Financing the growth of an Asian titan
Indian banks’ funding options in their country are prosaic and stable. Most banks are not allowed to issue rupee bonds in senior format — although they can get access to cheap bank capital deals — and they largely rely on their deposit base to fund. But in the international market, they have proven to be frequent and well-regarded issuers.
Regular issuers in both the offshore bond and loan markets, they do not limit themselves just to the dollar markets. They have closed deals in the Singapore dollar and offshore renminbi markets this year, managing to beat their dollar pricing in the process.
Indian banks are now used to getting a good reception in the dollar market and managing to price deals with little or no issue premium. It remains to be seen whether that is sustainable.
But Indian banks are certainly confident. There is a lot of room for them to grow their deposit base domestically, and even as GDP growth slows, the Indian economy is still on fire compared to much of the world, making banks domestic lending ever more important.
This is an argument they often make when on the road, talking about the fundamentals of the country almost as much as they talk about their individual credit quality.EuroWeek sat down with two Indian bank funding officials with experience of the international market, and two of the countrys high-profile investment bankers, to talk about the challenges facing Indian banks and the chance for ever more issuance.
Participants in the roundtable were:Atal Agarwal, head of financial institutions, India, Royal Bank of ScotlandAnil Kumar, senior vice president, Axis BankManeesh Malhotra, head of debt finance, India, HSBCMelwyn Rego, executive director, IDBI BankMatthew Thomas, Asia Pacific editor, EuroWeek
EUROWEEK: How does your institution approach the foreign currency funding market, and how does it compare to the domestic market?Anil Kumar, Axis Bank: We have operations in India, and in four countries overseas. Our overseas assets are around 12% of our total assets, so the US dollar funding requirement is a small portion of our overall funding needs.
We are one of the pioneers in the low-cost deposit market, offering a range of current and savings account products to our customers. These tend to be short term in nature, but empirical data shows that they are a very stable source of funding for us.
We generally go to the loan market for our overseas funding needs, but we occasionally tap the bond market as well. We have done only one syndicated loan in the last four years, but we close club deals every 15 to 18 months. This mix of funding bilaterals, club deals, bonds, and the occasional syndicated loan gives us more than enough liquidity to fund our overseas loan book.
We have moderated the increase in our overall loan book over the last few years. We used to grow our lending by around 30%, but now we have scaled this down to around 17% in both onshore and offshore markets. This is partly a function of our growing maturity as an institution, but it is also a function of how the economy is doing in India.
We can get bilateral loans distinctly cheaper than other sources of funding like syndicated loans or international bonds. The bond market is the most expensive market, but it gives you size that you cannot necessarily get in the loan market.
The Indian market is very deposit-focused, and this is no different for us. Around 40% of our deposits are in the form of savings and current accounts, about 20% are in the form of retail term deposits, and more than 30% comes from corporate deposits.Melwyn Rego, IDBI Bank:IDBI Bank is a very distinct financial institution in the Indian firmament. We were a development financial institution up to September 2004, and we converted into a commercial bank the following month. To that extent, we are the youngest bank in the country.
We have been the pioneers in India in project and infrastructure financing. According to the act of parliament by which we converted into a commercial bank, we are required to continue to play the development role in addition to doing commercial banking. To that extent, whether we look at the asset or the liability side, our profile is very different to other institutions. Since our expertise is in project and infrastructure financing, in these areas we are like a policy bank to the government of India.
We are trying to change the composition of our assets and also our liabilities. Being a bank, the primary source of funding is from deposits. Roughly 10%-15% of our funding requirement is from borrowing. That is to meet asset-liability requirements, since we have significant exposure to project and infrastructure funding.
During this fiscal year, we are looking at raising foreign currency funding of anywhere between $1bn and $1.5bn-equivalent, in various currencies. In the domestic market, we are looking for around Rs1bn, and again the focus will be on capital instruments, in other words lower tier two. This is because we can still raise money from these instruments under RBI guidelines, and they will be grandfathered for the next 10 years.
