April 3, 2017 / 3:49 AM / 3 years ago

Indian off-market bond deals risk distorting prices

* Low-yield placements sap drive to improve Indian market transparency

By Krishna Merchant and Suvashree Choudhury

SINGAPORE/MUMBAI, April 3 (IFR/Reuters) - For all of India’s efforts to improve transparency in the rupee bond market, investors are still a long way away from finding the right price for corporate debt.

A cluster of recent issues at much lower yields than secondary market levels has prompted a backlash from market participants on worries that more off-market deals could distort pricing.

“Any trade that is contrary to the collective market pricing is injurious,” said Killol Pandya, head of fixed income at Peerless Mutual Fund.

The introduction of an electronic bidding platform last year was supposed to improve price discovery and help deepen the local market.

Instead, a series of bilateral deals at off-market levels has highlighted the lack of liquidity in India’s shallow corporate bond market and made it harder for investors to value some such paper.

In the first week of March, Dewan Housing Finance and Adani Ports and Special Economic Zone sold bonds to Life Insurance Corporation of India, the state-owned insurer has confirmed.

DHFL also confirmed the details of the placement, while Adani Ports declined to comment.

In both cases, LIC bought the bonds directly from the issuers instead of involving bankers or underwriters, at yields 80-120 basis points lower than were available in the secondary market for similar credits.

In most mature markets, new issues of debt or equity come at a discount to secondary market levels. Instead, the LIC deals show that thin trading in the Indian secondary market is having the opposite effect.

“LIC’s heavy purchases of bonds at much lower levels have distorted the historical spread,” said one corporate bond dealer at a foreign bank. “Such off-market deals not only create wrong benchmarks for similarly rated companies to raise funds, but even stakeholders in the investing companies lose out on higher returns.”

PREMIUM PRICING LIC bought DHFL’s 15 billion ($232 million) rupee 10-year bonds at a yield of 8.0 percent, sharply lower than the 9.2 percent rate for 2026 bonds in the secondary market, even though the new issue had a longer tenor.

It also purchased 10 billion rupee 10-year Adani Ports bonds at 8.22 percent for a similar tenor, lower than the 9.00 percent yield for the issuer’s outstanding 2026 bonds, according to data on NSE’s trade repository.

LIC said in an email that its investment policy always favoured secure investments with a reasonable return. In assessing DHFL’s bonds, “it has taken into consideration the size and tenor of the issue, AAA rating, current market conditions, security cover and company financials”, LIC said.

In an email, DHFL said it had priced the AAA rated bond in line with the spread issued by the Fixed Income Money Market and Derivatives Association, the industry body for debt markets in India.

However, bankers said that DHFL typically prices its AAA rated bonds about 100bp-120bp wider than Housing Development Finance Corp, which is seen as the best-quality credit, and the yield on the bilateral deals, therefore, came as a shock.

Indian rules require large bond transactions to be conducted through electronic bidding platforms in order to make offerings more efficient and transparent. However, the recent LIC placements underline the limitations of that requirement, as some issuers and investors still prefer to agree pricing bilaterally. SHALLOW MARKETS One of the reasons for bilateral deals is the low liquidity in the secondary market, which means a large trade can move prices.

India’s corporate bond market is very shallow, with an average trade size of 40-50 billion rupees daily, compared to five times more volume in the government bond market.

The pricing of a corporate bond depends partly on the size.

“If an investor wants to buy or sell a huge quantum of, say, 10 billion rupees ($152 million) or more, it will likely impact the market, and the yield can show variations from the secondary market,” said Lakshmi Iyer, senior vice president and head of fixed income and products at Kotak Mutual Fund.

Bilateral deals will continue to happen because of the lack of depth in the secondary market.

“If today a large buyer comes to the market and buys a sizable chunk of bonds, the prices could get affected by a huge margin because the market is shallow,” Iyer said.

Low liquidity in DHFL bonds in the secondary market could have impacted its yields there, DHFL said in its email.

“The market is opaque and it is still in a private placement domain,” said another DCM banker.

The government security market is very liquid and buyers and sellers can execute huge transactions, but this is not replicated in the corporate bond market. In February, the Securities and Exchange Board of India put out a consultation paper recommending that issuers should maintain fewer, larger bond lines to avoid fragmenting liquidity.

Until there is a vibrant secondary market, bilateral trades at off-market prices will continue to be an attractive option for issuers and large investors alike. (Reporting by Krishna Merchant of IFR and Suvashree Choudhury of Reuters News; Editing by Daniel Stanton and Steve Garton)

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