Collapse of commercial papers volume puts debt schemes at risk: Ind-Ra

According to Ind-Ra, while the banking system liquidity has been aplenty, the market liquidity conditions “have been on tenterhooks”, noted Ind-Ra analyst Abhishek More.
The daily average trading volume of commercial papers has fallen to less than 1 per cent of the outstanding amount, and just about 1 per cent of the holding of debt mutual funds (MFs), posing a serious challenge to the liquidity profile of these MFs, India Ratings & Research (Ind-Ra) has warned. 

The total outstanding of commercial papers is close to Rs 4.3 trillion. The average trading volume is now less than Rs 4,000 crore. 

Non-banking financial companies (NBFCs) and housing finance companies (HFCs) are the major issuers of commercial papers. 

Generally, the daily volume is Rs 10-15,000 crore in commercial papers in the secondary market. 

“The daily commercial paper trades in the secondary markets is less than 1 per cent of the total outstanding amount and around 1 per cent of the total exposure of debt MFs in commercial papers,” Ind-Ra said in a note. 

They are not as active in these markets. Investors are shying away from buying these papers — both in the primary and secondary market. 

On the other hand, papers issued by all India financial institutions, such as Nabard and Sidbi, are not getting traded in the secondary markets, as buyers are not willing to part with these papers in uncertain times. Hence, their share of volume in the secondary markets has also collapsed. 

According to Ind-Ra, while the banking system liquidity has been aplenty, the market liquidity conditions “have been on tenterhooks”, noted Ind-Ra analyst Abhishek More.  

Markets are preferring only a few entities with low-risk perception — in both the primary and secondary markets — and the availability of liquidity for NBFCs and HFCs has been low, “due to elevated perception risk largely to do with the lack of confidence in specific entities or on the sector as a whole”.

This elevated risk perception will be detrimental to these funds, “as some of the rated schemes have significant exposure to the NBFC/HFC sector,” Ind-Ra noted.

A diminished secondary market activity should be a major worry for open-ended debt MFs, and can be credit-negative for the MF industry. 

“Due to redemption pressures, fund managers may be forced to sell the best quality investments. This may leave the portfolio with relatively illiquid and weaker quality assets.”

While debt schemes rated by Ind-Ra have maintained adequate credit quality commensurate with their rating levels, some of their assets under management are witnessing sharp reduction due to redemption, it noted. 

The rating agency said it considers liquidity and diversification of investments as critically as credit quality and duration of the underlying risk for rating purposes. 

“Ind-Ra understands that weak liquidity and significant investor redemptions may increase risks in the scheme portfolio by way of increasing concentration over entities and sectors,” it said, adding, it is currently reviewing the portfolio in terms of the credit quality of the underlying investments as well as diversification to manage concentration risks and may take rating action on the MF schemes that are holding securities in high concentration on a sustained basis.

The rated schemes showed a drop in assets under management (AUM) in March, which is common during the year, but the change in AUM from January to April 2020 shows that there have been net outflows from most funds and AUM is yet to stabilise due to the Covid-19 impact, the rating agency said. 

To be sure, the AUM of debt mutual funds has been falling in a few categories since 2019, followed by a period of weak growth. 

“The redemptions were largely a consequence of the weak balance sheet liquidity of corporates which has aggravated during the lockdown. The contributions from corporates in liquid funds and credit funds have dried up,” which is worrisome as the secondary market environment and redemption pressures could sharply deteriorate the portfolio quality. 

The mutual fund industry is set to face more challenges amid further deterioration in macro-conditions and any idiosyncratic credit event, according to India Ratings.

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