State Development Loans (SDLs)

….. Invest in SDLs

SDLs offering high credit equivalent to Govt. of India, with slight alpha for the the moderate maturity. Brief snapshot capturing Know-how on SDL.

What is SDL?

1. SDLs are bonds that are issued by the state government to manage their state finances and fund their fiscal deficit.
2. Each state is allowed to issue securities up to a certain limit defined for the year.
3. SDLs are issued in the primary market through normal auctions conducted by the RBI and traded in the secondary market
4. Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date.

How SDL is issued and managed?

1. RBI manages the issuance of SDL along with monitoring periodical payment interest and principal at maturity.  Auctions the SDLs through E-Kuber.
2. SDL is serviced by RBI through Consolidated Sinking Fund and Guarantee Redemption Fund that state maintains with RBI.
3. RBI can also make payment from the budget/Tax  allocation to State from centre in case required. RBI Auctions SDLs through E-Kuber, hence pricing is determines by Yields, market cycle, auction amount and most importantly demand. Auction is held once in fortnight, however issuance calendar is not fixed. 
4. Financial Benchmark India Pvt. Ltd. make available prices for the valuation of SDLs.

Credit Worthiness

1. SDLs are considered equivalent to Govt of India bonds, they do not fall under CRAR Guidelines (Capital to Risk Weighted Guidelines) i.e. risk weight of SDL is zero under CRAR norm.  Banks need not keep any capital for investing in SDLs. 
2. The SDL securities issued by states are credible collateral for meeting the SLR requirements of banks as well as a collateral for availing liquidity under the RBI’s LAF including the repo. Hence, these fall under the credible collateral for the bank.
3. SDL securities are considered as superior to loans mobilized or bonds issued by state government entities.
4. SDLs are considered equivalent to G Sec, however in hierarchy it will be following the G Sec in credit stack.

Ways to invest in SDL :

1. The trading of SDLs is done through electronic mode on the RBI managed NDS-OM(Negotiated Dealing System-Order Matching) and is tradeable in the voice market (NDS).
2. Participate through Target Maturity funds (Mutual Funds and ETFs) i.e. Buy & hold strategy where fund manager will hold scripts till maturity.

Advantages: Generating alpha with sovereign credit.

Disadvantages: Fund may have MTM impact with interest rate movement, however invest with view of hold till maturity.

SDL Index (General Points):

1. These are majorly Fixed tenor index with maturity 2026, 2027, 2031 etc.
2. Basis the outstanding top 12, 15, 20 issuance is taken in construction of Index and investment is made in equal weights or weights defined. Along with over all issuance in many cases minimum outstanding is taken into account.
3. Index forms basis the liquidity score e.g. 80% weight to aggregate trading value, 10% weight to number of days traded and 10% weight to number of trades of the bond during the twelve months period
4. Index is rebalanced on Quarter ending basis the mismatch in holding criteria. Index has defined minimum and maximum number securities. Post exclusion if number of securities fall below minimum number than new security is added , else value got distributed among the existing.

Investment Recommendation (Current market scenario) :

Invest in  SDL funds with view of hold till the maturity (generating accrual income), offering alpha over theGSec and security equivalent to GSec. There will be an interest rate risk , however same fades away near to maturity. Funds with no active management & low expense offering returns in the range of 7-8% basis current market yields .