Hedge Funds Bullish as Banks’ Premium Double Peers: India Credit

Indian bank debt offering almost double the yield premium of global lenders is attracting hedge funds impressed by Prime Minister Manmohan Singh’s reaction to the threat of a junk credit rating.

Finisterre Capital LLP is betting on a decline in bond risk for State Bank of India (SBIN) Ltd. and Bank of India Ltd., while Observatory Capital Management LLP bought dollar-denominated notes of ICICI Bank Ltd. (ICICIBC) The nation’s corporate debt yields 353 basis points more than Treasuries, according to a JPMorgan Chase & Co. index of 55 issuers, including 39 lenders. The spread on global banks is 181, a Bank of America Corp. index shows.

“Come January, investors will realize the relative attractiveness of Indian banks,” Rahul Sharma, a London-based fund manager at Finisterre, which manages $1.6 billion of emerging-market assets, said in a Dec. 4 telephone interview. “There aren’t a lot of Asian senior bank bonds trading at this spread in the investment-grade territory.”

Singh has stepped up efforts since mid-September to improve government finances and boost economic growth from the slowest pace since 2009. He has cut subsidies, sold assets and allowed foreign investment in aviation and retailing. The measures came after Standard & Poor’s and Fitch Ratings lowered their rating outlook, putting India at risk of becoming the first BRIC nation to lose its investment-grade ranking.

Moody’s Outlook

Risk assessors “should wait to see the upcoming budget and also how the reform agenda pans out,” Sharma said, referring to the government’s annual budget statement due at the end of February. While a downgrade is possible, it’s unlikely before March, he said.

Moody’s Investors Service maintained its stable outlook on India’s credit rating on Nov. 27, citing growth and investment exceeding emerging-market averages. Moody’s ranks India’s debt Baa3, while S&P and Fitch have a BBB- rating, the lowest investment grades.

The average cost of insuring the debt of five Indian banks against non-payment using credit-default swaps fell to 265 basis points on Dec. 4 from 422 at the end of 2011, according to data provider CMA, owned by McGraw-Hill Cos.

A basis point on a swap protecting $10 million of debt from default for five years is equivalent to $1,000 a year. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. The seller collects the premium on the contracts, which becomes more valuable as default risk declines.

Finisterre, Observatory

Finisterre sold the swaps protecting government-owned State Bank of India (BOI), the nation’s largest lender and a proxy for the sovereign, and Bank of India in mid-November, according to Sharma, whose fund has gained more than 13 percent this year through November. The contracts declined 157 and 139 basis points, respectively, this year in New York, according to CMA.

Observatory Capital bought into ICICI Bank when the nation’s biggest private lender sold $750 million of 5 1/2-year notes in August. The fund bought more of the securities two weeks ago, London-based fund manager Iftikhar Ali said in a Dec. 4 telephone interview.

The yield on the 4.7 percent bond due February 2018 fell 28 basis points to 3.72 percent when it last traded on Nov. 30, according to Trace pricing. The spread over similar-maturity Treasuries has narrowed to 314 basis points from 400 basis points when the debt was sold.

‘Good Investment’

“ICICI is one of the stronger banks that we are comfortable with,” said Ali, who helps manage about $1 billion at Observatory Capital, a vehicle backed by Brummer & Partners AB, Sweden’s biggest hedge fund. “If we can achieve 4 to 5 percent yield on a five-year maturity at a spread of 300 plus, it’s a good investment.”

India’s state-owned lenders enjoy strong backing through annual equity infusion by the government, which maintains a “high degree of involvement” with the industry as a whole, Moody’s said in a Dec. 4 statement. This suggests both public and private banks may receive “extraordinary support” by way of unsecured loans and capital injections, if needed, it said.

Moody’s affirmed its negative rating outlook on Indian banks, saying a weak economy and high borrowing costs will lead to a further deterioration in asset quality.

Central bank governor Duvvuri Subbarao has held the Reserve Bank of India’s benchmark repurchase rate at 8 percent for the last seven months, refraining from adding to a 50 basis-point reduction in April to curb the highest inflation among the largest emerging markets. The RBI next reviews policy Dec. 18.

RBI Forecasts

On Oct. 30, Subbarao cut the RBI’s growth forecast for the fiscal year ending March 31 to 5.8 percent, the least in a decade, from 6.5 percent. He raised its estimate for gains in wholesale prices to 7.5 percent from 7 percent and said consumer prices will stay elevated mainly due to food costs.

Asia’s third-largest economy grew 5.3 percent in the July- September quarter, matching the slowest pace since 2009. The budget shortfall will be 5.6 percent of GDP this fiscal year, according to the median estimate in a Bloomberg News survey last week. The official forecast is 5.3 percent. The deficit was 3.68 trillion rupees ($67.6 billion) in the seven months through October, the government said, almost 72 percent of the annual target.

The yield on 10-year benchmark sovereign notes has dropped 40 basis points to 8.17 percent this year, data compiled by Bloomberg show, heading for the first annual decline since 2008. The rate may drop a further 37 basis points to 7.80 percent by the end of March, according to the median forecast of eight economists surveyed by Bloomberg.

Bad Loans

The rupee fell 2.6 percent in the last two months after appreciating 5.1 percent in September, when it was the region’s best performer, data compiled by Bloomberg show. It gained 0.2 percent to 54.5575 per dollar in Mumbai yesterday.

India’s non-performing loans may climb to 4 percent of the total by the end of March, from 3.6 percent in September and just under 3 percent six months earlier, Nomura Holdings Inc., Japan’s biggest brokerage, said in a Nov. 28 report.

“The government isn’t going to make much inroad with its fiscal position,” Rob Subbaraman, Nomura’s chief economist for Asia excluding Japan, said in a Dec. 4 interview in Singapore. “Ultimately, a lot of the reforms won’t get implemented.”

Fortress Investment Group LLC, which manages about $48 billion, isn’t daunted by the prospect of rising bad loans, Adam Levinson, chief executive officer of its Singapore unit, said in an e-mail yesterday.

‘Not Super Exciting’

“The RBI is very draconian when it comes to recognition, so there are unlikely to be surprises in the system,” said Levinson, who has traded in and out of Axis Bank Ltd. (AXSB) and currently doesn’t own debt of Indian banks. “At 300 basis points over Treasuries, the spread is OK, not super exciting.”

Eastspring Investments, which manages about $87 billion in Asia, has held on to ICICI and State Bank of India’s debt, even as it trimmed India’s overweight position in its Asian High Yield Bond Fund (IOFAHYD) after the market rallied more than 5 percent since August.

Policies announced since September, including a cut to withholding tax on interest income earned by foreign investors, have reduced the nation’s downgrade risk, Leong Wai Mei, a fund manager at Singapore-based Eastspring, said by e-mail yesterday.

“Any widening in bond spreads is limited because some of the downgrade risk and growth concerns are already priced in,” Observatory Capital’s Ali said. “There is room for India to perform.”

To contact the reporter on this story: David Yong in Singapore at dyong@bloomberg.net

To contact the editor responsible for this story: James Regan at jregan19@bloomberg.net

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