CLN exposure may cost Uco Rs 97 crore

Public-sector lender Uco Bank may face pressure on its fourth-quarter profits on account of possible provisions of Rs 97.42 crore for an exposure to credit-linked notes (CLN).

The bank has not made the requisite provisions on a marked-to-market basis as it treated the exposure to CLNs as loans and advances and not as exposure to a financial instrument. Auditors who conducted a limited review covering two-thirds of Uco Bank’s advances have pointed to the accounting treatment.

CLNs are structured financial instruments whose principal and interest payments are contingent on the performance of the borrower. They are created by embedding credit default swaps (CDS) to form an investment whose credit risk and cash flow characteristics are similar to a bond or a loan. CDS enable the credit risk of a financial asset to be transferred from one party to another without actually transferring ownership of the assets themselves. Investors often opt for CLNs over CDS to avoid legal and operational constraints.

When contacted, Uco Bank Chairman and Managing Director S K Goyel did not respond to the queries. But bank executives, on condition of anonymity, said that the exposure is to a company that has filed for bankruptcy. They, however, refused to disclose the identity of the CLN issuer.

While the auditors – AR & Co, Chatterjee & Co, D R Mohnot & Co, Goel Garg & Co, Bansal & Co and KKG & Co – have flagged the issue, bank executives said that a provision has not been made as the company is clearing its dues on time.

Uco Bank has now taken up the issue with the Reserve Bank of India for clarity on how it should treat the exposure. Based on the feedback, the future course of action will be decided, a senior executive said.

“We have been following the system for a while and we have treated such exposure as standard advance. So, we have not provided for it fully. RBI has asked for a detailed report regarding this,” the source said.

On its part, RBI has sought details regarding the bank’s exposure to CLNs and similar instruments and the provisions made so far.

At the end of January, Uco Bank’s CLN exposure was estimated at $190 million (around Rs 950 crore) and a part of it was marked-to-market, sources said.

During the quarter ended December 2008, the bank reported a net profit of Rs 171.62 crore, more than double compared with the corresponding quarter last year. For the year ended March 2008, the bank’s net profit was estimated at Rs 412 crore.

Uco Bank has two overseas branches in Singapore and Hong Kong and also has representative offices in China and Malaysia. Most Indian banks with exposure to complex derivative instruments entered into such arrangements through their overseas branches. Derivatives are instruments used to hedge interest rate and currency risks.