In April 1996, ICICI barely managed to raise Rs 1,072 crore from the market against a targeted Rs 1,500 crore. Not only was the financial institution unable to exercise its greenshoe option of Rs 500 crore, but its bonds carried a coupon of 16 per cent. The effective yield, however, then was 17.25 per cent, but only after including a front-end discount (by offering the bond below the issue price).
Today, with financial markets awash with liquidity, bond markets have been rejuvenated. Yields for top quality bonds have dropped below the prime lending rates (PLR) of most banks. Currently, yields on top-grade securities are less than 14 per cent. And the yield gap between AAA category securities and government securities, which was 300 basis points, has come down to as low as one per cent. Currently, the maximum yield on 10-year government securities has dropped from 14 to 13 per cent.
Coupons on bonds issued by financial institutions (FIs) are as low as 13.5 per cent, down from the earlier 16 per cent. And the yield to maturity (YTM) on bonds issued by public sector undertakings such as the Mahanagar Telephone Nigam Limited (MTNL), the National Thermal Power Corporation and the Steel Authority of India are slightly on the higher side.
This is because bonds issued by companies registered under section 4A of the Companies Act need to be risk weighted only up 20 per cent . All financial institutions are registered under this particular section of the Act. This in turn reflects on the asset yields. Therefore assets risk weighted cent per cent carry higher yields than those with a lower risk weighting.
Accordingly, for institutions like banks and non banking finance companies (NBFCs), subscription to such bonds entail a capital adequacy of only Rs 1.60 for every Rs 100 invested . For investments in corporate bonds and debentures, banks are expected to provide a capital adequacy of 8 per cent.
This factor, accordingly, reflects in the distinctive YTM patterns. YTMs on FI bonds, for instance, are around 13.50 per cent whereas that on PSU bonds is about 14 per cent at present. The ICICI bond carrying a coupon of 15.5 per cent and maturing in 2000, is quoting currently at around Rs 104.3 giving out a YTM of around 13.5 per cent. MTNL securities maturing in 2000 with a coupon of 16 per cent, are quoted at a price of around Rs 104.8 giving an yield of 14 per cent.
Today, however, banks are showing greater partiality for corporate bonds as they were to gilts because the yield gap between the two has narrowed. Today, for example, IDBI's latest flexibond series carries a coupon of only 13.5 per cent which is only about 50 basis points over the sovereign rate compared to a coupon of about 300 basis points a year ago.
A crucial determinant for the narrow gap is the increase in liquidity in the markets. This in turn has come from several sources. One, the changes in the last credit policy. These changes had completely removed all reserve ratios on inter bank liabilities and allowed banks to borrow up to $10 million in the international markets.
Two, the removal of the ban on ready forwards (agreement to buy back securities at a future date and at a predetermined price) which had tightened liquidity in the markets.
Three, foreign currency inflows have caused an expansion in reserve money. During the last two months alone, exchange reserves have gone up by $4 billion causing a primary liquidity expansion of about Rs 15,000 crore.
As a result "asset chasing" by the banks has begun in earnest. Since credit offtake has not expanded substantially, the obvious choice for banks has been to park funds in high coupon securities. And public sector and corporate bonds fit that category, since neither of these securities are governed by any quantitative regulation by the Reserve Bank of India (RBI). As a result, , PSUs and corporates have begun postponing their primary issues. Says a top official of the Indian Overseas Bank, "several PSUs that had planned their private placements for the current financial year have postponed it to the second half expecting yields to drop even further."
This in turn has lead to a situation where the availability of top quality assets is restricted, driving up prices and driving down yields further. A foreign banker has another explanation. "Actually, in a tight liquidity situation, bankers prefer to park funds only in government securities since they are the most liquid. However, in a situation where liquidity is lax, there is very little interest in government securities."
This has already started happening. Currently there are more sellers for government securities than buyers. This is partly because with the reduction in statutory liquidity ratios banks no longer find the need to invest in government securities beyond what is required. Besides, with time liabilities itself becoming mostly short term, banks are also restricting their investments to short dated securities, mostly treasury bills.
Accordingly there are few takers for long dated government securities unless the yields are really attractive. In fact, as banks begin marking a higher proportion of their securities to the markets, the interest is in having high yield securities in their portfolios. Says a banking official, "In such a situation a further fall in gilt yields could become difficult. And what is now going to determine investments in government securities is no longer SLR, but capital adequacy."
This would imply that only those banks that have hit the capital adequacy ratio (CAR) limit may actually prefer to invest in gilts or alternatively restrict expansion of their liabilities. Most banks have begun preferring the latter option. The last auction of five year paper had actually devolved on to the RBI and primary dealers, as this security offered a low coupon of just 12.69 per cent.
Banks that are still way above the CAR limit of 8 per cent would prefer to invest in risk weighted assets -- PSU bonds, corporate bonds or credit. There are currently only about four nationalised banks that have fallen short of the CAR. And even these banks this year may probably be last time they may be falling short of the CAR.
It is the fully capitalised banks that have emerged as the largest players in the PSU or corporate bonds. This is because returns are higher and the possibility of earning higher spreads better. Whereas in zero risk weighted securities the spreads are not very attractive, higher spreads means better bottom lines. And this obsession with bottom lines is causing the switch in interest from gilts to PSU or corporate bonds resulting in competition for bank funds from both government and non government sector.
