#Fincabulary 28 – Gypsy Swap

Meaning – A gypsy swap is a unique method by which a company may raise capital without issuing debt or holding a secondary offering. In many respects, a gypsy swap is similar to a rights offering, except that the restricted party’s equity claim does not elapse and the swap instantly becomes dilutive.

The gypsy swap is broken into two parts:

1. An existing shareholder exchanges freely traded shares for restricted shares (shares restricted by time and/or price constraints) from the issuing company. In economic terms, the existing shareholder neither gains nor loses money from the transaction, although it may have tax consequences.

2. The issuing company then sells the existing shareholder’s freely traded shares to a new investor(s) at a price that may be higher or lower than the current market price. The issuing company now has additional capital and the new investor(s) has equity in the issuing company.

In almost every case, a gypsy swap is a last-ditch financing option because the new investor(s) almost always demands some combination of below-market value price or special consideration from the deal.

 

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WEATHER DERIVATIVES – CONCEPT, CHALLENGES, AND FEASIBILITY

By  Ishan Kekre & Girish C

Introduction

A weather derivative is a tool for managing weather risk. It is a financial contract that allows a firm to hedge itself against unexpected and adverse weather. A weather derivative contract or WD derives its value from future weather conditions. Contrary to stereotypical weather insurance, the payout of this kind of derivative is based on a parametric weather index. For instance, the index could be centimeters or millimeters of rainfall. The index could also be a cumulative frequency distribution of temperatures across many locations. The underlying of WD could also be related to snowfall or hurricanes.

Origin of Weather Derivatives

The weather derivative market as compared to other financial instruments is relatively young. The first transaction in the WD market dates back to 1997. The sector developed due to the severe repercussions of El Niño. These events were forecasted correctly by the meteorological community. Firms that had their revenues linked to weather realized the importance of protecting themselves against seasonal weather risks. Many companies who were in the business of dealing with financial futures and options saw WDs as attractive tools to hedge weather risks.

The insurance sector achieved substantial financial consolidation. As a result, there was significant capital to hedge weather risks. Insurance firms started writing options with payoffs linked to weather events. This, in turn, elevated the liquidity for the development of a WD market. Thus, the WD market evolved over the years into a strong over-the-counter market.

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Budget Impact Analysis – Banking & Financial Sector

By Payal Sachdeva and Tuhina Kumar

Expectations

  1. Increase in tax concessions on bad loan provisioning as the Asset Quality Review by RBI has led to a steep increase in provisioning.
  1. The total requirement of capital infusion by banks till march 2019, as gauged in 2015, is 1,80,000 crores out of which the government has committed to allocate only 70,000 crores under the Indradhanush plan. The rest is expected to be raised by the banks from the markets. This may be difficult due to low valuation of the banks.
  1. Disinvestment in PSU banks to below 51% to help raise capital.
  1. Higher allocation to infrastructure, housing and urban development as a boost in the commodity sector would improve the banks’ asset quality.
  1. Provide a roadmap of incentives for a digital push.
  1. Enhance capital expenditure for credit demand revival.

Announcements made in the Budget

  • Abolishment of FIPB: The Foreign Investment Promotion Board (FIPB) will be abolished in 2017-2018. FIPB is the body responsible for approving FDI proposals which are not cleared through the automatic route. Since 90% of the FDI inflows are through automatic route, the government has taken up this measure. Also, it focusses on ease of doing business.
  • Housing Finance:  Under the government’s aim to provide housing for all by 2020, the government proposed various measures. National Housing Bank (NHB) will refinance loans worth 20k crore in 2017-2018. This move saw a rise in stocks of HDFC (3.6%) and LIC Housing Finance (2.78%).
  • Tax relief on Masala Bonds: The government has announced that the rupee-dominated offshore bonds, called masala bonds will be subjected to a lower tax deducted at source (TDS) of 5%. This would be applicable retrospectively from 1st April 2016. This has been done to provide relief arising due to the appreciation of rupee against a foreign currency.
  • Law on Money Laundering: To curb money laundering by high net worth individuals via fake long-term capital gains, the government has tightened the screws on long-term capital gains. Only those equity investments are eligible for long-term capital gains where securities transaction tax (STT) has been paid.
  • Move to attract FPI: In order to attract funds from FPI, the finance minister made a proposal to exempt category I and category II FPIs from the provision of indirect tax transfer. Category I foreign portfolio investors include foreign central banks, sovereign wealth funds, and government agencies.
  • Recapitalization of banks: The government is going to infuse 10,000 crores out of the 70,000 crores committed under the Indradhanush plan for recapitalization of banks.
  • Set up PARA: An idea to set up a centralized Public Sector Asset Rehabilitation Agency (PARA) that will take over banks’ largest and the most challenging bad loans. PARA will help reduce NPAs and restructured loans.
  • Amendment in SARFAESI Act: The amendment in the SARFAESI act will allow listing and trading of security receipts issued by securitization company or a reconstruction company on SEBI-registered stock exchanges. This will boost capital flows in the securitization industry and aid in dealing with NPAs.
  • Mudra Yojana: The Pradhan Mantri Mudra Yojana has been allocated 2.44 lakh this fiscal as it exceeded the target of 1.22 lakh crore allocated in the year 2015-16.
  • Attempt to push Digital Economy: In an attempt to promote digital transactions in the Indian economy, the allocation to BharatNet Project has been increased by Rs 10,000 crore in 2017-18 which will connect 150,000-gram panchayats with high-speed broadband. Also, BHIM, an Aadhaar-based mobile wallet, would be promoted under two schemes, a referral bonus scheme for individuals and a cashback scheme for merchants.
  • The Role of SIDBI: Moreover, the government wants to ease loan disbursement, where the Small Industries Development Bank of India (SIDBI) would refinance credit institutions for extending unsecured loans to borrowers at reasonable interest rates based on their digital transaction history.

