Date:27/03/2006 URL: http://www.thehindubusinessline.com/2006/03/27/stories/2006032701971200.htm

Back PSBs exiting State development loans

C. Shivkumar

Low coupon, long tenor papers seen risky amid tightening liquidity, rising yields

Bankers said that they would prefer to bring down the average maturity since it would help insulate against portfolio depreciation.

Bangalore , March 26

The tightening liquidity has prompted public sector banks to contain their exposure to State development loans (SDL) and exit from the existing holdings.

Bankers said that exiting from State development loans was part of their portfolio derisking strategies. This implied bringing down the average maturity of their investment portfolio down to under three years. The more aggressive banks have brought the average maturity down to less than a year. This is to ensure that the portfolios remain liquid. SDLs are also treated as illiquid.

Bankers said that they would prefer to bring down the average maturity since it would help insulate against portfolio depreciation.

High depreciation on portfolios would impact earnings and even leave a red line on balance sheets, as it happened last year in the case of several banks.

This was particularly so in a condition where liquidity was tightening and interest rates were acquiring an accelerated northward momentum.

Low coupon securities

Bankers said besides several of them were stuck with low coupon SDL securities issued during the last two to three years, when yields were soft. Several SDLs issued in 2004 have coupons under 6.5 per cent.

Accordingly, bankers said that there was little interest in SDLs at this moment. SDLs are usually 10-year securities without any early exit options.

As a result, bankers said they would prefer to stay away from these securities to preserve "portfolio integrity." Bankers said another major deterrent was the surplus of statutory liquidity ratio (SLR) securities.

Currently, bankers have an investment-deposit ratio of close to 39 per cent.

Most banks are attempting to align this close to the mandated SLR of 25 per cent.

The disinterest in SDLs was also on account of the Finance Minister's decision to convert outstanding recapitalisation bonds to SLR securities.

This would leave the banks with securities in excess of their SLR requirements, the bankers said.

As borrowing costs for the State Governments were on ascent, the spreads for some of the State loans were already close to over 60 basis points over comparable sovereign yields.

This was despite SDLs being sovereign guaranteed securities.

If some of the last few State loans have been placed successfully, bankers said, it was mostly on the intervention of life insurance companieswith an appetite for long dated securities.

Future subscriptions

As a result, unless SDL yields met the insurers' expectations, subscriptions in future were likely to become increasingly competitive, the sources added.

This implied that yields on SDLs would begin to move further north.