Indian brokerages are borrowing ultra short-term money at almost twice the market rate, often from mutual funds, to lend to clients seeking shares in IPOs, fund managers said, in a sign of froth building in the market.
Demand from investors for relatively costly funds to invest in IPOs demonstrates an increase in risk appetite and craving for higher returns as one-year bank deposit rates have been slashed to roughly 6.5 percent from about 10 percent last year.
It also shows individual investors expect to see a strong market performance by newly listed companies in the soaring Indian stock market, as they would need big early returns in order to repay loans carrying interest rates of as much as 20 percent.
"I think this is the beginning of such risk-prone behaviour from investors. It will only increase until there is one listing debacle," said Arun Kejriwal, director at research firm KRIS.
Brokerages have between them borrowed up to 100 billion rupees ($2.1 billion) for IPO financing in the last few weeks, the fund managers said. None of the brokers would comment.
"They are lending the 15 days paper at 7-8 percent levels for IPO funding," said K. Ramkumar, head of fixed income at fund manager Sundaram BNP Paribas. He declined to name the issuers.
Three-month commercial paper pays a coupon of about 4.5 percent.
The brokerages are issuing secured non-convertible debentures with a 15-day call option to fund houses and are lending the money to their rich clients at a minimum 11.5 percent and as much as 20 percent, the fund managers said.
When rates were broadly higher early last year, brokerages were charging about 13.5 percent to applicants for shares in the IPO by Reliance Power, which has never traded above its listing price.
Individuals are turning to expensive loans from brokers because banks can take longer to process applications and can be less willing to lend large amounts.
Indian IPOs are making a comeback after an 18 month absence, helped by a rally of as much as 87 percent in the benchmark index from its March low.
While no major listings have yet been completed, there is high demand and high hopes for over-sized returns.
Adani Power's $630 million IPO in late July closed more than 20 times subscribed and state-run NHPC's $1.25 billion IPO, which closed on Wednesday, was nearly 24 times covered.
The NHPC shares earmarked for high net worth investors were subscribed nearly 57 times, according to stock exchange data, meaning many applicants will receive far fewer IPO shares than they had sought.
Adani Power expects to make its trading debut around Aug 20.
Another state firm, Oil India Ltd, is readying a $500-$600 million IPO in September, bankers have said.
A clutch of companies, including at least a dozen state-run firms, are considering either IPOs or follow-on offerings as they gear up for expansion in Asia's third-largest economy.
Treasury heads of financial services firms said the NHPC IPO led to a spurt in demand for 10-to-15 day paper, pushing up rates on short-term paper by about 80 basis points in the last 15 days. They declined to be named as they are not authorised to speak to the media.
"The interesting aspect is whether people would make money (from these deals) and that depends on the equity market and how the listing goes," said the treasury manager of a diversified financial services firm.