Conclusion

The government has met most of the expectations except for more capital infusion in the banks.  Thus, markets reacted positively to the budget and financial stocks shot up. Both Nifty and Sensex closed at a 3-month high of 28000 and 8700 respectively.

Stock Recommendation

The government’s move towards affordable housing is likely to push CanFin Homes as its loan portfolio is skewed towards the same.

 

Budget Series 2017-18-#1 Impact on Banking Sector

Akanksha Mund & Vishaka Sivanainar

The Budget 2017-18 – Banking Sector

The Union & Railway Budget released on 1st February was highly anticipated for it attempted to overcome the existing global and economic challenges. Possible increase in policy rates by the Federal Reserve, an uncertainty of commodity prices and pressure for protectionism are a few existing challenges. According to the December monetary policy statement, the Rs. 17 lakh crore demonetization of the economy slowed the growth rate down to 7.1% from the earlier estimate of 7.6%. In the past 2.5 years, the administration has become more transparent. Industry expectations included recapitalization, focus on NPAs, consolidation of government-owned banks, the creation of affordable housing, a digital push towards a cashless economy, insurance boost, reduction of the gold import duty and corporate tax rate.

Key highlights include:

NPAs – The allowable provision for NPAs has increased to 8.5%. There is a tax concession for provision on bad loans. The interest taxable on the actual receipt with respect to NPA accounts of all non-scheduled co-operative banks are to be treated at par with scheduled banks.

Cashless economy – No transaction above 3 Lakh is permitted in cash (excluding certain exceptions). After the success of the BHIM app, Aadhar Pay, a UPI for Aadhar Enabled Payment System, will be launched shortly. Banks will introduce 10 Lakh POS terminals by March 2017 and 20 Lakh Aadhar based POS by September 2017

Impressive figures – Income tax has reduced from 10% to 5% for the income slab of 2.5-5 Lakh. Rs. 10000 Crore has been allotted towards bank recapitalization compared to previous year’s Rs. 25000 crore. Government spending in the banking sector will touch Rs. 3.96 trillion in the next fiscal year. The net market borrowing figure of Rs. 3.48 Trillion (considers bought-back securities) was set.

Stock market – Banking stocks rallied more than the broader market with the BSE Bankex gaining 2.7%. Low fiscal deficits and lack of populist measures turned out to be positive for the banking stocks. Asset reconstruction companies would be allowed to list the security receipts issued against bad loans on stock exchanges registered with SEBI.

The penultimate budget in Prime Minister Narendra Modi’s tenure was remarkably neutral, however, it managed to elicit positive reactions from the banking sector.  

Development of the Indian Corporate Bond Market

By Abraham Mathew Valliyakalayil

The world GDP stood at nearly 74 trillion in 2015. The worth of the world bond markets was 100 trillion. Where was India at that time? This article attempts to juxtapose the Indian bond market with that of the world. Indian debt market is just 17% of its GDP as compared to the US which is worth 123%. We also lag behind with respect to other emerging markets such as Malaysia, Thailand, and China.

There can be a plethora of reasons for this trend. Firstly, India in contrast to these countries offers much higher interest on fixed deposits. These attractive interest rates discourage retail investment in corporate bonds as term deposits carry lesser risk. Thus, risk-averse retail investors prefer fixed deposits over debt and risk-seeking investors opt for equity. 

  Break-up of Term-Deposit & Inflation Rates of Asian Countries

Country Fixed deposit rate Headline Inflation
India 7.95 % 3.4 %
Malaysia 4.33 % 1.8 %
China 3.75 % 2.1 %
Thailand 2.8 % 1.1 %

Secondly, institutions which are the major players in the bond market shy away from investing in corporate bonds. The reason being that the secondary market is still underdeveloped, owing to the lack of demand and supply (causing market illiquidity).

Issues on the demand side:

  • The first barrier is a high SLR of 21.5% that, places restrictions on various players including banks, insurers, FPI and Provident funds. Also, only 15% of the funds is allowed to be invested in corporate bonds below AA rating. However, for mutual funds, there are no such restrictions.
  • Secondly, India lacks a well-functioning derivatives market. This hampers the ability of players to hedge credit and currency risks.
  • Lastly, a factor that banks will have to deal with is the ‘mark to market’ aspect. On the balance sheet, corporate bonds will be valued according to the market in contrast to the loans which won’t be valued similarly.

Issues on the supply side:

The institutional restrictions, preference for higher ratings (reason for higher interest rates) and the high cost of issuing (resulting in a high cost of capital, KD) has an adverse impact on number primary issues.

Conclusion: 

Analyzing the supply and demand aspects, we can say it is analogous to the chicken and egg situation. The above problems can be tackled by an effective implementation of the Insolvency and Bankruptcy Act which was passed on 5th May 2015. This can hasten the liquidation of distressed companies, thereby protecting the value of companies’ assets. It will also aid the asset reconstruction companies by attracting more participation into the NPA market. Furthermore, improved banking governance and adoption of Basel III norms mandating holding of high-quality liquid assets can also act as an elixir. Overall, these measures can improve the investors’ confidence in the corporate bond market.

#Fincabulary 8- January effect

Meaning: A seasonal  increase in stock prices during the month of January

Explanation: It refers to a pattern exhibited by stocks, particularly small-cap stocks, in which they’ve shown a tendency to rise during the last several trading days in December and then continue to rally throughout the first week of January. Analysts generally attribute this rally to an increase in buying, which follows the drop in price that typically happens in December when investors, engaging in tax-loss harvesting to offset realized capital gains, prompt a sell-off. Another possible explanation is that investors use year-end cash bonuses to purchase investments the following month.