PSU banks skirt high gilt yields

Leading public sector banks were seen striking off-market deals in bonds yesterday to beat down yields on government securities on the last day of the financial year.

The benchmark 10 year paper - 7.38% 2,015 - was trading at Rs 105 at the beginning of the day. However, these banks entered into trades for the 10-year paper at Rs 105.30. In the process, the yield on the paper fell from 6.705% to around 6.665%. In the government securities market, prices and yields move in a reverse direction.

Similarly, the prices of seven-year paper - 7.40% 2012 - rose from Rs 104.60 to Rs 105.10 through off-market deals. As a result, the yield went down from 6.56% to 6.49%.

In the case of five year gilt - 7.55% 2010 - price rose from Rs 105 to Rs 105.20 during the day, and the yield dropped from 6.39% to 6.34%.

An Illiquid five year paper - 11.03% 2012 - was traded at Rs 125.50 (yield of 6.57%). Dealers said the paper's fair value should have been about Rs 124.70 and the yield around 6.67% or so.

Public sector banks tried to beat down the yield as a lower yield would translate into lower provisioning on account of marking-to-market their investment in government paper under the available for sale (AFS) and available for trade (AFT) category. In the mark-to-market formula, banks need to provide for bridging the gap between the acquisition price and the market price of a security at the end of the year. With the rise in rates, the price falls and hence the requirement for provision.

The held-to-maturity (HTM) category is not affected by the movement in rates as paper in this basket need not be marked to market. Most of the banks have shifted statutory liquidity ratio paper kept under other baskets to HTM to ward off the impact of rates.

After a gap of eight years, yields on government securities were higher at the end of the financial year than they were at the beginning. As a result, commercial banks will be required to make mark-to-market provisions in their investment portfolios.

The yield on the benchmark 10-year gilt has risen by over one and a half percentage points during 2004-2005 (from 5.12% at the beginning of the year to around 6.66% now).

In contrast, the yield on the benchmark 10-year paper dropped by about one percentage point (from 6.09% to 5.12%) in the previous year.

This has been the story since 1996-97 when the yield on the 10-year paper dropped by about 60 basis points (one basis point is one hundredth of a percentage point).