RBI leeway, spreads spur banks to chase illiquid gilts

After driving down yields of frequently traded benchmark government papers, banks have started chasing illiquid government securities "" or gilts that are not traded much.

In fact, these papers are being lapped up not just by banks but also by primary dealers and insurance companies to book higher income as the yield differential between them and the liquid, traded papers is large.

With no fear of depreciation loss looming large, value-based buying has gathered momentum. Illustrating the yield differential, a dealer said the 12.32 per cent 2011 and the 12 per cent 2008 are the top traded illiquid securities currently, yielding 6.81 per cent and 6.15 per cent, respectively.

A liquid paper of the same tenor such as the 9.39 per cent 2011 offers a yield of 6.11 per cent. Similarly, the 11.40 per cent 2008 paper's yield is 5.94 per cent.

So, the yield differential works out to 70 basis points for a seven-year paper and 21 basis points for a four-year paper. As the momentum for buying illiquid stocks gathers steam, the difference will begin to shrink, dealers said.

Earlier, banks refrained from buying these papers and nationalised banks in particular stayed away for fear of booking losses in their trading portfolios.

However, the recent RBI leeway allowing banks to park part of their market portfolio in the held-to-maturity category "" which is immune to market volatility "" has made PSU banks bold enough to scout for illiquid stocks.

Meanwhile, prices of government bonds recovered on Tuesday after registering early losses with the Reserve Bank of India announcing Rs 10,000 crore bond auction through a mix of floating rate and short-term papers.

The auctions will be held on September 9. The key 10-year 7.37 per cent bond closed at 5.89 per cent, down 9 basis points from 5.99 per cent. The yield had risen from Saturday's close of 5.88 per cent.

The auction will include reissue of 6.65 per cent government stock 2009 for a notified amount of Rs 3,000 crore, floating rate bonds 2013 for Rs 4,000 crore and reissue of 8.35 per cent 2022 for Rs 3,000 crore.

Market dealers are of the view that while the 18-year paper is aimed at insurance companies, banks and primary dealers are eyeing the fixed rate 5-year paper.

Dealers said banks have already pruned the investment duration of their investment portfolio, so the five-year paper is a good catch.

Floating rate bonds, with their varying interest rates, provide a hedge against interest rate risk while short-term bonds tend to be less affected in a bearish market.

However, a section of the market was not very enthusiastic about the floating rate bond as it felt that the secondary market for the floating rate issues is illiquid.