Mutual funds liquidate CDs to tackle redemption pressure

Fund sell-off pushes up yields of Certificates of Deposit in secondary market.

Caught in the Euro cross-fire, mutual funds have begun liquidating Certificates of Deposit (CDs) to meet the redemptions of the foreign institutional investors (FIIs).

FIIs are large investors in MFs, particularly in the debt markets schemes. FIIs are not allowed to invest directly in CDs. Traders said that redemptions were largely by FIIs driven by mounting risk aversion, as a consequence to the escalating Euro crisis.

The fund sell-off of CDs, in turn, resulted in pushing up CD yields in the secondary market, leading to a sharp divergence between secondary and primary markets rates. Six month CDs in the secondary markets are at 6.3 per cent now.

Buyers of the CDs are mostly banks — and they are doing so at steep discounts. CDs maturing in November are sold by some funds at yields as high as 6.3 per cent or well over the three month bulk deposit rates. The card rate for three-month bulk deposits range between 4.5 and 5 per cent, as of now, among the public sector banks.

However, banks continue to receive CD subscription from corporates at rates lower than the prevailing one-year term deposit rates.

On June 2, the State Bank of Travancore was able to raise Rs 290 crore at a weighted yield of 6.7 per cent.

Subscription to the CDs was mostly from cash surplus corporates, both private and in the public sector, traders said.

Some private sector corporates have opted to invest in public sector bank CDs, as capacity ramp up of investments continue to be on hold for some more time.

Credit lines

Corporates normally deploy internal resources in the initial stages of such investments, before drawing down their sanctioned credit lines. That credit lines have not been drawn down, was evident from the incremental CD ratio that is at minus 26 per cent now.

FIIs, in May, sold the equivalent of Rs 9,436 crore ($2.4 billion) of equities and picked up only Rs 2,450 crore ($535 million) of debt, almost entirely short-term instruments for liquidity purposes.

Yet, despite the FII selloff, liquidity in the markets remained under control. This was evident from the weighted average collateralised borrowing and lending obligations rates that remained well below the Reserve Bank of India's repo rate.

On Wednesday, the weighted CBLO rates were barely 5.2 per cent or 5 basis points below the RBI repo rate. (CBLO platform allows money market participants to lend overnight/term liquidity against a collateral of eligible securities.)

However, with advance tax outflows looming, short-term liquidity preference remained high.

Yield

As a result, the yield on the 91-day T-bill spiked to 5.20 per cent but was level with the 364-day T-bill cut-off yield, implying that the liquidity overhang could return to haunt the markets soon. This fear manifested in the 10-year YTM dropping to 7.49 per cent, down from last weekend's 7.58 per cent.

Source: http://www.thehindubusinessline.com/2010/06/08/stories/2010060851530600.htm