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Posted on 26-Apr-2019 Comments  0

Dollar Swaps

Are the dollar swaps putting pressure on the Indian Rupee? 

During the last week, the rupee rapidly weakened against the dollar and went as low as 70.56/$. While oil prices were one of the reasons for the rupee slide, there was another more immediate reason for this rupee fall. It was the dollar swap auctions that set the tone for the weakening of the rupee. Let us see how it worked!

Second tranche of swaps

How exactly does the dollar swap work? The RBI purchases dollars from the banks in exchange for rupees. The only difference is that it is a back-to-back transaction where the RBI commits to sell back the dollar to the banks at the end of 3 years. Future dollars will obviously be sold back at a premium as the dollar has consistently appreciated against the rupee. In the first tranche of dollar swap auctions, the premium to the spot was Rs.7.76 but in the second round the premium was a whopping Rs.8.38. That literally translates into an annual rupee weakening of minimum 4.1%. That is also the yield that the banks will earn from their dollar deposits with the RBI. Most dealers in the market have expressed surprise at the sharp increase in the premium. Also, unlike the first tranche, where the allotment was made to 89 applicants, the second tranche was only allotted to 5 applicants. That has made the entire dollar auctions extremely vulnerable to the pricing efforts of a single player or just a handful of players.

Signal on forward premiums

The dollar swap auctions can be seen as a proxy for the forward premiums. You typically pay a premium for forward dollars as the hard currency normally appreciates over time. That can be seen as a proxy for the dollar auction premiums. When the premium of the auction is hiked from Rs.7.76 to Rs.8.38 in just one month, the market interprets it as a signal of a weak rupee. That was explained by a surge in the forward premiums on the US dollar and most market analysts are now expecting a surge of nearly 25% in the forward premiums. The sharp rise in forward premiums in turn is making the rupee weaker as it is factoring in a stronger dollar in its future projections.

What it means for markets?

Higher premiums on dollar swaps will be interpreted by the market as the RBI giving out a deliberate signal on rupee weakness. Firstly, it could mean that the interest rates in India will remain more dovish compared to other countries and that is good for market sentiment as a whole. But that will also mean that the bond yields could be lower on Indian bonds and that the rupee could weaken consistently. That is not great news for FPIs looking to invest in Indian debt paper. Higher dollar auction premiums could be seen as a negative signal for Indian bonds and that is already visible in FPI activity. Time to watch out!

Valuing AMCs

What you must know before adding AMC stocks to your portfolio

When HDFC AMC announced stellar numbers in the March 2019 quarter, the markets were abuzz with buying ideas. How good an idea is it to buy AMC stocks in the equity market? Of course, there are only two listed AMC stocks of Reliance and HDFC AMC and hence the choice is fairly limited. However, before taking such decision, here are 3 important points to consider.

Value as yield on AUM

An asset manager is obviously not to be valued like other typical valuation basket cases. It is in the business of managing money and the stock tries to create wealth out of the earnings from managing this money. Globally, AMCs are rarely valued on the basis of P/E but they are valued on the basis of value as a percentage of AUM. This is called the value that a buyer would pay to take over the AMC. Normally, for reputed funds with a higher exposure to equity AUM, the regular rate is 7-8% of the AUM. Considering that HDFC has AUM of Rs.345,000 crore and market cap of Rs.36,000 crore, the stock is already quoting at more than 10% of its AUM. That is higher than what most AMCs with a strong equity franchise have commanded in the past. In pure valuation terms, the valuation may still depend on how quickly the AUM grows and one must remember that it depends on competition and on the continued appetite for mutual fund investing. That makes growth a major challenge!

Margins are narrowing

What is the biggest source of revenues for the asset management companies? Obviously, it comes from the fees charged by the AMC in the form of total expense ratio (TER). This is charged proportionately on a daily basis to the NAVs. There are two challenges for the AMCs here. Firstly, the SEBI has already taken steps to reduce the costs for mutual fund investors and that is going to have an impact on the AMC profits. Secondly, there is a customer angle. Last five years have been years of high returns. Hence investors did not grudge the cost of equity funds. But as markets reach higher levels, you could see outflows and also a shift to index funds. That could also impact AMC revenues.

FMP uncertainty for AMCs

The big question mark could be what happens to FMPs which have been used to fund promoters via pledged shares. It is estimated that promoter funding by MFs is to the tune of Rs.3.2 trillion with nearly Rs.1.2 trillion coming up for redemption in the next few months. One must be prepared for a lot of ungainly revelations when these come up for redemption. How that will impact the valuation of these AMCs will be known only when push comes to shove? The moral of the story is not to get carried away by the hype surrounding the AMC stocks. The real picture on AMC stocks may be a lot more complicated!

IL&FS Bad Loans

It is time banks wrote off their loans to IL&FS and Jet

Recently, the RBI had instructed all banks having exposures to IL&FS group to make provisions for their exposure to the IL&FS group. Indian banks have lent close to Rs.97,000 crore ($14 billion) to the IL&FS group and it is not clear how much of that is recoverable. As a special case, since the group was under government sponsored restructuring, the NCLT had exempted the banks from making provisions for these exposures. However, the RBI had expressed its disappointment as it did not reveal the true picture of the asset quality of the banks. But, how big is the problem?

Pending provisions

It was only when Yes Bank made a big provision for its exposure to IL&FS and Jet Airways that the real size of the problem is beginning to dawn. Some of the IL&FS subsidiaries are said to be able to recover only 10-15% of the total outstanding amounts. That would leave a huge hole of Rs.85,000 crore in the balance sheets of banks. The irony is that the entire IL&FS issue is currently shrouded in secrecy. Banks are yet to make provisions for IL&FS but the prospects of recovering anything from these loans is gradually fading. Most of the funds are supposed to be lent and then routed back and there has been little progress in seriously interrogating the erstwhile management of IL&FS which had been playing ducks and drakes with public money. Ducking the issue hardly solves the problem!

Now for phase 2 of NPAs

The banks and the NCLT have surely had some success in the first phase of bankruptcy resolution. These were industrial companies with solid assets on the ground and they did have ready takers. The problem in phase 2 is a lot more complex. These are companies like Jet, IL&FS and Essel where the money trail is yet to be established. In most cases they have been done via complex layers of companies and no assets created on the ground. A traditional NCLT approach may recover nothing as most of the assets on the balance sheet could be either fictitious or wasting assets. We have only scratched the surface of the second phase and it promises to be a lot more complicated compared to the first phase of NCLT!

Some transparency please!

The RBI is absolutely right in asking for more transparency from banks. The second round of NCLT could be a lot more complicated and the recovery ratios could be much lower. As RBI rightly put it, the best banks can do is to give a clear picture of stressed assets rather than offer any surprises at a later date. In an effort to spruce up the balance sheets, banks have been going slow on writing off stressed debt. That is a lot like going back to square one. RBI should be the sole arbiter of how banks present asset quality and the NCLT should ideally stay out of it!

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