asset-liability management tool,” she explains.

The bigger picture is that floating rates are the future. The RBI has been exhorting banks to do this. Both Dr Jalan and Dr Reddy elaborated on this aspect at some length at the Monetary and Credit Policy review media interface on April 29: But largely on floating rates on the deposit-front.

The story on floating rates is not moving forward — be it wholesale banking or in retail as in the case of deposits or housing loans. But hopes still float; the wait continues.