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PNB Gilts: Bet on the debt market

Aug 18, 2001

While equity markets are witnessing lack of confidence, debt markets are flying higher as the risk associated is relatively low. The volumes in government securities (G-Sec) market jumped exponentially after the entry of primary dealers (PDs) in the year 1996. PNB Gilts was amongst the first to get the licence in July ’96. In a short span of five years, the company has emerged as a frontrunner in the G-Sec market. PNB Gilts was a wholly owned subsidiary of Punjab National Bank (PNB) till FY00. The company came out with its maiden public issue in July ’00 and raised Rs 700 m from the markets. With this the holding of PNB was reduced to 74%. (PNB is one of the largest public sector banks in India with an asset base of Rs 635 bn.)

PNB Gilts enjoys several firsts. The company with a market share of 7% is the only listed primary dealer having a turnover of Rs 330 bn in FY01. It is the first PD to get a P1+ rating from Crisil for its short-term borrowing programme upto Rs 5 bn. It is also the first PD to achieve the distinction of being an ISO 9002 company. The company has a strong foothold in the government dated securities and treasury bills, which contributes about 90% to its total business. Apart from this, it deals in PSU bonds, state government securities and money market instruments (such as zero coupon bonds, capital indexed bonds and floating rate bonds). PNB Gilts has a wide client base including banks, provident funds, pension funds, charitable trusts, insurance companies, other primary dealers, corporates and individuals.

With the increase in number of players, the competition is mounting. However, the business opportunities for the PDs are immense. The introduction of derivatives in the Indian market and the permission to PDs to act as market makers for derivative products has opened up the new growth avenues for PNB Gilts. Also, with gradual phasing out of non-banking financial entities (like mutual funds) from the call and notice money market, there is a good scope for the development of treasury bills (T-bill) market. T-bills offer good opportunities for short-term investments with safe and reasonable returns (higher than bank fixed deposits) to corporate bodies. But due to lack of awareness among the retail investors, this market is at a nascent stage. To educate the investors, PNB Gilts is conducting conferences and seminars at major cities. The aggressive marketing initiatives of the company are expected to create more awareness about the dealing in the G-Sec market, resulting in improvement in its topline.

On the financial front, PNB Gilts has reported a mixed performance in the last four years. The company’s revenues grew by a compounded annual growth rate (CAGR) of 22% during this period. The CAGR in profits was however, negative at 5%. This was due to adverse debt market conditions and volatile interest rate environment. This has resulted in diminution in value of its investments and consequently subdued growth in earnings.

Financial snapshot
(Rs m)FY98FY99FY00FY014 yrs CAGR
Net worth 1,014 1,319 2,105 3,358 49.0%
Total Income 1,254 1,504 2,638 2,246 21.5%
Net Profit 551 426 658 471 -5.1%
Dividend (%)21%22%14%18% 

Interest rate expectation is a major factor, which determines the performance of the company. This is because of an inverse relation between bond price and interest rate. With a rise in interest rates, prices of government securities falls and vice versa. The financial year 2002 brought a win-win situation for the company. With a favourable debt markets scenario, the company’s profits soared to 290 m in the June quarter, 60 times higher than Rs 4.8 m recorded in 1QFY01. Its income from operations also witnessed astounding growth rate of 93%.

Volumes in the secondary debt market and government borrowings program primarily drive the company’s topline growth. Before the entry of PDs in FY96, volumes were lacklustre at Rs 295 bn. However, it started flaring up in FY97 to reach to a level of Rs 5,670 bn in FY01, a CAGR of 81% in the last five years. With the markets becoming more matured and a rise in number of players, volumes are expected to cross Rs 10,000 bn towards the end of the current year.

The gross borrowings of government would support a substantial rise in volumes going forward. In the last ten years, the government borrowings grew by leaps and bounds to Rs 1,152 bn in FY01 from a mere Rs 90 bn in FY01, a CAGR of 29%. The fiscal deficit of the government is budgeted at Rs 1,163 bn in FY02. To meet this, the gross market borrowings are budgeted at Rs 1,189 bn. Comfortable liquidity in the economy on account of substantial deposit accretion to banks, and a steady rise in the prices of G-Sec due to softer interest rate regime is likely to boost revenue growth of the company. Stable rupee, lower demand for credit and supportive global interest rate environment, points towards the softer interest rate regime. Agreed, but any adverse movement on the fiscal, forex and inflation front may cause the G-Sec prices to fall with consequent pressure on the profitability of the company.

Returns on a rise
Average return on assets   
Treasury bills9.1%9.6%9.4%
PSU bonds22.3%23.3%18.9%
Cost of funds8.6%8.6%7.4%

Rs 11 bn investment portfolio of PNB Gilts is large enough to allow it to trade actively in the markets. This was funded through call money market and other short-term funds like ICDs (inter corporate deposits). PNB Gilts also has a line of credit of about Rs 30 bn from the RBI. These diversified sources of finance aid the company in building the strong investment portfolio.

To mitigate the interest rate risk PNB Gilts follows judicious risk management policies. The average holding of its portfolio is in the range of 15–20 days. The company has adopted the strategy of high trading to increase profits in any market situation (declining, rising or flat). Also keeping the inventory levels on the lower side with high portfolio turnover and low leverage would helps in diminishing the financial risk, which the company is exposed to.

Being the only listed PD, PNB Gilts valuations are not comparable. The company’s Price/Book value ratio of 0.7x and a P/E of just 2x on 1QFY02 annualised earnings are a result of inherent risk involved in the business of primary dealers from interest rates. If the interest rates moves up it may result in a loss on the trading stock of the company due to depreciation in the value of securities held by it. Also, gilt markets are sensitive to changes in the macro economic factors. However, being an investment company, the company’s business is most liquid (99% of capital employed is into current assets) compared to others. As a result, book value per share of Rs 27, indicates the price, the company would be able to pay any time if the business is liquidated. PNB Gilts also has a consistent track record of dividends payouts in the range of 14-22% in the last five years. If the company were to maintain the rate of 18% for the current year than based on the current price, the dividend yield works out to be attractive 10.6%, and that too tax-free.

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