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ICICI Bank – More On Credit Derivatives


Chanda Kochhar says a few interesting things in an interview with Mint:

… there are four things that have contributed to the $264 million figure: $69 million credit derivatives losses that have already been provided for by the bank, $20 million provided for in the books or our subsidiaries for similar losses, an estimated $70 million for further erosion in value in January and $100 million for investments by our subsidiaries.

Interesting – they still maintain that they had provided $69 million (350 cr.) earlier, when it seems from their publicly available transcripts that they had only allocated 260-280 cr.

Now they have allocated a further $170 million. That is around 680 cr. which should technically halve their net profit. Will have to wait and see.

Considering that the spreads have dramatically increased since January – a further 10% if not more – chances are they will need at least $100 – $200 million MORE at the end of March. Of course they can choose not to take it – our regulators seem to be fairly lax on this issue – and they can randomly pick a number from the air and throw it at us. Still, if we believe that they’re honest, we must see another 400-800 cr., apart from the 680 cr. write down already.

Note: According to this interview, they have $2.2 billion in credit derivatives and $4 billion in credit investments.

What are the underlying securities on the collateralized debt obligations (CDOs) that ICICI bought?

We cannot disclose the names. But as I have said, we have exposure to 65% Indian firms and 35% overseas and all of them are investment grade. They are continuously rated by external global rating agencies.

A typical CDO is sold in three tranches according to risk and maturity—low risk, medium risk and high risk. Do you hold the riskiest tranches of the CDO in your books?

About $1.6 billion is credit swaps or credit-linked notes, the lowest risk category. We also have about $600 million collateralized debt obligation. They are of medium risk

Rating agencies aren’t much to go by, it seems. They still have AAA on companies like Ambac and MBIA, both of which are pretty much insolvent. The agencies have re-rated a lot of CDOs recently, moving them from AAAs to nearly junk.

Now ICICI has only $600 million in CDOs, which is good – but the term “medium risk” scares me. CDOs are usually structured so that the first 10% or so is high risk, another 5% is medium risk and the rest are “low risk” (called the AAA tranche or the senior tranche). The first 10% that default, are taken by the high risk holder – called the equity tranche – which is typically owned by the loan originators (banks who gave out the loan). The next 5% to default get absorbed by the medium risk or the mezzannine tranche, and the rest is by the seniors.

Now you can say that 65% of companies being Indian, they won’t default. (I don’t buy that, but still) They have about 35% non Indian companies out there, with a global recession. It will take just 15%-20% defaults on the entire CDO to wipe out the mezzannine tranche.

In general 15%-20% defaults are way off the mark. But in today’s recessionary state the risk is much higher; this is indicated in the market spreads, which is why there are MTM losses. The point is: If there were no MTM losses, the bank would have held the credit risk and it would remain “unknown” – and suddenly out of the blue, we could see $600 million loss because the CDO tranche went bust. Would you rather have that, or work with market to grade the investment according to the prices other people are paying, so you always have an idea where you stand? I would choose the latter any day, regardless of whether the intention of ICICI is to hold to maturity or not.

Swaps and notes are also impacted with failures when the senior tranches are hit. Regardless of whether the “hit” is caused by an Indian or foreign company.

Lastly, Indian companies are not immune from the global recession. It is likely the debt that ICICI has taken on through derivatives has no recourse to the Indian company – for instance, Corus can take on debt where if it defaults, lenders can’t go ask Tata Steel to pay. Meaning, even sound Indian corporates can default abroad and still be sound Indian corporates.

Some more bad news, potentially: ICICI supposedly has a yen denominated loan taken in September, of $1.5 billion. The yen has gone from 114 to the dollar, down to 102, while the dollar/rupee has remained constant (actually rupee has gone a little down against the dollar). The nearly 10% change is to ICICI’s
disadvantage – an impact of nearly 650 cr. on the capital. I don’t know if they actually have this loan right now, and if they hedged the currency risk – but this is something to look out for.

I don’t want to sound so bearish that people overreact. Do not do crazy things like removing your fixed deposits from ICICI Bank. They are not in a position of insolvency. Of course, there could be other news that is dangerous, but this derivative writedown is not going to kill them, and you should not panic. As shareholders you have reason for concern, especially in a globally tough scenario. I am definitely not long ICICI – their growth is way too slow for their P/E – but I am not yet short. I would be short if a) there is more bad news and b) price actually goes up from here to cross 1000.

Disclosure: No positions. I had a small short position on ICICI futures initiated and closed on Friday itself. Too volatile to trade.


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