ICICI Bank Ltd, India’s largest private sector lender, has seen its market value shrink by about 34% since its stock reached an all-time high of Rs1,465 in mid-January, even as the country’s benchmark stock index, the Sensex has fallen about 21% during the period.
One of the recent reasons behind investors fleeing ICICI shares has been the impact of its exposure to credit derivatives. The bank has so far reported around $264 million (Rs1,064 crore) mark-to-market losses on account of its exposure to credit derivatives as well as an erosion in value of investments made by its subsidiaries in the UK and Canada. The losses are likely to climb.
In an exclusive interview with Mint a day after confirming the derivatives-linked loss, ICICI’s joint managing director and CFO Chanda Kochhar disclosed that ICICI has stopped taking further exposure to such assets even as she dissected the losses and defended the bank’s exposure to such derivatives. While such investment decisions are taken by a committee of directors, Kochhar says that as CFO, and someone who manages ICICI’s risk, the buck stops with her. Edited excerpts:
When did you get to know of this loss?
We always knew our derivatives portfolio and so there is no discovery as such. Every quarter, we need to see the portfolio and follow the accounting practice of mark-to-market that values investments according to the prevailing market prices and at the price at which they are made. Until August, there was no real widening of spread and so, there was no erosion in the market value of the portfolio. In the September quarter, the spreads widened and we first booked losses.
We are aware of our portfolio and every quarter we need to follow the accounting practice of marking to market. It will all depend on the spread...
In mid-January, you had mentioned that the bank had made provisions for Rs120 crore in the quarter ending September and another Rs150 crore in the December quarter. That’s about $65 million. Now you are talking about $264 million. How did this rise so fast?
It’s not correct to say that losses worth $65 million has now risen to $264, which is a combination of many things. Let me start with $65 million first. Actually, we had provided $69 million in September and December quarters for ICICI Bank’s exposure to credit derivatives. Over and above that, we had also provided another $20 million in these two quarters in our subsidiaries. So, we have already provided $89 million.
Dissecting losses: Chanda Kochhar, ICICI Bank joint MD and CFO. (Bloomberg)
Now, when we estimated the extent of widening of spreads in January, we found that we would require another $80 million worth of provision to take care of mark-to-market losses. This is an estimate and the figure will actually get crystallized on 31 March.
Other figures that have been added to arrive at the final figure of $264 are some investments by ICICI Bank’s UK and Canada subsidiaries. They have their own asset liability management system and they need to keep some money in liquid assets. That portion is about $4 billion. We don’t understand the equity market well and so, we deploy funds in fixed-income securities and like any other securities, investment in those securities also need to follow the mark to market accounting principle. In December quarter, we provided in our subsidiaries books $100 million for this. There is nothing new in it.
So, 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.
If your exposure is $2.2 billion and your mark-to-market losses are $264 million, your losses are around 12% of your portfolio. Can this rise?
Actually it’s $164 million and so, about 8% of our portfolio. It’s difficult for me to predict to what extent it can rise. Mark-to-market losses are not real loss. It’s a notional loss. What we can monitor is the credit quality of the underlying papers. Are the companies paying interest on time? Is there any deterioration in the credit quality of these companies? About 65% of the portfolio is blue-chip Indian firms and none of them are defaulting. We are monitoring the global companies on a daily basis and their rating continues to be investment grade. We will take immediate action if anything goes wrong. None of them has defaulted in their payment obligation so far and there is no worry on that front.
Our portfolio is good but, if the global spread widens we will have to book notional mark-to-market losses again. I cannot predict this.
Even if all the losses do not affect your profit and loss account, as you have said they can be adjusted in the balance sheet, it will affect your net worth. How will it impact your capital adequacy?
It definitely brings down the capital adequacy ratio. We have already adjusted $65 million with our reserves of our subsidiaries and despite that they are sufficiently capitalized. The post-tax impact is around $47 million.
Why did you hold these loans as investments, instead of loans?
Out of our $25 billion international balance sheet, we hold only $2.2 billion in such assets and the rest of it are all loans. We hold these papers because direct loans to some Indian firms do not give us such a high return. For normal loans, you need to work on a very thin spread but these structured deals give us better spread. In a way, it is a sort of guarantee. A bank has already taken exposure to these companies and they want a sort of protection against any default. We know these companies well as we have already given them term loans or working capital loans in India. So, we are very comfortable (with them).
Relevant proportions: Kochhar says ICICI Bank’s banking balance sheet is $103 billion and the credit derivatives portfolio is $2.2 billion. (Rajeev Dabral / Mint)
The global market does not understand the India risk as well as we do and therefore we have the arbitrage facility of making better margin on the same set of Indian firms than what we would have made by giving rupee loans.
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. Beyond this, I cannot say much. They are structured deals and we are not supposed to reveal their names.
Why did ICICI Bank buy these credit derivatives in the first place? Is it to manage credit risk or are they stand-alone investments? Some analysts say you operate like a hedge fund and take too much risk.
Our banking balance sheet is $103 billion and the credit derivatives portfolio is $2.2 billion. Can you call us a hedge fund, based on 2% of our investment? The proportion is relevant.
We looked at these instruments as pure credit risk and was convinced that returns from structured deals would be higher than returns from loans to these companies. So, it was nothing but a lending decision, but in the form of a structure that offers better returns. In fact, that is why we have not been selling this portfolio. The underlying companies continue to remain good and they will pay us up over the four years when these papers mature. We are not in a hurry to sell them because of the notional mark-to-market losses. If we were operating like a hedge fund, we would have bought and sold, depending on the market conditions. That has not been the case.
Have the underlying assets also depreciated? Will you provide for them as well?
All underlying assets continue to be investment grade and their ratings are constantly been reviewed by the rating agencies. There is no credit quality deterioration.
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.
What is the risk management structure in ICICI Bank? Is it done in an integrated fashion from India?
First of all, we have a consolidated risk management policy across the bank. No individual subsidiary can dilute the policy and, in fact, they add additional safeguards to the policy, depending on the local regulations. These policies are then adopted by the individual boards of these subsidiaries.
Is the bank’s board the final decision maker on these investments? Where does the buck stop? At you, since you oversee the bank’s international operations?
These decisions are taken at the committee of directors level. The working directors are members of the committee. These decisions were contemplated and taken from 2005 onward, when we started our international operations. These are new concepts and large investments decisions on such issues are always taken by the committee of directors. So, the buck stops with the committee. Incidentally, I am no longer the head of international operations. I am the joint MD and CFO looking at all supervisory aspects.
I manage the risks and so you can say that the buck stops with me.
For higher returns, will you continue to invest in such papers?
No. We have taken a decision not to add to this exposure. Even today, (decision on) whether we should continue to hold this portfolio or sell will be taken by the risk committee—a committee of board of directors where independent directors are also present.
How has your international business been growing?
Our international book is about $25 billion. It accounts for 24% of our balance sheet and roughly the same proportion of our profits. The focus is on Indian customers—corporations and non-resident Indians. We believe this is a very good, viable and profitable business, and we will not change the business model.