Corporates junk bonds, queue up for term loans

After almost three years, the corporate bond market has given way to term loans as the chosen means to meet funding needs of companies.

Dealers said term loans which usually command a premium in terms of interest rates over bonds, now fetch almost the same price or in some cases are even cheaper than the bonds.

This is because most of the banks are advising their corporate clients to shift to term loans rather than floating bonds to raise money.

Many banks have decided not to invest in corporate bonds for fear of having to face depreciation losses if yields rise further. Banks suffered huge depreciation losses on their bond portfolios in 2005-06 as interest rates started rising.

The banks' decision to stay away from corporate papers has led to the bond market becoming illiquid with virtually no trading and turned the term loan market more attractive.

Earlier, term loans used to be priced 100-200 basis points higher than bond yields. One basis point is one hundredth of one per cent.

Currently, term loans of 3-5 years, which are long-term loans, are being sanctioned at 8-8.5 per cent for triple A and double A rated companies.

On the other hand, triple A corporates and PSU undertakings are floating five-year bonds with yields at 8-9 per cent. The National Bank for Agriculture and Rural Development (Nabard) has come out with a 3-year bond at 8 per cent.

Similarly, ICICI Bank floated 5-10 year bonds with 8.60 per cent yield. IDBI Bank mobilised 5-year funds at 8.25 per cent and Indian Railway Finance Corporation raised 10-year funds at 8.55 per cent.

Term loan rates were hovering around 9.5-10 per cent a month back. Some companies with good track record could negotiate even lower rates for term loans. The rates have come down to the levels of bonds or even cheaper because liquidity has improved and banks are more than willing to give loans than to subscribe to bonds.

Earlier, banks preferred investing in bonds to fund corporate requirements as additional capital was not required to be provided for creating these assets.

Moreover, there was no fear of bonds turning into bad investment as in case of bad loans. Bankers added that bonds could be sold in the secondary market to create liquidity.

Banks, now armed with the Securitisation Act, could sell the collateral pledged for loans to get out of bad assets which solves the problem of liquidity of the loan asset.