Local currency bonds become new fad for investors; here’s how interest increases as ratings downgrade

By: |
August 3, 2020 9:44 AM

Investors are buying local-currency bonds whose interest increases every time their credit ratings are downgraded.

Bond market, local currency bonds, investment Investors are concerned that businesses will deteriorate further after prolonged lockdown restrictions brought the economy to a standstill.

With the health of Indian companies’ balance sheets deteriorating at the worst pace ever, investors are demanding more protection. One way they are doing that is by buying local-currency bonds whose interest increases every time their credit ratings are downgraded. The number of such notes sold jumped to a record in the quarter through June, making up 102 out of the 513 bonds issued, according to Bloomberg-compiled data. And sales remained strong in July.

Indian borrowers are trying to address investor concerns that businesses will deteriorate further after prolonged stay-at-home restrictions brought the economy to a standstill. Such bonds are sold overseas too in countries including Israel and New Zealand, but issuance from India has far surpassed the rest of the world in recent years.

“Investors will continue to demand such covenants as many companies are expected to be downgraded after lockdowns hit business operations big time,” said Murthy Nagarajan, head of fixed-income at Tata Asset Management Ltd. “Bond buyers need to protect themselves in this dynamic situation and will seek tighter bond terms.”

The phenomenon flags broader concerns about debt in India, even as stimulus steps drive a rally in credit markets. The central bank last month warned that the bad loan ratio of lenders could swell to the highest level in more than two decades.

In July, 35 bonds with so-called credit rating protection metrics were sold, compared with just four a year earlier. In some cases, issuers can benefit as well. Just as they promise to pay more in case of a downgrade, some notes let companies lower coupons if their bond grades are raised.

That helped sales of such securities gain traction in 2016, when the credit quality of Indian companies was improving on supportive government policies. Before that, offerings of the bonds had been sparse since their introduction in India in 2005. One example of such debt was sold in June by Tata Power Co., part of India’s largest conglomerate.

Those AA rated bonds have a clause that the 8.21% coupon rate would be raised by 25 basis points for each step of a rating downgrade and vice versa. If the rating were to fall to A- or below, the notes would be called back before their August 2023 maturity. There have been no rating changes since issuance.

The boom in such notes comes amid a broader rush to raise funds in the debt market, after bond yields recently hit record lows. “Issuers are raising big amounts from the bond market because they want to lock in lower borrowing costs, but investors are worried about the credit quality,” said Nagarajan at Tata Asset Management.

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Bank of India gets shareholders approval for raising Rs 8,000 crore
2Karnataka farmers urge Centre to exempt ‘Bengaluru Rose’ onions from export ban
3IPO market in for a busy week; should you invest in CAMS, Chemcon Chemicals, or Angel Broking?