Firms tilt towards fixed-rate bonds for borrowing as interest rates fall

Companies have increased the share of fixed-rate bonds in new bond issuances amid falling interest rates.

The net outstanding data, which reflects all outstanding bonds and not just the bonds issued during a given period, shows that over 90 per cent of the bonds were fixed-rate ones in the March, June, and September quarters.

This is the first time that it has crossed this mark since December 2017. It was 90.42 per cent in March and above 91 per cent in both June and September. The share of floating-rate bonds has fallen to low-single digits (see chart).

Companies pay interest rates that can change on the basis of an underlying benchmark in floating-rate bonds. The interest rate remains the same throughout the term in fixed-rate bonds.

These are the two major bond categories. Other instruments like structured notes account for the rest. The move towards fixed-rate bonds comes even as the cost of borrowing has reduced significantly. The RBI in May last year cut its key lending rate, called the repo (repurchase) rate, to 4 per cent. This is the lowest since the benchmark was introduced 20 years ago in 2000. It also took other steps to ensure that companies could borrow cheaply to survive even as gross domestic product (GDP) fell by almost a quarter amid the Covid-19 pandemic.

“… liquidity-augmenting measures, amounting to Rs 12.8 lakh crore (6.3 per cent of 2019-20 nominal GDP), resulted in the lowest financial markets borrowing costs in a decade, with yields on instruments like the 3-month Treasury bill, commercial paper (CP) and certificates of deposit (CDs) trading closer to the lower bound of the policy rate corridor in the secondary market,” said the central bank in its “Report on Trend and Progress of Banking in India 2019-20”, released on December 29.

The report noted there were record corporate bond issuances of Rs 4.4 trillion between April and October 2020, compared to Rs 3.5 trillion in the same period in 2019. This period of accommodation is not expected to last. “We anticipate the RBI will withdraw accommodation and reduce liquidity in turn starting the process of rate normalisation. Unless we see a huge fiscal consolidation or downward growth/inflation shock rate cuts looks unlikely …” said a December 18 note entitled “Hindsight is 20/20”, by Axis Asset Management Company.

It said the central bank was likely to hike rates slowly to avoid endangering the current economic recovery. The rising rates are expected come in during the next 12-18 months, according to the note. This may be a time for caution for investors in lower-rated companies.

“…as a general principle, at the bottom of a rate cycle it is prudent to demand higher compensation for deeper commitments of capital. While a steep yield curve is possibly providing this for longer tenor commitments (at least at particular points on the yield curve where implied forward rates are quite attractive), credit spreads on lower rated assets in general may no longer be doing so,” said a December 24 note entitled “Where The Light Is: A Year in Review”, by Suyash Choudhary, head (fixed income), IDFC Asset Management Company.