Our foreign currency funding will come from very diverse sources. I mentioned our legacy as a development financial institution, so we have close associations with multilateral institutions like IBRD, the Asian Development Bank and the Nordic Investment Bank. We also raise money through ECA-backed lines of credit. Of course, these are a little restrictive since they can only be used to fund imports from those countries that provide the loan. The third element of our foreign funding is the bank market, where we raise money from a mix of bilateral, club and syndicated loans.
We always have the dollar bond market available. We have a $1.5bn MTN programme listed on the Singapore stock exchange, and very soon we will increase this, probably doubling it to $3bn. During the last year, we have been looking at various markets to diversify funding sources, so in November we did the first dim sum bond issue from any emerging market, in April we did a Swiss franc bond issue, and last month [August] we did a Singapore dollar bond issue, which was the first from India. We were also the first ever Swiss franc issuer from India, although that was way back in 1987! We were, in addition, the first Indian entity to tap Swiss francs in this fiscal year.
We are now closely following different markets, and will get involved when the time is right. We get benefits from splitting our funding between different markets. We prefer to raise funds in tranches rather than one chunky issuance. In the dollar market, anything less than $500m is not considered a benchmark. We would rather do smaller deals than that. But where the dollar market scores is that you can get longer maturities, and when your funding requirements are chunky, that is the appropriate market.
In the middle of September, we successfully priced a $500m 5.5 year Reg S bond at 370bp over Treasuries, which is the tightest spread achieved by any Indian bank in the dollar market. The issue received an overwhelming response and was oversubscribed nine times.
The key to the success of the issue was the speed of execution. The issue was launched amid a backdrop of positive policy announcements by the government of India, as well as the announcement of QE3 in the US. But the success of the deal was still a testament to the IDBI Bank growth story. What is even more heartening is that the bonds were trading well in the secondary market.
We like to fund in a variety of markets. IDBI is the only Indian bank to have tapped four different markets over the last 12 months. We have sold dim sum bonds, Swiss franc bonds, Singapore dollar bonds, and US dollar bonds. This is in line with IDBI Banks strategy to diversify funding sources.
But whatever market we look at, we would look at the swap market to see how the deal compares to our dollar funding, because that has to be the benchmark for us.EUROWEEK: This is true whether or not you are actually swapping the deal?Rego, IDBI:Thats right. We need to get some pricing benefit in order to go into these markets. Trophy value is not the only consideration. The key factors are diversification and the pricing being lower than what we would have got had we accessed the dollar market.
There is another strategic reason to tap markets which others have not tapped. We are opening up these markets for other Indian banks, as well as corporate issuers. I understand that immediately after our Singapore dollar issue, there were a number of banks that started to consider the market. If that happens, we are happy because we have done our job of paving the way for other Indian issuers.
There is no Indian issuer that has tapped such a diverse range of markets and investors.EUROWEEK: Should we expect a big increase in Indian bank issuance in Asias local currency markets, like offshore renminbi or Singapore dollars, or even smaller markets like Thai baht or Malaysian ringgit?Atal Agarwal, RBS:There is a strong interest in tapping these markets because, as Mr Rego said, the dollar markets typically require a larger transaction size. Local currency markets allow you to tap smaller tranches, and offer a diversification of funding sources.
When we talk to banks, they definitely stress a desire to look at different markets and currencies, and also different tenors. But the most important aspect is the cost of funds swapped into dollars. We also find that sometimes a dollar bond tranche meets all of a banks foreign currency needs in one go, so they may choose to delay issuance in other markets.
Indian banks are certainly interested in going into Asian local currency markets, and they can see the benefits, but it is hard to tell when we will see more issuance from the sector. Whether they get a good response would really depend on the timing of the transaction and the pedigree of the issuer.Maneesh Malhotra, HSBC: Indian banks and borrowers in general are a smart lot. They know when to tap each market, so the movement of the swap curve plays a big role in determining whether it makes sense or not. We saw when IDBI did their Singapore dollar transaction that the swaps worked in their favour. The same was the case with their offshore renminbi issue.
