ICRA warns of potential rollover risks for investors and issuers, as CP issuance volumes hit an all-time high



Commercial papers (CPs) have gained more importance than in the past over the last few years with the debt market activities picking up amidst strong flows into the main investor segments i.e. the mutual funds and the softer rates in the CP market, when compared to the lending rates of banks. Consequently, most top-rated entities deepened their activities in the debt capital markets to raise short-term funds by replacing a portion of their bank funding through CPs and long-term bonds. Better-rated entities are able to raise CPs at around 7% today, which is 150-250 bps lower than the bank lending rates, despite the transition to MCLR system from the current fiscal.

The volume of CP issuance has been steadily increasing over the last few years and stood at an all-time high of Rs 5.29 trillion in Q1 FY2017. Given the shorter tenure of these instruments, the CP outstanding increased by 25% YoY to Rs. 3.38 trillion as on June 2016. On the back of a smaller base, the CP outstanding has increased at a CAGR of 35.5% over the last three years as compared to 10.5% for bank credit and 15.0% for corporate bonds. Accordingly, the CP outstanding now accounts for around 4.5% of the total domestic bank credit as on June 2016 as compared to around 3.5% as on March 2016 and around 4.0% as on June 2015. If we analyse with reference to the banking sector credit only to the large and medium companies and the services sector, as almost all of the CP issuers would be from these sectors, the CPs outstanding increased to around 8.8% as on June 2016 as compared to 7.3% as on the previous year.

While credit risk for the investors is largely mitigated as they generally invest only in entities at A1+, Karthik Srinivasan, Senior Vice President and Co Head-Financial Sector Ratings, ICRA Limited, said: “The issuer and the investor segment need to be mindful of the potential rollover risks with the reduction in CP tenures in the industry, amidst growing volumes.  The main investor class has shifted to the shorter maturity CPs, given the regulation for marked-to-market implications for all investments with residual tenures of more than 60 days.” Report of month-end holdings by MFs indicate that the proportion of investments in CPs, with residual maturity of less than 90 days, has increased over the last few quarters to 87% as on June 2016 from 82% as on June 2015 and 79% as on June 2014.

Mutual funds, with a market share of around 65-70%, remain the main investor segment in CPs, followed by banks, which account for 20-25%. The total asset under debt-oriented MFs was around Rs. 9.7 trillion as on July 2016. Mutual funds have been investing around 20-25% of their assets in CPs in the last few quarters. With the revision by SEBI on single party, group and sectoral caps on investments by MFs with effect from January 2016, investments in NBFC CPs have come down over the last two quarters on an absolute as well as a proportional basis, while the investments in CPs of corporate entities have increased steadily as more players increase CP issuances to manage their funding requirements.

“The CP market however is expected to grow in the near term and will remain an attractive source of funding for better-rated corporates in the current environment of ample adequate systemic liquidity, sound inflows into key investor segments and structural inability of banks to sharply reduce their lending rates,” Mr Srinivasan reiterated.