Thursday, November 28, 2013

Unbankable- The lure of banking business

The Tata Group finally seems to have got something right. They have withdrawn their application for a banking license. It is perhaps the induction of the new Chairman, who must have had a hardnosed look at it. Tatas had made a hash of Tata Finance with scandals galore. The problem was / is that at the Tata group, some professional managers used to treat companies and businesses like personal fiefs. Maybe the airline business investment is just to humour the outgoing Chairman. I cannot understand why a business house should get in to poor businesses using public money. Personal passions should be explored by using personal money.

What is driving 25 others to remain in the fray is simple regulatory arbitrage. Get a license, tell a story, sell stakes at a fancy price to someone stupid and have a ball. The other way is to inflate all capital costs (real estate to technology) and skim it off. There is no advantage a bank gives as opposed to a NBFC. If you own a bank, you cannot lend to your own group. So what is the lure? Obviously, dreams of a capital market play and/or a continuous siphoning off of money. Give loans, take a bribe. Everything is possible.

When we invest in stocks, we are betting on the premise that we will be able to sell it to someone else at a price. This is the liquidity that stock exchanges provide. We make many assumptions in arriving at what price we are willing to pay. All of these basically boil down to what money (earnings) the company will make from its business. The other big investor (the promoter) also theoretically gets the same benefits, apart from other non financial benefits that may come his way. I am not talking about any money he may make other than the legitimate dividends and the management compensation he gets. His wealth is represented by his share in the market capitalization of the company.

For the promoter, the company is a real asset and he is at full liberty to deal with the profits of the company. He can pay dividends, buy assets or simply keep cash. He can use funds from one company to promote another. In short, he is the absolute master of all the assets of the company. He has a high level of motivation in keeping the company as profitable as he can. The promoter also wants to own as much of the company as he can and he also has the freedom to take the company private by buying out all the shareholders.

Other investors have the confidence that whatever happens to the shares held by the owner, the same fate awaits them. The promoter, within the framework of law, is the absolute master of the company.

I wonder whether this premise can be applied to someone who sets up a commercial bank. A bank is not at all like other industries in respect of ownership. In fact, being an owner of a bank is very demanding and legally complex. Firstly, the Central Bank (RBI) puts a limit on the ownership in a Bank. The main promoter cannot have a clear majority. The day to day functioning, the deployment of the bank’s assets etc all are subjected to guidelines laid down by law. If the promoter has other industries, a bank owned by him cannot lend monies to it.

The profits that a bank makes cannot be disposed at will. Dividend payments have to be approved by the regulator. The regulations cover virtually every aspect, including the remuneration that a CEO can draw. The promoter cannot use the bank’s money to do any single act that is not permitted by the regulator. And there are not many things that are permitted. A bank cannot promote a company n another industry. A banker cannot promote a car manufacturing business.

Of course, instances abound of shady promoters who have bent the law to have higher ownership apart from diverting loans to friends and family. But these cannot be a goal on which one would like to buy shares in a bank as an investor. And of course, we have businessmen who have ‘used’ a bank to push business in other financial services like mutual funds, stock broking or wealth management. They have used banking clout to build and strengthen other businesses. However, in this, the bank shareholders may not be participants.

A bank takes money from various people and lends it to different people for a fixed return. There is no upside on what it lends. If it lends a rupee, it will not get back anything more than a rupee. The book value of the share of a bank represents the value of all its assets (loans) less its liabilities (deposits, borrowings etc). The only difference between a mutual fund and the bank is the fact that a bank has ‘capital’ that is provided by the shareholders is leveraged by some borrowings. The only way to look at a bank is how much does it add to its book value each year, after dividends etc.

The argument is that a bank’s profits grow. So does the NAV of a mutual fund (the debt part surely). A bank has to provide for assets that are stressed. A mutual fund NAV rises or dips as per the market prices. So, if we are paying three times or five times the book value of a share of a bank, is it solely on account of the incremental profits that we expect the bank to show? And these profits are not available for disposal, except in liquidation. No bank will voluntarily liquidate when the going is good. When it liquidates, it is generally because it has blown away all the money in poor lending.

