Of Passing Interest

Interest rates have started to slide in the last few months. While it seems a short-term trend, there is already a perceptible impact on some companies. A report

After having risen to unbelievably high levels last year, interest rates have finally commenced on a Southbound journey. And while there is debate on whether the current rates will persist, already there appears to be an impact.

There can be no two opinions on the situation last year. Corpo-rates had to juggle with slowdowns in demand, increased input costs and a fast-vanishing money market. It was not unusual to hear of a company borrowing at 30 per cent or more from the ICD market. Check out the performance of companies in Se-ptember 1996 and the increase in interest outflows over September 1995.

For manufacturing companies, the situation was particularly nightmarish. The overall liquidity was bad, chances of raising funds from the bourses path-etic, and several expansion or diversification programmes held up midway through. At the same time, banks and NBFCs were caught at the other end of the squeeze. For NBFCs in particular, cost of funds went up hugely. Banks had hiked their prime lending rates. The end-user market was not showing much growth either. In the latter stages, with industry itself trapped in the economic slowdown, inventory pileups had their effect on cash flows up and down the production chain.

Almost inevitably, a switch-over to debt instruments with high yields occurred. Comp-anies reasoned that they could attract retail investor interest only by giving high rates of interest. This could be ploughed further up to their end users with appropriate spreads maintained. For the retail inve-stor too, it made sense. Equity markets were on a no-return downturn, and yield in debt began to rise.

Since the kind of instrument would probably decide the kind of return it was no surprise that a variety of debt instruments became popular last year. FDs in particular became the NBFC flavour of the season because of the earlier freeing of rates. Certificates of deposits were the type of instruments usually offered by banks.

The overall decline in interest rates has come largely due to macro-economic factors. However, the NBFC sector is the first to feel the impact. And ironically, the fact that these companies were so successful in FD collection is the indirect source of the problem today. The complete figures for the amounts collected by the NBFC sector via the FD schemes are not as yet available. However, some trends are worth noting.

In particular the performance of Punjab National Bank may be worth checking out as an indicator of the general trend. It was reported in the Business Standard last Friday to have turned the corner. Whereas in the last year it had posted a loss of around Rs 95 crore, this year it is expected to show a net profit of roughly Rs 300 crore. This turnaround has been attributed to high growth in deposits, a greater credit offtake and a fall in non-performing assets.

PNBs deposits have gone from Rs 27,000 crore last year to Rs 30,000 crore by the end of January 31, 1997. While this is an increase of 10 per cent, by April 1997 the bank is expected to show a deposit increase of a whopping 17 per cent. And, as a Mumbai based analyst says, In itself this could imply that other deposits for NBFCs have also increased substantially.

Moreover, some companies such as the AAA rated Sundaram Finance has even pulled out of the FD market since last December. The company is believed to have collected around Rs 700 crore in FDs from March to December. Market sources say that the company, which does business to the tune of Rs 2 -2.5 crore per day did not want to increase its offtake for the simple reason that its markets are not growing very fast.

This is the crux of the matter. While overall collections have gone up fast, there is not much difference in the borrower profiles. So NBFCs are faced with a situation where they have cash surpluses but not many viable borrowers. The problem is states a Delhi based corporate finance executive Last year a lot of us had got burned by lending indiscriminately. And since companies across the board fared badly, recovery also became a problem. Defaulters are legion. As a results we are not lending to just anybody these days. AAA companies of course are in a position where they can get access to funds at lower rates. But, for the others, it has come down but not by very much.

A few trends are clearly discernible. For one, while conditions vary from company to company, the ICD market yields have also come down somewhat. The 90 day ICD for the better companies, according to market sources, has come down to around 20- 24 per cent, whereas six months ago it was 22-26 per cent. For companies with a lower rating the figures are 26-28 per cent and 24- 26 per cent respectively. These figures vary considerably across companies.

We have collected a lot of money over the past few mon-ths says a corporate finance head of a Delhi-based NBFC, Now the money has to work. Now that interest rates are down we will focus aggressively in all segments, including the main one: car financing.

That may be so. However, because of lower offtake or beca-use other NBFCs have the same ideas, or even due to both factors, rates on car finance have also come down appreciably in the last few months. Flat rates are around 14.5 per cent or so. The IRR, which is a better way of working out the return, is around 19-24 per cent depending on the NBFC and the car manufacturer. Other reasons for the variation is that Cielo and Esteem are passing on huge discounts as well as incentives to dealers, and NBFCs can ther-efore afford to charge lower rates. But even these are coming down from the 22- 26 per cent range of last year.

Perhaps as a direct fallout of the above trends, FD rates have come down by as much as 1-2 per cent over last six months. AAA companies have come down by as much as two per cent. Others such as L&T Finance offered of 16.5 per cent last year on its one and two year deposits and 18.5 per cent on the five year deposit. At present, the overall rate has come down by one per cent, the five year rate is down 2 per cent.

The question is, what impact will this have on manufacturing companies ? It would be difficult, though not impossible in some cases, to make a correlation between decline in lending rates and interest outgo on a companys balance sheet. Especially since even banks have reduced lending rates in the past few months, though market sources say that credit offtake has not increased dramatically so far.

However, a direct impact may be perceptible on AAA companies where it is easier to calculate than with the second rung. Second, the impact is far more likely to be felt in the first half of 1997-98. At the same time, no one expects interest rates to stay at current levels. However, while they may go up from here, it is not expected that the 1996 scenario will prevail again.

The attached charts assess which industries and companies stand to gain the most if rates do stay at present levels. Both ind-ustry and company specific aggregates have been compiled. It may be seen that 15 companies with the highest interest to sales turnover ratios are all in the red- high interest outflow being one of the main reasons. A further softening in interest rates or even stability at current levels would help them immensely.