Skewed bond spread to hit banks

Spread between corporate bonds and underlying gilts stood at 145 bps in March.

The domestic banking sector may suffer a valuation loss of Rs 2,000-2,500 crore on its corporate bonds portfolio for the financial year 2005-06.

According to bond dealers, spreads between corporate bonds and government securities of comparable maturity widened beyond expectations in 2005-06 and the increase was stiff in the quarter ended March 2006.

It is the short- and medium-term papers ranging from 1 to 3 years of maturity whose valuation has been hit. In this segment, the spread between triple-A rated corporate papers and the underlying government security has shot up from 25-30 basis points in April 2005 to a high of 145 basis points in March 2006.

Meanwhile, yields on papers with 1-3 year maturity have gone up from 6.24 per cent to 8 per cent. As per a rough estimate by a market dealer, this 175 basis points hike has resulted in a loss of Rs 7, which turns out to be around Rs 2,000 crore on a triple-A corporate bond portfolio of Rs 25,000 crore. One basis point is one-hundredth of a percentage point.

Banks have approached the Indian Banks' Association (IBA) to make a representation to the Reserve Bank of India. They are seeking relief similar to the one granted on the government securities portfolio.

Last year, RBI had extended one-time relief to banks by allowing them to transfer government securities from held for trading category to held till maturity category (HTM).

The securities held under HTM category are not marked to market.

Marked to market is a valuation exercise whereby a bank values its investment portfolio at the end of the financial year at market prices vis-a-vis the prices at the beginning of the year.

The banks will have to only provide for the last quarter of 2005-06, when, incidentally, spreads firmed most.

However, dealers clarified that banks may have to provide for little less than Rs 2,000 crore for the last quarter, but the amounts adds up to much more when the portfolio of below triple A rated papers are taken into account

The combined portfolio of banks and mutual funds stands around Rs 40,000 crore in corporate bonds across rating levels.

According to market players, some banks had hedged the adverse interest rate movements through interest rate swaps but the extent of the depreciation in price was unexpected.