These Value Traps Have the Potential to Wipe out Your Capital - The 5 Minute WrapUp by Equitymaster
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These Value Traps Have the Potential to Wipe out Your Capital

May 18, 2016

In this issue:
» Jim Roger's take on the world economy and investments
» Missed opportunity from low crude prices
» Market roundup
» ...and more!
Madhu Gupta, Research analyst

India's banking system continues to battle the war against surging bad loans.

And the Reserve Bank of India's call to clean up stressed books by March 2016 has added to the burden.

The aggregate bad loans of the 26 banks that declared their March 2016 quarter results jumped 87% YoY resulting in a 132% YoY surge in provisioning.

Six private sector banks managed to grow earnings, whereas seven public sector banks slipped into the red during the quarter. Overall bank earnings slumped 98% YoY, but the dismal financial scorecard of public sector banks clearly stands out.

Are the economic slowdown and the poor financials of India Inc alone to blame for this washout?

The problem runs deep and has more to do with poor management at state-run banks.

The gravity of the situation is evident from the fact that Syndicate Bank wrote off a whopping Rs 8.8 billion in the March 2016 quarter due to fraud in its Jaipur branches over the last four years.

Reportedly, the bank's fraud management systems could not detect the fraud as loans of Rs 20-25 million each were extended to more than 350 accounts based on fake documents. This is ridiculous and bizarre.

As a result of this gross oversight, the bank has posted a massive loss of Rs 21.6 billion for the quarter. The bank's former chairman and managing director was arrested in 2014 as part of a cash-for-loans scam. But no lessons were learnt then.

Other than poor risk management and fraudulent practices, public sector banks reek of high government intervention and unionisation.

IDBI Bank is a classic case of lack of the autonomy that has impeded the efficient functioning of public sector banks today.

The bank was set up more than five decades ago as a term lending institution but has failed to come out of the shadow of its former self and is facing an identity crisis today.

The bank was initially floated as a subsidiary to ward off protests by the militant trade unions. But government diktat prevented it from growing its retail business. The bank merged with the development finance institution in 2005.

All its efforts to transform into a modern bank have met with little success. The acquisition of the private sector bank, United Western Bank, in 2006 did expand its branch network and retail business. But it also added the baggage of unions.

IDBI bank today has a lower proportion of low-cost deposits and operates on thin profit margins compared to its peers. The bank's huge exposure to the corporate segment has led to bad loans spiraling out of control. As of December 2015, the bank's bad loan ratio stood at 8.9% and losses mounted to Rs 19.3 billion for 9mFY16.

The recent passage of the Bankruptcy Code alone cannot solve the bad loan problem that is rooted in the poor, inefficient, and non-professional work culture that exists in the public sector banks today.

The need of the hour is complete management overhaul. Until that happens, public sectors banks will remain bad debt factories.

The StockSelect team, headed by Tanushree Banerjee, has been extremely careful in avoiding the trap of the deceptively cheap public sector bank stocks. The team has not recommend PSU banks from late 2013 until late 2015...when the bad loan problem was coming to the surface.

This strategy meant foregoing many enticing investment opportunities. But they never got stuck in the dangerous landmine of bad loans. Only recently did the team recommend two of the largest public sector banks on the premise that they will survive the NPA crisis and are here to stay.

Do you think that public sector banks are victims of their own misdeeds? Let us know your comments or share your views in the Equitymaster Club.

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2:31 Chart of the day

Jim Rogers is well known. After all, he is one of the world's most successful investors. So whenever Rogers does an interview, we always sit up and take notice.

Recently, Truewealth Publishing Asia conducted a very insightful interview with the legendary investor. One of the questions put to Jim was his opinion on what is going on in the world right now. Here's an excerpt:

  • The world is going to have serious problems because of the massive buildup in debt over the past eight years. It's going to be serious, and worse than the global economic crisis in 2008-2009, because we have so much more debt now. For example, the balance of the Federal Reserve in the U.S. has increased by more than six times.
  • It's going to hit Asia as well. In 2008, Asia had saved a lot of money for a rainy day. But now, much of that has been spent. And China has a lot of debt now. It's going to be worse this time.

We cannot help but agree. The global financial crisis of 2008-09 was a product of loose monetary policies of the US Fed. Americans were encouraged to consume and borrow. All this blew up when Lehman Brothers filed for bankruptcy in late 2008. The rest they say is history.

But has the response from the central bankers to this crisis been satisfactory? Quite far from it.

Not just the US Fed, but even the European Central Bank and the Bank of Japan went in for heavy doses of monetary stimulus, which included keeping the interest rates close to zero. Seven years since the crisis, these developed countries are still struggling to recover. Meanwhile, the massive reliance on credit has only added on to government debt. The chart below shows how debt as a percentage of GDP has only increased since the crisis. In other words, central banks have chosen to solve the debt crisis with more debt.

At some point, this will blow up into another crisis. And that is what worries Jim Rogers because he thinks the next crisis is going to be even more serious.

