'HFCs may look at covered bonds as additional funding option'

Moody's Investors Service today said covered bonds or securities backed by a loan portfolio will provide additional funding options for financial institutions, including NBFCs, in India.

NBFCs, including housing finance companies (HFCs), have been diversifying their funding sources as a way to reduce their dependence on financing from banks.

"As part of this strategy, these companies are actively engaged in securitisation. In this context, covered bonds could provide an additional source of funding," Moody's said in a report.

It said, covered bonds in India could provide an additional funding option for financial institutions at a time when high economic growth is driving a significant uptick in retail lending by both retail-oriented banks and non-bank finance companies (NBFCs).
 

Moody's said covered bonds could assist HFCs to manage the interest margins between their lending and funding.

The cost of funding for HFCs in India is significantly higher than banks because they do not have access to retail deposits, which means they are lending at thin margins.

Also, the majority of HFC funding is on a fixed rate of interest, whereas lending is on a floating interest rate basis, which poses an interest rate risk in a declining interest rate scenario, Moody's said.

"Yields on Asian and global covered bonds tend to be lower than senior unsecured bonds. If this spread differential were to be replicated for Indian covered bond issuers, it could help housing finance companies that issue covered bonds to better manage interest rate risk," it added.

Covered bonds are issued by a credit institutions and are backed by a loan portfolio that remain on the issuer's balance sheet.