Commercial Paper

Why are NBFCs in a rush to buy back their Commercial Paper

At a time when the biggest risk in the market is the ability of NBFC’s to access funds, there is a different kind of story that is playing out in the market. In the last one week, three very reputed NBFCs have bought back their commercial papers in the market. The numbers are huge. IIFL bought back CPs worth Rs.1700 crore, JM worth Rs.900 crore and Edelweiss worth Rs.1000 crore. Together nearly Rs.3,600 crore worth of CPs have been bought back by the companies from the market. What is this hinting at? First a brief background to the issue.

It all began with IL&FS default

It all began when IL&FS started defaulting on ICDs and CPs over the last 2 months. Problems got compounded when the rating agency downgraded IL&FS from AAA to Junk in one go. This forced some of the CP holders to sell the bonds in the market creating further pressure on the prices. The last straw was when DSP Mutual Fund sold a chunk of CPs it held in Dewan Housing at a steep yield of 11.5% against the market yield of 8.5%. This led to rumors of default by DHFL and the stock has corrected by over 70% since then. The situation is so explosive that even one more default would lead to a downgrade of NBFCs across the board and virtually shut them out of the CP markets. To prevent this eventuality, the cash rich NBFCs are using their surplus cash flows to buy back this CPs from the market.

Two perspectives to it

The first perspective is that NBFCs with cash flows want to make a statement. But the problem has never been with these names. They have typically borrowed and lent at the short end. The problem lies with companies like Indiabulls Housing, Dewan Housing and Repco that were relying on short term CPs to fund long term projects. Secondly, while there is a small loss that these NBFCs might incur, they are still putting the money to better use rather than lending in these troubled times. More importantly, this move will also help to segment the NBFCs based on the asset profile and the risk profile. Companies with cash flow abilities will still be able to borrow in the CP market. That is critical as these companies need to keep rolling over their loans.

Is this an exit route?

After the DSP and DHFL episode, mutual funds and other institutional investors have been talking with CP issuers to buyback without much damage to the market yields. For these NBFCs, a decision to buy back their CPs keeps the CP taps open for them and can continue to count on the domestic mutual funds to finance their short term borrowings. The timing is also right. The markets for equity and debt will increasingly look for NBFCs with strong cash flows and less risk of maturity mismatch. This may just about be the answer to that!

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