An owner of any business can sell off the business to anyone at any point in time. A bank cannot do that. It can at best merge or sell itself to another bank. Again, we come to who can take the call. Typically, someone with no personal stake in the bank will take the call if it is ‘professionally’ managed or a PSU. Or someone who takes a decision would have reasons beyond the balance sheet to make the corporate event happen. All in all, buying or selling a bank is a cumbersome process and not very exciting.

Thus it does not make any economic sense to either promote a bank or invest in shares of one. What is keeping the happy circle going is a combination of reckless optimism, misguided valuation and benign regulators.

Saturday, November 9, 2013


Secularism. A word wrongly introduced in to our constitution that is breaking the nation today. Secularism according to Nehru and his descendants has become a tool to divide and remind people constantly through the tool of reservation.

I always believe that religion is a personal business and should not come out in to the open. Pray at home. Keep your gods at home. Break down temples, churches, mosques. Maybe make them in to public conveniences. If you believe in your gods, they should be all over. Why go to one place and pray? And why use loudspeakers in this modern era? Why have public festivals that are nuisances to those who give a damn for those dunkings and processions?

The word that should have enshrined in our constitution is "LAICITE" and not secular.This is a word used by the French to define secularity.IT DENOTES THE ABSENCE OF RELIGIOUS AFFAIRS IN GOVERNMENT BUSINESS AND ALSO THE ABSENCE OF GOVERNMENT INVOLVEMENT IN RELIGIOUS AFFAIRS. This would surely have been a far nobler goal to reach than the appeasement tools used by different parties to whip up sentiments.

In the west, progress happened only after the separation of the Church and the State.History is evidence.

It is high time that we ban ALL religious outfits. And this will make people focus on economy. A sad case where the head of a scientific outfit goes to a stone idol with a plastic model to seek divine assistance. How terrible.

Tuesday, November 5, 2013

Bank Stocks- which to buy- New incumbents or existing ones

Tough Going for New Banks? (This appears in the latest issue of Moneylife)

If you have to buy a banking stock, the odds are in favour of buying an existing one rather than a new one because banking is a tough business

There are as many as 26 aspirants for the business of banking and the Reserve Bank of India (RBI) is supposed to grant licences to seven of them? At least, that seems to be the message of the finance minister P Chidambaram to RBI. Why seven? Why not five or why not 12 or why not all 26, if they meet the criteria laid down by RBI? Well, one day, we will find out. Hopefully, the new governor will make it an ongoing process rather than an occasional one. I fail to understand why there should be some special time windows for selling or issuing these licences. The bureaucrats and the politicians conspire to keep things complex and mysterious. That is the way we work. Transparency is for speeches. There is no good governance practised by the government or the regulators.

Let us look at the few private licences that were issued the last time: Times Bank, Centurion Bank, Bank of Punjab, Global Trust Bank are four names that come to mind, which folded up and were sold. If they had done well, they would surely have been around. The ones that survived are HDFC Bank and Kotak Bank. Axis Bank is a strange animal, having been promoted by Unit Trust of India and was lucky to have been led by the hard-nosed Dr PJ Naik. ICICI and IDBI were forced transitions of elephantine institutions and not greenfield ventures. And Kotak is known more for its capital market business than for banking. In my book, it leaves HDFC Bank and Axis Bank as the sole winners in the banking space since financial liberalisation started in 1992.

Among the new applicants, there are a few who have had problems in running non-banking finance companies (NBFCs). Will they be excluded by the government? The mutual fund arm of one of the aspirants ran afoul of the Securities and Exchange Board of India (SEBI) in the past but SEBI has been very generous in giving it a new mutual fund licence after having shut down the old one. So regulators are very indulgent and, unless the Supreme Court intervenes, past conviction on offences is no bar to entering the business where, once upon a time, trust was the key word.

