Lower-rated corp bonds may continue to face illiquidity: Experts

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Published: April 28, 2020 12:30:35 AM

Market participants say the demand is still concentrated within the top-rated papers. Papers that fall within the investment grade category but are rated below AA+ are still finding it hard to get traded.

Market participants say the demand is still concentrated within the top-rated papers.

Corporate bonds that fall in the investment grade category but are rated below the top tier may still continue to bear the brunt of the illiquid market despite the Reserve Bank of India’s (RBI’s) extension of liquidity facility to mutual funds (MFs) via banks as lenders may continue to stick with the top tier investment grade bonds in the prevailing environment of risk-aversion, experts say. The RBI on Monday opened up a liquidity facility for MFs under which banks can avail funds from the central bank at the policy repo rate which can be either be extended as a loan to MFs or can be used for an outright purchase and/or repo against the collateral of investment grade debt securities held by MFs.

A fund manager told FE on condition of anonymity that around two-three different MFs are facing some issues with their credit schemes due to redemption pressures and it may get difficult for these institutions in coming times. “We are aware of top executives of a few MFs who have prepared a list of illiquid papers and are holding talks with the banks for a potential sale of these papers. Although, the RBI has come out with the liquidity facility, the discretion on what papers to buy still lies with banks. Lenders are of the view that they will not take any sort of risk on their balance sheets. We understand that banks are intending to concentrate only on short-tenor securities that have a good rating and are liquid,” the fund manager said.

Arvind Chari, head, fixed income and alternatives, Quantum Advisors, stated that the liquidity window may not be effective to resolve the current problem. “Currently, banks are extremely risk averse to take any credit exposure. We have seen this in case of TLTROs in which they were not willing to buy anything except for few top rated corporate bonds. And with imposition of issuer wise limit they just stayed away. I don’t see them taking lower rated corporate debt as collateral, which has been lacking in liquidity. So, if we see heavy redemption in schemes, which carry large exposure to lower rated corporate debt, liquidity will remain a problem,” Chari said.

Market participants say the demand is still concentrated within the top-rated papers. Papers that fall within the investment grade category but are rated below AA+ are still finding it hard to get traded. “Below AA+, it is mostly the papers belonging to strong entities or groups with a good reputation that are able to find buyers in current times,” said an expert.

Ananth Narayan, professor-finance at SPJIMR, told FE that the liquidity facility to MFs necessarily does not get banks to buy the illiquid papers. “At best, the step helps in providing funding for MFs via banks against good quality papers. Banks likely remain averse to credit risk in these uncertain times. Effectively, the credit transmission has broken down due to risk aversion, and hence, liquidity itself will not solve the issue. I think the government eventually will have to step in to take on the credit risk of SMEs, NBFCs, and be prepared provide some sort of credit guarantees to financial institutions that are starved of capital,” Narayan said.

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