Banks go for bilateral deals to improve debt portfolio valuation

MARCH 22, 2007: BANKS are entering into bilateral deals, selling illiquid bonds to each other at high prices to improve the valuation of their debt portfolio. By doing so, they hope to reduce the extent of provisions required to be set aside for depreciation when they mark-to-market their securities portfolio at the fiscal year-end.

The past two days have seen call rates going through the roof by touching over 75% levels, thanks to the tight liquidity conditions due to a huge outflow through advance tax payments. While the effect was sharply felt in the forex market, the bond market did not experience much of an impact. Yields still remained well within 8.1% level, with volumes of around Rs 635 crore.

However, treasury managers expect call rates to ease by the next week, when liquidity is expected to return into the system. The bilateral trading activity is expected to gather further momentum in the last week of March once call rates show signs of easing. The demand for bonds on Wednesday could have been for SLR purposes or maybe more for valuation reasons, said a senior official with a primary dealership firm. Illiquid securities typically are bonds with higher premium, which are not traded on a regular basis. Fixed Income, Money Markets and Derivatives Association (Fimmda) conducts the valuation of gilts based on their last-traded price on March 31 every year. Hence, banks, mostly the nationalised players, try to artificially create a marketable rate for these securities by trading in them in the second half of the month.

They also look at entering into bilateral arrangements with each other, where a small quantum of their total holding is sold to another bank at a slightly higher price and the second bank also makes a similar purchase from the first player. Thus, while the traded volume will be a small proportion of the total stock held, the artificial rigging of prices due to the bilateral deal helps in boosting the valuation of the entire stock held by both banks.

The third option which banks consider is to enter into repurchase deals, which again necessitates that the price needs to be in line with market rates. Out of nearly 100 such securities issued so far, less than 10 of them are actually traded in the market. This leaves behind very few set of players who may be interested in buying the illiquid securities, for which Fimmda may use its own valuations which could be lower than the market price levels.

Across the same tenor, there is likely to be a difference of up to ten basis points between the actively traded security and the illiquid ones. Correspondingly, the price variation could lie in the range of 100-200 paise. While calculating the valuation of securities in each bucket, banks need to take into consideration the appreciation or the depreciation on bond prices. Banks attempt to reduce the extent of depreciation by getting into bilateral deals with each other, by rigging up bond prices.

On an average, nearly 5-10% of a bank?s total bond portfolio could comprise illiquid papers. This could be deciphered from the yields that banks quote on their portfolio. Most of the recently issued securities had coupons in the 8% range.

Source: Economic Times