Whatever happens, there are some consequential investment decisions to be taken. Most of the promoters would be listed companies. And their main purpose for opting for a bank licence is to play the valuation game in the capital market and access to low-cost funds (as deposits) rather than any fascination for banking per se.

Banking does not give the promoter any control over the cash flow. It cannot lend to group companies, cannot declare dividend without RBI approval and cannot appoint a director without RBI approval. So, obviously, the licence is a play on valuation that the analysts will give for owning a bank. A well-run bank, like HDFC Bank, can fetch a fancy four times the book value; even if you do a bad job, it still could be twice the book value! And if it ends up with a fraud, some bank will be forced to take it over as allowing a bank to fail can have negative political repercussions. In any case, it will be a few years before a fraud comes to light.

These new banks will compete in the same main cities, I guess. Unless, of course, RBI turns very radical and says that they cannot open in metro cities until they have opened a minimum number of rural branches, in the name of financial inclusion. Operating rural branches in the private sector is an unviable and losing proposition and no one will do it by choice. If there is sufficient money in any town or village, you can be sure that banks will reach there. Many NBFCs are already out there and one can be sure the public sector banks are already have a presence.

And these new banks, if they are going to be in the metro cities, are all going to drive up rentals and salaries for the top and middle level bankers. Stock options for a lucky few will be large drivers. A director in a bank has to have his salary approved by someone sitting inside RBI who is on a government salary. There is one NBFC where the CEO earns more money in a year than he earned in his entire lifetime of service with the promoter company. Should the NBFC get its banking licence? Forget the obscene salary he is getting, he may not even get approval as a director for the bank.

It is going to be an interesting race. Should the licence go to one of the NBFCs that already have a few hundred to a thousand-odd branches, they will simply seek conversion of their branches into banks. They are clearly at an advantage. Even if one of the licensees were not to have any branch, it might be very tempting for it to acquire the branches of an NBFC that has been denied the licence. Most large NBFCs are keeping small branches alive only in the hope of getting a bank licence. If they are denied the licence, selling those branches to a new kid on the block should surely fetch them a good price. If this were to happen, it would be interesting to see what the mandarins at RBI would do.

Whilst a few new private banks would come up, there is also an old generation of private sector banks that seem to have forgotten to grow or are simply content with what they are. These include Lakshmi Vilas Bank, South Indian Bank, Karur Vysya Bank, etc, although some others, like Federal Bank, are trying to grow fast. In the meanwhile, two private sector banks that seemed to have run into rough patches are trying to put their house in order, namely, DCB and Dhanalakshmi Bank.

Against this backdrop, one wonders what any new entrant would do. I also recall that a couple of applicants had failed NBFC businesses. To be a relevant player, what these private sector banks will need to build is trust which a bank like HDFC has built up. Winning big business and staying profitable is not going to be an easy task. The new entrants are going to be faced with higher costs compared to those of the existing players.

Technology is going to be the single biggest investment these new banks will have to make and it is very expensive, especially if it is imported.

To be quick off the block, they will need experienced people. So, they will have to have a mix of senior retired people from the public sector to run their operations and snatch some stars to run their IT and credit. Sound lending holds the key and there is not much talent around to ensure a correct mix of risk and return. Bankers who mistake sound credit decision-making with fancy terms like ‘risk management’ are going to pay a price.

I would be betting more on banks promoted by industrial houses (if they are licensed) rather than standalone players. They would be the ones with ability to bring in large amounts of capital. The NBFCs that have applied for licences, to my mind, do not have what it takes to run a bank over the long term. They are perhaps more interested in starting and then make an exit by selling out to a foreign or a domestic player. The NBFCs that have applied are already leveraged and pumping meaningful sums of equity into banks is going to be tough.

For investors, picking and choosing is not going to be easy. Further, it is unlikely that anyone will offer equity at a fair or reasonable price like HDFC Bank did when it got listed. So if you have to buy a banking stock, the odds are in favour of buying an existing one rather than a new one.