Whether you want to go for a foreign currency or not really depends on your funding requirements. The size available in markets like offshore renminbi is not significant compared to the dollar market, and even offers less than the Singapore dollar market, so it needs to make sense as part of a banks varied funding plan.
In the Singapore dollar market, the roadshow went a long way in getting IDBI the pricing it got. That is an important aspect of offshore local currency markets. Roadshows become much more important. You need to get out and explain the credit, give the whole story about the issuer, and show the differentiating factors from other banks. These are the factors that can make or break a transaction.Rego, IDBI:The roadshow was really very useful because what it did was convey the India story. Today we are seeing that everything that comes out in the press is negative. That means there are certain facts that need to be told, and need to be backed by numbers. We detailed these points to investors.
The India growth story is here to stay. The 8%-9% growth we have seen in the last six or seven years has certainly dipped. Growth was around 6.5% last year. But the fact remains that Chinas growth has dropped by 2%. The composition of our GDP has also undergone a transformation over the years.
Today, 59% of GDP comes from the service sector, 27% comes from manufacturing and only 14% is agriculture. The service sector is less capital intensive and is growing between 8% and 9%, and while we expect to see a slowdown in manufacturing growth, it is still growing by 5% this year. When you put these numbers together, we are still seeing a growth rate of between 6% and 7%. That may be lower than in previous years, but India is still one of the fastest-growing economies in the world.
Then you look at the clear positives: a large middle class population, in excess of 650m people; a high savings rate of between 32% and 36%; and very favourable demographics, with the median age of the population being 26.5 years.
The debt-to-GDP ratio was around 77% in the financial year 2006. It has now dropped to around 65%. We have among the highest remittances from overseas Indian workers in the world. Foreign direct investment is growing. When you look at the numbers, the India story is nowhere near as negative as the media make out. We are the third largest economy in the world in terms of purchasing power parity, and we are growing at a fair clip. The growth story is here to stay.EUROWEEK: Did you find that when you were on the road you were talking more about India than you were about IDBI?Rego, IDBI: The government is required to hold a minimum of 51% of our equity capital, so the first story we need to tell is the India story. But then having told that story, we need to differentiate ourselves from other banks in the country. That follows the discussion about the Indian economy.
When we talk about India, we are not only helping our own cause, we are helping the cause of all Indian issuers. But when we move to talk about IDBI, we show how we are different. Our core competence lies in project and infrastructure financing, and that is our DNA.
Today, the growth story is driven by two factors: large infrastructure demand, and retail demand. In infrastructure, were already there. In the retail space, we have a lot of potential for growth, so we are well poised to take off.Agarwal, RBS:One thing we have seen is that issuers understand that, apart from raising money, they also have a responsibility to raise awareness of Indias story and showcase Indias growth.
These bank issuers spend a lot of time telling investors what the reality is in India, since there is some degree of focus on India and the countrys growth. These meetings make it easier and easier for the credits that follow.EUROWEEK: How much, on the other hand, are you focusing on India as a whole when you take a privately-owned bank on the road? That would seem to be a very different sort of pitch, which requires more individual differentiation.Malhotra, HSBC: There has been a lot of discussion on the macro side with investors this year, and they now understand the story. We are spending less and less time on the macro story, because they have heard this story from the issuers that have come before.
There is a good balance between stressing the quality of the individual issuer and talking about the macro story. We cannot help but talk about the economy, but as long as private banks follow state-owned issuers into the market, the arguments have largely been made already.
