Indian banks grapple with bond losses
* Spike in local yields threatens to erase bank profits
* RBI steps in to mitigate mark-to-market pain
* Lenders still hurting from corporate bond holdings
By Manju Dalal
SINGAPORE, Aug 30 (IFR) - Indian banks are staring at losses in their bond portfolios that may completely wipe out their profits elsewhere, according to ratings agencies. The situation is so severe, that it prompted the Reserve Bank of India to change the rules on how they account for bonds they hold to mitigate the pain.
On August 20, the regulator decided to allow the country's lenders to account for up to 24.5% of the government bonds they hold on a discounted cashflow basis instead of marking them to market.
RBI gave additional relief to banks by permitting that they transfer their bonds eligible for the statutory liquidity requirements to held-to-maturity. Lenders were given the option of valuing these securities at the yield on July 15 2013 when they transfer them to the held-to-maturity basket.
The move came after the yield on the 10-year government benchmark had risen from 7.45% at the end of June to a high of 9.23% on August 19 - its highest since 2008. At the peak, that would have resulted in a loss of almost 12% on the market value of these securities.
"The magnitude of the mark-to-market losses at 9.20% [yield for the] Government-securities would have been 80% or higher (of the quarterly profit before tax) for a large number of banks," said Indian rating agency Icra.
The move may have saved lenders from recognising present value losses on their bond holdings amounting to Rs250bn-Rs300bn, based on Icra's calculations.
"Such a large quantum of losses could have led to several banks reporting losses in the second quarter of 2013-14 and this in turn could have worsened the prevailing negative sentiment," Icra said in its report.
The regulator has allowed banks to maintain securities in the held-to-maturity category to the extent of 24.5% of net demand and time liabilities.
The government a few months ago had asked banks to bring that number down to 23% by March 31, 2014, but has back-tracked the decision amid the potential losses.
It has also allowed the amortisation of mark-to-market losses equally over the remaining three quarters of the current financial year ending March 2014.
However, while the central bank may have mitigated the losses on government bond portfolios, banks are still dealing with large mark-downs on their corporate bond holdings, which are not included in RBI's relief measures.
Icra has estimated that Indian banks' investment portfolios stood at around Rs25trn (or 27% of total assets) as of June 30. Analysts estimate that around 15%-16% of those investments are in corporate bonds.
That suggests that some Rs4trn of assets are still showing mark-to-market losses of more than 10%, considering that corporate bonds closely track benchmark yields.
The 10-year government benchmark retreated slightly last week, but remained elevated at 8.816% on August 30.
As a result, some banks have been unloading their holdings of corporate bonds when possible, with traders reporting heavy selling again last week.
Amid the recent rate volatility, the only area that has been active in the local corporate bond market has been tax-free bonds.
Even as bond losses piled up and yields spiked in India, investors - mostly banks - bought over Rs45bn of local tax-free bonds from state-owned Indian entities recently.
With four transactions wrapped within 10 days, the unusual success of these private placements is being attributed to "window dressing" by investors trying to mitigate mark-to-market losses on their bond portfolios. If they cannot unload the bonds that are dropping in price, they can at least show better returns with new, more valuable ones.
The key for the sudden demand is a feature particular to the way the Fixed Income Money Market and Derivatives Association of India (Fimmda) accounts for tax-free bonds. The regulator requires investors to calculate the equivalent taxable coupon, and that is how it goes into the overall portfolio return calculation.
That means that a 15-year tax-free bond with a coupon of 8.46%, considering a tax rate of 33%, will be booked with a return of around 12.6%, a big spread over corresponding 15-year government bonds at 9.10% or top-rated corporate bonds at 9.75%.
So far, three state-owned entities - Indian Infrastructure Finance Co, Power Finance Corp and Rural Electrification Corp have raised around Rs45bn from four private placements of tax-free bonds.
REC has announced plans to raise another Rs35bn from a public issue of tax-free bonds opening on August 30, while National Housing Bank and Housing and Urban Development Corp are also in market with tax-free sales.
India has allowed 13 state-owned entities to raise Rs480bn via tax-free bonds this fiscal year ending March 2014. Nearly 70% of that quota is to come from public issues. (Reporting By Manju Dalal; editing by Christopher Langner and Steve Garton)
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