Leasing companies and mortgage banks are raising more money through debt issues to take advantage of higher demand for credit and to cap their own interest rates. Leasing companies and mortgage banks are raising more money through debt issues to take advantage of higher demand for credit and to cap their own interest rates. However rising rates coupled with macro economic imbalances are posing new challenges for arranges of these loans who say that buyers are no longer willing to consider fixed interest rates or the government debt yield curve as a benchmark.
Corporate finance institutions like Peoples Merchant Bank, say structured debt deals are becoming sophisticated because of market demands and macro economic imbalances.
Interest rates started rising in September last year but the hike accelerated this year when the markets detected the government’s loose fiscal management was creating many macro economic imbalances.
One year Treasury bill rates, normally used as a benchmark for structured debt deals, rose by nearly two percent this year.
Leasing providers are some of the biggest borrowers in the financial sector.
Unlike banks, that lend their deposits, leasing companies and specialized housing banks have to borrow money from the market.
Many of these institutions use securitized paper, which helps them lower the cost of borrowing, when they approach lenders, mostly banks, to finance their businesses.
Companies that arrange debt for these leasing and mortgage banks say credit growth has spawned more borrowing in the last few years when the market for leasing grew around 20 percent annually.
Mortgages were also popular when interest rates were low.
Since the rise in rates the average size of mortgages has nearly doubled at some specialized housing banks catering to low and middle income earners.
Arrangers like Peoples merchant bank say investors who seek the lowest possible risk profile for their investments are demanding credit enhancements now more than a couple of years ago when the economy was not as volatile.
“One of the enhancements that we have structured is the buffer of receivables for the securitized debt portfolio,” says Nandi Anthony, Head of Corporate Finance, Peoples Merchant Bank.
“In general that was at a level of about 120 percent. Increasingly the prospective investors expect 130 percent or more. That shows that the level of uncertainty is more,” he says.
Nandi Anthony who made Rs. five million in arranging fess for Peoples Merchant Bank last year however says they have not been able to lower the rates despite the lower risk offered by the credit enhancements.
Borrowers, like Peoples Leasing Company (PLC) the biggest player in the local market who borrowed on fixed rates a few years ago say it’s no longer possible.
Players say the economic uncertainty and interest rate volatility contributed heavily to make fixed rate debt instruments a thing of the past.
“Previously there was an effort by the government to bring down the rates. At that time the appetite of the investors was to go for longer term. But now with the increasingly they tend to look at short term or a floating rates,” Anthony says.
Financial establishments that don’t raise public deposits however have to tap the market for funds to keep growing even if the economy takes a down turn like it is doing now.
“We had problem at the initial stages. We had a very small capital. But we were able to raise money because we were good in other aspects like loam portfolio, and the financial indicators were good. We had to keep on borrowing,” says D. P. Kumarage, CEO, People’s Leasing.
“But the net equity also comes into play. Still there is a limit in our borrowing. We are happy that the parent companies have given additional funds. It will help increase our net equity and the market confidence too,” he says.
The push use lease securitization is a natural response to lower the cost of funds and compete with commercial banks that have cheap customer deposits according to experts.
Experts say finance companies here should also start looking to broad base their sources of debt.
A Credit Rated instrument helped HDFC, a listed specialized housing bank to tap the long term market to finance its mortgage lending.
Pension funds like the EPF lent under the 10 year securitized instrument when even the government yield curve did not extend that far.
Borrowers HDFC bank, which is planning an IPO soon said it was tough to place the instrument initially.
“We had to have several meetings with the investor to come to a consensus,” says C.A. Sarathchandra, CEO, HDFC Bank.
“It was favorable because the market view is that since virtually there is not long term market here the rate would be high. Even if you take a cross-section of the market, the short tern instruments are cheaper. This is very long term but we managed to have a rate which is equal to medium term instruments,” he says.
HDFC says the securitized paper that was rated two notches above the bank’s rating, helped convince captive funds like EPF and others like the NSB that tends to take a longer term view.
The instrument was at a floating rate premium to the one year Treasury bill.
But others are finding the absence of a credible yield curve a problem to pricing debt issues.
Recent securitized paper by a leasing company used the prime lending rate as a benchmark instead of the usual one year Treasury bill rate, an indication according to critics that T bill rates are not market driven.
Critics say captive funds have been used to keep rates low through their bids in the primary market.
These macro economic complications have made pricing also complex and forced investors to ask for credit enhancement and shorter maturities to lower their risk.
“It would be a fruitless exercise to plan ahead five years. Because the level of uncertainty is such,” says Anthony.
Specialist leasing companies now want their businesses to be regulated because they think it will give more confidence to lenders.
“When there is a regulatory framework governing the leasing companies, even the lender will be confident. The public will have lot of faith, when an institution like the Central Bank regulates,” says Kumarage.
Lenders like Commercial Bank who are acting as market makers are likely to feel more comfortable with a regulator especially since all issues don’t have credit ratings.
The macro uncertainty however has not dampened borrowers or lenders.
But for businesses seeking to lease assets and people looking to build houses the costs have gone up not just because of interest rates going up but because lenders want premiums for the higher risks through extra security or a higher rate.
They worry that unless macro indicators improve maintaining the same levels of profit and market growth will be difficult.
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