Tuesday, December 31, 2013

The SDL Valuation game

Today's State Development Loans (SDL) saw better than market expected cut-offs in the auction (Auction results page): with yields in the range of 9.35%-9.40%. If an investor (read: banks / Mutual Funds) has bought the SDLs in auction today, they would get a valuation gain of close 27-30 bps owing to weird valuation mechanisms followed in India.

As per FIMMDA valuation guidelines, SDLs are valued at 25 bps spread over corresponding G-Sec. Though INR 8000 Cr of SDLs are sold in auction today - the auction cut-off prices are not used for valuation but spread over GoI 8.83% 2023 security is used. As an illustration, if an MF/bank has bought 10Y Tamilnadu paper at 9.41% yield, it can instantly show a gain of 9.41% MINUS (8.83%+0.25%) of 33 bps or equivalently close to 2.31% overvaluation.

With the current quarter being pathetically bad for most fixed income investors (read: banks) they might tend to use such 'valuation' gains to hide real losses in their bond portfolio. In times when most global regulators are seeking more transparency, it is a sham(e) India still continues to have such not-so-above-the-table valuation practices.

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