Is the Credit Scenario getting better? 

Green shoots in investor preference seen

Background:

In the aftermath of the IL&FS crisis, low rated entities have been facing differentiation in market access and financial conditions, with only the higher rated entities able to raise funds. Investors were on a risk-off mode and mutual funds continued to face redemption pressures in their credit-oriented funds. Asset Quality trends among banks were consolidating with gross NPA and Net NPA ratios of all SCBs coming down to 8.5% and 3% in Mar-20 from 9.3% and 3.7% in Sep-19. Banks and other financial intermediaries were also on capital protection mode. This is further corroborated with long-term rating momentum (quarterly upgrades versus downgrades ratio) showing an adverse rating downgrade movement starting in Q3FY19 right till Q1FY21 from 0.87 times to 0.05 times.

Source: Financial Stability Report, RBI July 2020. *Till end-May 2020

Pandemic further worsened sentiments:

The strike of the pandemic - COVID-19 posed a cataclysmic threat to global financial stability and was expected to take a colossal toll of lives and livelihood of global population. With this sudden disruption prices of risk assets collapsed, and market volatility spiked, with expectations of widespread defaults leading to a surge in borrowing costs.

In the wake of Covid-19 induced disruptions leading risk to short-term payments the regulatory dispensations extended across regulatory jurisdictions were intended to minimise the risks in an effort to protect solvency of the overall system. As a consequence, it inevitably increased stress in the financial system.

Collective global efforts bore fruit: Crisis of Confidence was addressed

Given the unprecedented nature of the crisis, global central banks through both conventional and unconventional instruments – interest rate reduction; funding liquidity and market liquidity expansion; asset purchases; credit easing; macro prudential policies; and swap lines kept financial markets and financial intermediaries functional; and were able to preserve global financial stability. As a result of these measures, equity markets recovered from their troughs, credit spreads narrowed from peaks, investor confidence improved, and risk appetite is gaining traction.

Corporate Sector efficiency and austerity worked well - Credit Ratios were among the best since 2017

Indian corporate sector gained strength and resilience in a steady and broad-based expansion through the pandemic. Turnover and realisations were back to healthy levels. Leverage ratios and interest coverage matrices improved materially. Durable trend in better credit ratio quarter after quarter continued as it strengthens to 2.80 times in Q2FY22 from the lows of 0.05 in Q1FY21 when the pandemic had struck by surprise. This is mainly on the backdrop of sustained recovery in domestic and global growth, operational efficiencies amid better ability to pass higher costs, consolidation within sector with limited competition from nations like China and broader corporate sector deleveraging amid buoyant equity markets. Broad credit outlook continues to be stable to positive across rating agencies.

Protection of Long-Term Investor interest would be much better post implementation of SEBI’s new guidelines:

Potential Risk Class Matrix (PRC) would define the risk each of funds could take. We have classified each of our product offerings within this PRC matrix taking into account both interest rate risk and credit risk. In our internal Risk management framework (RMF), we have clearly articulated our outer limits scheme-wise at issuer and rating level along with rating/ duration floor. Both PRC and RMF could help investors understand risk profile of the schemes better. With minimum liquidity thresholds through Redemption at Risk (LR-RaR)/ Conditional Redemption at Risk (LR-CRaR) we have aligned scheme liquidity based on its liability profile which would help in managing the redemptions better. Swing Pricing (w.e.f. March 2022) would provide flexibility to investors during market dislocations. Collectively all of these measures are expected to protect and boost confidence of long-term investors.

Preference for Quality prevailed in non-AAA category

Companies with deep pocketed promoter, better corporate governance and favourable rating migration were preferred. Due to skewed demand supply conditions amid abundant liquidity corporate AA rated issuers are trading at rich valuations. These trends are expected to correct when liquidity conditions normalize, capital expenditure restart and more issuers tap into debt capital markets. However, preference for quality in credit decisions are here to stay for good.

Strategies better suited during current times -

We are currently in a rate hiking cycle where liquidity is expected to normalise and policy rates are expected to head higher through narrowing of rate corridor followed by repo rate hikes. Moreover, with corporate balance sheets being in a much better condition, financing conditions being amiable and credit outlook expected to be stable to positive we think it’s time to relook at accrual /credit strategies. Some of the themes are highlighted below –

Credit:

Generic corporate spreads in non-AAA are still around their historic averages. Additionally selective opportunities are available especially in issuers which are recovering from Covid impact. Credit oriented funds could capitalise on such opportunities better.

Medium Term:

This category is positioned more like a 65:35 AAA to non-AAA portfolio composition. Unlike a Credit category rating wise, it is unconstrained and could adequately capture opportunities in 3-5 years highly rated structured credits where there are periodic issuances. Its USP would be competitive YTM relative to the risk it takes.

Product Labelling:

#Risk-o-meter for the fund is based on the portfolio ending December 31, 2021. The Risk-o-meter of the fund/s is/are evaluated on monthly basis and any changes to Risk-o-meter are disclosed vide addendum on monthly basis, to view the latest addendum on Risk-o-meter, please visit addenda section on https://utimf.com/forms-and-downloads. Potential Risk class matrix w.e.f December 01, 2021.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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