India's largest mortgage lender, Housing Development Finance Corp (HDFC) issued the first Masala bond by an Indian company on Thursday, opening up a new fundraising avenue for domestic borrowers.
The offshore rupee-denominated market has been very long on promise but short on delivery ever since the government finalised a framework agreement for domestic issuers last September.
Over the past eight to nine months a number of companies have roadshowed potential transactions that subsequently failed to materialise because offshore investors demanded a yield pick-up over domestic comparables to compensate for a likely lack of secondary market liquidity.
Underlying this, there have also been currency concerns since the rupee has been one of Asia's worst performing currencies for most of the year. This now appears to be on the turn: one of the key factors accounting for the relatively strong demand for the issue according to syndicate bankers.
A second big sticking point has been the government's 5% withholding tax on offshore bonds, which market participants have so far been unable to persuade it to scrap.
In this instance, HDFC has decided to absorb the additional cost to ensure the market gets off the ground.
Therefore while HDFC's offshore pricing level superficially looks like it has come at the same level as onshore yields, the real cost to the issuer is higher because of the need to gross up and pay the withholding tax.
Onshore, three-year HDFC bonds were yielding 8.38% when the group finalised terms on Thursday.
The new Rs30 billion ($448 million) London-listed deal was priced at 99.24% on a coupon of 7.875% to yield 8.163% or 8.33% on an annualised basis. It had initially been marketed around the 8.45% level.
This means the offshore bond has been priced about 5bp through the onshore bond on a like-for-like basis, but 35bp over from the issuer's perspective when the tax is added back in.
Nevertheless, HDFC and the Indian government are likely to have been extremely pleased with the outcome.
Gaurav Pradhan, Credit Suisse’s Indian co-head of investment banking and capital markets said “Upon opening, the transaction immediately attracted strong interest from high quality institutional accounts with the deal covered within a couple of hours after the books opened.
"During the course of the next two days of bookbuilding, both institutional and private bank investors continued the momentum. The order book eventually reached over Rs80 billion."
Onshore investors are not allowed to buy Masala bonds and the distribution statistics show that 86% went to Asia and 14% to Europe. By investor type, fund managers took 81% and private banks 18%, with banks accounting for the remaining 1%.
Bankers said that two types of accounts predominated: private banking clients searching for yield and international funds with open currency mandates but restrictions on buying bonds outside of mainstream clearers such as Euroclear and Clearstream.
Prior to HDFC, a troika of international borrowers have issued Masala bonds including the European Bank for Reconstruction & Development, KfW and International Finance Corp (IFC), whose three pioneering transactions have raised a combined total of $1.5 billion.
The new deal has the same structure as its predecessors and investors will be paid the INR/US dollar spot rate for the coupon and principal payments at the time they fall due.
This means investors need to have a positive view on the currency and the direction of domestic interest rates. One of the bond's main draws is the higher nominal yields India offers relative to other Asian countries and the likelihood of the central bank continuing to cut rates.
Reserve Bank of India governor Raghuram Rajan unexpectedly announced that he was standing down last month and market participants believe his successor is likely to keep cutting rates below their recent five-year low of 6.5% in April.
Since he announced his departure, the currency has begun appreciating against the US dollar once more after hitting close to all-time low of 68.7875 in February. On Thursday, it closed at the 66.9138 level (up 1.6% over the past two weeks), although some brokers such as Kotak Mahindra are still predicting it could breach the 70 level by year-end.
However, from an issuer's perspective the necessary payment premium to execute a Masala bond begs the question: how many private sector issues will be willing to pay over and above their domestic cost-of-funds to diversity their investor base and help develop a market the government has set great store on?
From the latter's perspective a thriving Masala bond market will help to institutionalise a rupee bond market that is still dominated by Indian bank investors, although syndicate bankers on HDFC's deal said that registered foreign investors now typically account for about 15% to 20% of new issues.
Prime Minister Narendra Modi has previously expressed hopes for a £1 billion market in rupee bonds listed on the London Stock Exchange.
Other issues, which have previously expressed an interest, include Dewan Housing Finance Corp, Adani Trransmission, National Highway Authority of India, Rural Electrification Corp and Power Finance Corp.
One syndicate banker said, "We've had a number of calls from other issuers today asking us what this deal means for their own prospects. It's really great to see this market finally get off the ground."
Joint global co-ordinators for HDFC’s deal were Axis Bank, Credit Suisse and Nomura. The final line-up differs from the five banks HDFC originally mandated to complete the deal late last year: Barclays, Citi, Credit Suisse, HSBC and JP Morgan.