But everybody has a story to tell. Even the state-owned banks and the biggest banks have individual strengths that investors should take notice of. They should not just be seen as proxies for the India story when they have their own stories. We are now, thankfully, seeing the questions about the economy abating, and investors are focusing more on the fundamentals of individual issuers.Agarwal, RBS: An interesting point that we have noticed is that most issues this year have happened without roadshows. That is largely because most Indian issuers have MTN programmes in place, and they have been in a state of readiness.
They have accessed the markets before, so investors are familiar with them, and typically what has happened this year is that the issuer makes the decision in the morning, and they pull the trigger and the deal prices overnight.
Indian banks have been able to hit their funding targets this year, and investors have been happy too, even when roadshows are not happening. This shows that issuers have done a good job in the past of detailing their individual stories. They can go out and access investors pretty much on the same day as the roadshow without having to explain the strengths of the Indian economy.Rego, IDBI: It greatly helps to have an MTN programme in place for these quick deals. But it is also extremely important to have a close relationship with the arranger group.
Our experience in the Singapore dollar market was that, after we came back from the roadshow, we were told it would be prudent to start of pricing in the 4% area. We looked at the swap market and we found that this was higher than where we would have liked to price on a swap basis. Nevertheless, we took a call on price discussions and agreed to start at the 4% area.
We had a sense that it would tighten before final pricing. Within two hours of launch, the book crossed S$1.5bn and we changed the price guidance, and started to speak about the 3.70% area. Finally, it was priced at 3.65%. That gave us a price that was inside what we wanted when we came out. But we would not have got that price if we had not had the confidence to go out into the market.
This is one of the other benefits of being a regular issuer. You can issue more quickly, if you choose. But you also have a greater sense of where pricing will go, and get the confidence to start with wider pricing than you really want to offer.EUROWEEK: Indian issuers can get away with pricing in the dollar market that is inside, or flat to, their secondary curves. How sustainable is this?Agarwal, RBS:There are two main reasons why this happens. The cumulative issuance from India is far, far smaller than we see from other countries like South Korea. There is a scarcity value for Indian issuers, so the fact that youre able to price inside secondaries is not that big a surprise.
Will this continue over time? This will depend on the volumes that come out, and how deals perform in the aftermarket. So far, most of the issues this year have traded slightly tighter in the secondary market.Malhotra, HSBC:I agree with those points. There was hardly any issuance for much of the year if you compare India with some of the other countries in the region, although we saw a few more banks approach the bond market in September.
Investors that want to buy Indian dollar bonds in any significant size [cannot rely] on the secondary market. There is just not enough offered for them to have an alternative to the primary market.
Indian banks have shown that they are resilient, and the problems are not what they were thought to be. Banks are run by professionals. They know what to do. We have a very strong regulator, and it has been cited by other regulators throughout the globe. This has been communicated to investors for years, and we can now see the result in the demand.Agarwal, RBS: Indian banks also have a very strong capitalisation, and it is almost all core tier one. That gives investors confidence in the system.Rego, IDBI: The RBI has been a very tough regulator in the banking sector. You need only to look at the prudential norms for statutory liquidity ratio and the cash reserve ratio. The SLR today is 23%, meaning that for every Rs100 an Indian bank takes as a deposit or borrowing, Rs23 has to be invested in government securities. On top of that, 4.5% has to be held with the Reserve Bank of India in cash deposits. These rules mean Indian banks have a strong cash cushion, and they are well prepared for Basel III.
There are no structured products in India. There are no exotics or off-balance sheet issuance. Indian banks do not come out with these surprises. The risk is there out in the open. There is credit risk on Indian banks balance sheets that will move along with the economic cycles, and as the economy improves, the asset quality improves.EUROWEEK: The lack of securitisation in India could be seen by some international investors as a positive, especially when looking at banks. But securitisation clearly brings some real benefits to an economy by increasing the funding options for banks and companies. Are you seeing any steps to develop a securitisation market in India?Agarwal, RBS: It still seems to be very slow at this stage, and there do not appear to be any great changes coming on this front.Malhotra, HSBC: There have been attempts in the past few years to get this market up and running. It is not as if it is completely absent, but it is not as robust as we would like it to be. Its still a work in progress.
