Swaps hit a three-month high

The spurt indicates deteriorating investor perception of credit quality.

The cost of protecting Indian lenders’ bonds from default rose to a three-month high on concerns of rising bad loans, narrowing margin and erosion in treasury gains as economic growth slows.

According to available data, credit-default swaps (CDSes) of two of the country’s biggest lenders — State Bank of India (SBI) and ICICI Bank — touched the high on March 3. CDSes of ICICI Bank rose to 710 on March 6, the highest since December 8, while SBI swaps on that day climbed to 474.55, the highest since November 21. 

Apart from the two biggies, IDBI Bank CDSes also zoomed to 416.88, the most since December 8. CDSes are derivative instruments used for protecting investment in bonds against default. Traders use them to speculate on changes in credit quality. While a spurt in the swap price indicates deteriorating investor perception of credit quality, a decrease hints at improvement in the same.

The Reserve Bank of India (RBI) has been goading Indian lenders to drop rates and step up loan disbursals to spur demand in the economy.

The central bank has cut the key repo rate, or the rate at which it lends to banks, five times to 5 per cent since October 20, 2008. In other words, the repo rate cuts since the global credit crisis intensified add up to 400 basis points.

India’s third-quarter GDP estimates showed a lower-than-expected 5.3 per cent growth rate, the slowest in five years.

The rise in CDSes can also be attributed to Standard & Poor’s recent revision of India’s outlook to negative from stable. The negative outlook means that India could plunge below the investment grade of BBB-.

“Credit markets generally see SBI and ICICI as proxy-Indian sovereign risk, and the drift in spreads can largely be attributed to the spillover effects of the global credit crisis,” said Brayan Lai, a Hong Kong-based analyst with Calyon.

“Credit fundamentals themselves will also look worse due to increasing loan loss provisions and declining asset quality, which is the case with most banks,” he added. CDSes of these lenders had reached a peak between October 27 and 29, almost a month after Lehman Brothers filed for bankruptcy.

Gross non-performing assets (NPAs) of Indian lenders and financing agencies rose by 12 per cent in the three months ended December 31, 2008 to more than Rs 57,000 crore from a little over Rs 50,500 crore a year earlier, according to the initial research conducted by some analysts.

The asset quality is likely to deteriorate further as corporate profits come under pressure due to shrinking demand and large, accumulated debt on companies’ balance sheets.

On the other hand, public sector banks have been cutting rates at the instance of RBI, which, analysts say, may squeeze their margins and leave them with little money to provide for bad loans.