With the health of Indian companies’ balance sheets deteriorating at the worst pace ever, investors are demanding more protection.

One way they are doing that is by buying local-currency bonds whose interest increases every time their credit ratings are downgraded. The number of such notes sold jumped to a record in the quarter through June, making up 102 out of the 513 bonds issued, according to Bloomberg-compiled data. And sales remained strong in July.

Indian borrowers are trying to address investor concerns that businesses will deteriorate further after prolonged stay-at-home restrictions brought the economy to a standstill. Such bonds are sold overseas too in countries including Israel and New Zealand, but issuance from India has far surpassed the rest of the world in recent years.

Bloomberg

“Investors will continue to demand such covenants as many companies are expected to be downgraded after lockdowns hit business operations big time,” said Murthy Nagarajan, head of fixed-income at Tata Asset Management Ltd. “Bond buyers need to protect themselves in this dynamic situation and will seek tighter bond terms.”
The phenomenon flags broader concerns about debt in India, even as stimulus steps drive a rally in credit markets. The central bank last month warned that the bad loan ratio of lenders could swell to the highest level in more than two decades.

In July, 50 bonds with so-called credit rating protection metrics were sold, compared with just four a year earlier.

In some cases, issuers can benefit as well. Just as they promise to pay more in case of a downgrade, some notes let companies lower coupons if their bond grades are raised.

That helped sales of such securities gain traction in 2016, when the credit quality of Indian companies was improving on supportive government policies. Before that, offerings of the bonds had been sparse since their introduction in India in 2005.

One example of such debt was sold in June by Tata Power Co., part of India’s largest conglomerate.

Those AA rated bonds have a clause that the 8.21% coupon rate would be raised by 25 basis points for each step of a rating downgrade and vice versa. If the rating were to fall to A- or below, the notes would be called back before their August 2023 maturity. There have been no rating changes since issuance.

The boom in such notes comes amid a broader rush to raise funds in the debt market, after bond yields recently hit record lows.

“Issuers are raising big amounts from the bond market because they want to lock in lower borrowing costs, but investors are worried about the credit quality,” said Nagarajan at Tata Asset Management.