There have been instances in the past, most obviously the subprime crisis in the US, which have not helped inspire confidence among the regulators. But there are several committees at the government level and the RBI level having discussions about a securitisation law. At this point, we do not have a robust market, but Im hopeful that things will come around.Agarwal, RBS: There is no real pressure coming from the banking sector for securitisation to develop, especially since asset growth is slowing down.EUROWEEK: Is the local investor base in any way deep enough to support a securitisation market?Malhotra, HSBC: When we talk about the changes needed to create a securitisation market, developing the investor base is part and parcel of that. Each investor category has its own regulator, and these regulators are all acutely aware that there is a market to be developed. The lack of a natural investor base is a bit of a problem, but it is much easier to change regulations on the investor side, so once we have the market infrastructure in place, that should not be a lasting problem.EUROWEEK: How do the offshore and onshore markets compare in terms of pricing? And how often are Indian banks turning offshore and swapping the proceeds into rupees?Rego, IDBI: According to RBI regulations, you can raise foreign currency and swap it into rupees only up to 50% of unimpaired tier one capital, so there is some restriction there. These swaps will take place only when it is cost effective, and that generally happens only in the shorter maturities, usually of around one year.
The banks that are raising foreign currency in the market at the moment are not doing so to swap into rupees, however. They are raising foreign currencies to meet the foreign currency needs of their clients.Agarwal, RBS:We have not seen Indian banks go into the international bond market to boost their capital. That is one funding source which would be swapped into rupees and sent back to India to strengthen their local capital ratios. But the cost of subordinated debt in the offshore market is far, far higher than what they would pay to fund in the domestic market. Malhotra, HSBC: It is worth pointing out that the RBI does not allow Indian banks to borrow in senior bond format in the domestic market, with the exception of a few banks, including IDBI. Most banks can only sell capital instruments, fund through the bank CD market, or fund through deposits, which is the largest chunk of Indian bank funding. Kumar, Axis:In India, banks are not allowed to issue senior debt, but we manage to fund ourselves adequately through deposits.Agarwal, RBS: This contrasts with the flexibility they get offshore with senior funding. Banks use the interbank market to raise short term funds, use loans to raise money up to three years in tenor, and then use the bond market to raise money with tenors of five or five-and-a-half years. This mix of three broad buckets has given them a lot of funding options offshore.Rego, IDBI: Because we are funding infrastructure projects, we have permission from the central bank to sell bonds, as long as the maturity is not below five years. We have issued some senior paper with 10 year maturities, but our focus generally is our capital instruments. We have the same rating for senior paper as we have for lower tier two, so we may as well sell lower tier two instruments.EUROWEEK: Is there any hint from the government that the rules on banks raising money domestically are going to change?Malhotra, HSBC: It doesnt seem like that is going to happen. It is not that banks are yearning for the window to open up anyway. There are several funding sources, the cheapest being deposits. The lack of senior bond issuance is not a limiting factor for Indian banks.EUROWEEK: So, for foreign banks operating in India, the bulk of revenues come from guiding Indian borrowers to the international market?Malhotra, HSBC: We are not necessarily guiding Indian banks in any direction, since they have quite firm ideas of what they want to do. But the offshore market can often make sense in terms of pricing and tenor. The international bond and loan markets are open to Indian banks.Agarwal, RBS: Most Indian banks, when they raise foreign currencies, are funding Indian corporations. They are not looking to expand in those offshore markets, so you cannot really drive Indian banks offshore, since it is loan demand from their own clients that is driving them. We can obviously advise them on tenors and on timing, but the decision as to whether or not to issue comes from their side.EUROWEEK: Weve touched on the offshore loan market; lets look at that in more depth. Do you think the loan market is losing its place to the bond market in Indian banks overseas funding plans?Malhotra, HSBC: The syndicated loan market may have been rather abysmal in terms of numbers this year. But that doesnt mean that there are not other transactions that are happening, perhaps bilateral loans or clubs.
