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The rush to hold cash amid growing risk aversion resulted in yields rising even on paper of highly rated entities, including public sector companies and financial institutions. The differential or spread between yields on bonds of these companies, both governmentowned and privately held, and similar-maturity government papers widened by about 20-30 basis points (bps). A basis point is 0.01 percentage point. Dealers said the broadening of spreads to this extent is unusual and is a sign of risk aversion. During the global financial crisis and after the IL&FS default, the spread had widened by up to 50 bps.
Indian Railways Finance Corp (IRFC) on Friday sold three-year paper at 6.19%, about 20-25 bps higher than the usual. Rural Electrification Corp cancelled a primary bond sale on Friday as investors demanded 7.40% for three-year paper, deemed steep by the borrower. Both are state-owned companies.
Vedanta’s bonds, rated AA with a two-year residual maturity, changed hands at 11%, which, according to market participants, verged on distress levels. A large finance company, which deals in vehicle funding, saw a set of subdebt paper trading at about 15%.
“Yield spreads have widened overnight as investors turned more risk averse,” said Ajay Manglunia, managing director and head of fixed income at JM Financial. “Any desperate sale will be punished in the current market condition. This is not a credit crisis but a reflection of the slowing economy on the back of the lockdown.”
Market participants said the jump in yields on Friday was on expectation that mutual funds would be forced to offload their best paper if investors pull money out of debt schemes. There is little enough demand for lowrated debt securities these days. This, along with unprecedented redemptions in the past two months, was the main reason behind Franklin’s move to stall redemptions for now in six debt schemes with assets under management (AUM) worth Rs 26,000 crore. What has sparked panic among investors is that Franklin did not specify when it planned to return the money of investors stuck in these schemes. The move has no direct impact on other debt mutual fund schemes but it has shaken investor confidence in similar products across the industry.
“The concern among investors is whether other credit risk schemes or similar products holding low-risk papers will face similar problems,” said the head of a large mutual fund. “This part of the corporate bond market is illiquid and funds are preparing for any extreme reaction by investors.”
The mutual fund industry swung into firefighting mode on Friday with the Association of Mutual Funds in India (AMFI), the main lobby group, saying the issue is limited to six schemes of one fund house. Top industry executives said there was no need for a special liquidity window to be opened by the Reserve Bank of India (RBI) as it did in 2008 and 2013 because the borrowing limits of most fund houses are yet to be exhausted. The speculation in the industry is that Franklin has exhausted its borrowing limit, which is 20% of a fund’s net assets for a period of six months. This could not be independently verified.
Franklin Templeton’s woes began earlier in 2020 when concerns over the quality of the securities its schemes held started making investors and financial advisors uncomfortable. The fund has been criticised for spreading these instruments across schemes. Investors began exiting most debt fund categories including credit-risk funds in February and March after disruptions sparked by the coronavirus outbreak spooked equities, soon spilling over to the debt market. Franklin’s debt schemes faced higher outflows because of exposure to illiquid and low-rated papers. The redemptions were too heavy to handle in the absence of liquid securities, forcing the fund house to scrap the schemes.
Trading volumes in the secondary corporate bond market also shrank. They dropped 14% to Rs 8,600 crore Friday from Rs 9,984 crore, according to NSE data.
Many sellers have been quoting astronomical rates, sensing buyers’ desperation, dealers said. Consequently, deals are fizzling out.
“Rising corporate bond spreads are largely a function of corporate bond markets becoming more illiquid, due to a specific event,” said Derivium Genev managing director Ashish Ghiya. “The spreads gapping are more a function of bond markets illiquidity rather than reflecting macro or company specific fundamentals.”
Select top-rated companies, which had planned bond sales in advance, raised money Friday without a hitch. Mortgage lender HDFC on Friday paid 6.95%, raising two-and-a-half year money, lowering rates by a quarter percentage point from an earlier deal over a week ago.
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