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Non-Convertible Debentures Dominate Fund-Raising Option
Mon, 10 Oct Pre-Open

Companies normally raise money by going public, i.e. through an Initial Public Offering (IPO), follow-on-public offer (FPO), qualified institutional placement (QIPs), preferential issues, borrowing money from banks, and by issuing debentures which include Non-convertible debentures (NCDs) and convertible bonds.

NCDs are loan-linked bonds that cannot be converted into stocks. This instrument offers a higher rate of interest than convertible debentures. On the other hand, a convertible bond is a bond issued by a company which gives the bondholder the option to trade in the bond for shares in the company that issued it. Here, the bondholder gets both a fixed-income investment with coupon payments as well as the potential to benefit from an increase in the company's share price. As the bondholder gets an option of converting a bond to equity share, the coupon payment on the bond will be lower than that of an equivalent bond with no conversion option.

As per an article in Mint, Indian companies raised Rs 3.7 trillion in the first half of the current fiscal year and NCDs were the most preferred. According to recent Prime Database data, of the total funds raised in the 1HFY17, Rs 2.73 trillion was via NCDs (on a private placement basis). This comes to nearly 75% of the total funds raised.

So the question is what makes NCDs so popular among corporates? The answer lies in the bond market. With bond yields falling in line with policy rate changes, raising funds via NCDs has become a cheaper source.

Now, if the rates are falling, bank rate should also come down, right? However, that is not the case. On 5 October 2016, the RBI cut repo rate by 25 bps, how many banks lowered their base rate by at least 10 bps? The answer is zero. Why? Vivek Kaul has an answer. He writes...

  • While banks are quick to raise interest rates when the RBI raises the repo rate, they are slow to cut interest rates when the RBI cuts the repo rate. Also, if banks lower their base rate, the interest they earn on the money that they have lent comes down immediately. But the interest that they pay on their deposits does not change. While loans rate are floating, deposit rates are not. Hence, banks continue to hold on to interest rates on their loans.

Banks are currently grappling with issues of non-performing assets. The HYPERLINK "https://www.equitymaster.com/5MinWrapUp/detail.asp?date=09/25/2012&story=2&title=Will-PSUs-play-musical-chairs-with-bad-loans" \t "_blank" bad loans will also limit the ability of banks to cut their lending rates.

Due to above, many companies have been opting for NCDs. Muthoot Finance, Mahindra & Mahindra Financial Services, Dewan Housing Finance Corp. and Edelweiss Housing Finance were among the companies that mobilised funds through this route. Similarly, mining major Vedanta announced that it will raise up to Rs 12.5 billion through NCDs and several others like Apollo Hospitals and Shriram City Union Finance are in the fray to follow suit.

Will NCDs continue to be in trend? It looks like at the moment. With bond yields coming down further on the heels of the Reserve Bank of India's rate cut, the NCD route will continue to look attractive.

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