There are also money market lines that can offer Indian banks good rolling funding. This is not a permanent solution, but when Indian banks feel that they are not getting the pricing they want, they dip into money markets, club loans and bilaterals. The syndicated market is not doing well, but Indian banks are certainly not short of borrowing opportunities from banks.Agarwal, RBS: There are still loans happening for Indian banks. But we are seeing a slowdown of growth in the Indian economy, and that is making Indian corporations less aggressive in terms of expanding overseas. The need for funds has been down this year, so banks have less pressure to access the loan market.
We are still in active discussions with our Indian bank clients about funding. Our business with our clients still remains robust, and they have still have options.Rego, IDBI:The key is having the appropriate mix of funding sources, but we certainly find the loan market to be open. When I look back to last year, we did a $290m syndicated loan in September and in November we did a $170m club loan. We are now in the market with a $250m syndicated loan, so if you look at September 2011 to September 2012, we have raised $710m in the offshore loan market.
There is one noticeable issue. Banks will not go beyond three years at the moment when they are lending you money, whereas previously they were happy to agree to five year loans.
There are some banks, of course, that are dealing with us on a regular business and which will look at what other business they are getting rather than just pricing. For us, the loan market must be cheaper than the bond market. But we are happy to treat our lenders as preferred banks when we go into the bond markets, or when we go into the swap market. There is some cross-sell element, and that builds upon the relationship.EUROWEEK: What is the outlook for Indias banking sector over the next few years? Is there enough room for Indian banks to grow domestically, or is the next step going to be overseas acquisitions?Rego, IDBI: There is enormous growth available for Indias banking sector in the domestic market. There are 625m bank accounts today, but there are 850m mobile phone users. That one number shows the potential available.
People talk about the saturation of banks in India, but this largely applies to urban areas. Once you move into rural areas, there is still a lot of growth available. Banks are looking at financial inclusion as a very good opportunity for growth.
It is not just good for banks. Those living in unbanked areas would normally go to a money lender that would charge exorbitant rates of interest. So for both parties, the growth of banking in rural areas makes a lot of sense.
I dont expect any major bank mergers, but if there are acquisitions taking place, they will be through Indias biggest banks taking over some of the smaller, private sector banks.Kumar, Axis: The growth potential in India is among the highest in the world, and that certainly applies to the banks as well. There are many sectors waiting to make that big leap forward. The infrastructure sector is the most prominent among them and with investment of over $1tr expected in this sector in the next five years, it has a lot of room for growth. With adequate support and regulation, growth will remain strong compared with much of the world.
The Indian economy, even though in a trough right now, has a lot of steam left in it and is expected to grow not far below the 30-year average of 6.20% over the next few years. Even the scaled down GDP growth estimate by the government of India for the current five year plan period covering the financial years from 2012 until 2017 is 8.20%. That is an impressive growth rate for an economy that is going through a slowdown, particularly in the backdrop of the general economic gloom observed in most of the other economies.Agarwal, RBS:Indias economy has a very large productive population, and the general trajectory is good. The rule of thumb is that when GDP grows by 1%, bank lending grows by 2.5%, so there is exceptional growth potential for the sector over the next few years.
The big players in the local banking sector are government-backed. It is up to the government if it wants to see more consolidation, but the government is now preparing to give more banking licences, so it appears it wants to introduce more competition, not less.Malhotra, HSBC: India remains under-penetrated as far as banking goes. Most of the growth is coming from semi-urban or rural areas. People living in these areas often have little to no access to banks. That needs to change and change very fast. India is the second most populous nation in the world, and there is a large population that remains unbanked.Financial inclusion has been a buzzword over the last few years, but it is bringing results. There is more business to do for all the banks in India as that trend grows.