Massive Buildup in Debt Continues

 Massive Buildup in Debt Continues

This was just one aspect. In the interview, Jim Rogers gave his views on a lot of other topics such as stocks, oil, gold, real estate and the emerging markets. Read on to find out.


What will the Modi government do once the oil prices begin to move up?

Vivek Kaul, Editor of Vivek Kaul's Diary, has written a brilliant piece on how the Modi government has benefitted greatly from the sharp fall in oil prices.

It is well known that the government has been under considerable pressure to spruce up its finances. So when oil prices fell drastically, the Modi government used it as an opportunity to increase excise on petrol and diesel to mop up more funds. As a result, the benefit of low oil prices did not really pass on to the consumer.

Thus, when oil prices start inching up, the government will be in a quandary because if it raises oil prices, there will be a huge public outcry. An excerpt:

  • This time around the Modi government has benefitted tremendously from lower oil prices by raising excise duty on petrol and diesel. It had a tremendous opportunity to move towards a market driven price of petrol and diesel. But if it did that, it would have had to look for alternative sources of revenue.
  • It would no longer be possible for it to continue financing loss making public sector enterprises. This would mean that some ministers would have become totally jobless. It would have had to sell more shares in profitable public sector enterprises and so on. It would also have to look at ways for cutting down on frivolous expenditure that almost all governments indulge in. It would also have to sell its shares in the cigarette maker ITC, which it strangely continues to hang on to.
  • Of course, all these would have been difficult decisions and the government chose to latch on to the low hanging fruit of raising excise duty on petrol and diesel. A huge opportunity was missed out on.

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Indian stock markets languished in the red today on the back of persistent selling activity across index heavyweights. The BSE Sensex was trading lower by 110 points (0.43%) at the time of writing. Losses were largely seen in information technology, FMCG and auto stocks.

4:56 Today's investing mantra

"If a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result" - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Madhu Gupta (Research Analyst) and Radhika Pandit (Research Analyst).

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7 Responses to "These Value Traps Have the Potential to Wipe out Your Capital"

Thirumurthy R

May 20, 2016

Shri Logan's comments to the effect that unscrupulous corporates have stopped servicing their loans after the NDA came to power reveals more than it probably intended to. Has India's power play of bitter political rivalry reached its nadir such that corporates favoring one political dispensation would go to such an extent they would wreck our PSBs under pressure from their erstwhile political bosses? Did their loans and profits actually flow to their past bosses? If NDA had not come to power would the bad loans mess be not as serious as it is now? Or, in the alternative, has the NDA given a carte blanche to these corporates to go easy on debt servicing? Alas, as common men we can only wait and see for ourselves some glimpses of the actual truth from actual actions as and when they happen. Even then our own political predilections would color our perception. However, it is not unreasonable to assume that the present political dispensation appears cleaner than the past one.
There is also a third possibility that there could be taking place a very real power play between crony capital corporates who don't seem to get much access to the corridors of power, as of now, both literally and metaphorically, in the present administration, and they may be trying to put this administration 'in its place', by bad debt servicing. After all, PSBs are the Government's babies!
The Insovency Act when it kicks in would do a lot in addressing this problem.
However, some unique legislation tightening the screws on defaulters, is badly needed for India whose Banking system is also unique in the world. Debtor's prisons of the 17th and 18th century England and other European Countries maybe necessary, (history repeats itself, remember?) with built in safe guards against genuine defaults due to reasons beyond the control of the borrowers, in keeping with the zeitgeist of 21st century humanism.
India should and will think and act out of the box when it comes to fashioning a future blending the past and the present, both so amazingly unique and variegated.



May 19, 2016

This refers to your coverage of the bad loans mess of India's PSBs.
Nationalisation of Banks was the greatest blunder, though the goal was socially laudable in that priority sectors were identified and financed. In spite of all these years of priority sector lending the unorganised sector which constitutes a good chunk of our GDP is still an under-banked sector. Nationalisation only opened the floodgates for political interference in the functioning of Banks. It encouraged crony capitalism to such an extent that the Kingfishers of India caught a lot of hefty fish and flew abroad in flamboyant style with their money. There could be a lot more in the system even now. The Panama Papers could reveal a lot of diversion of our Bank loans, apart from black money stashed abroad by tax cheats. Maybe we should improve the resources of our financial-cyber-forensic expertise to trace them. Maybe the Governments of countries who could help us trace these funds would respond to us positively because of our international and diplomatic goodwill built up strenuously over the decades.
It is a toss up if our RBI Governor has gone overboard or not in gunning for transparency and high rectitude in identifying bad loans according to Basle norms, devised and imposed on global financial institutions by developed countries while their own famous Banks cheated and manipulated the LIBOR to their advantage, to mention only one of their shady operations. Who is going to read the fine print about the story of bad loans of PSBs that says the figures err on the side of abundant precaution and that many of them will be recovered and may not result in write offs or actual losses? What matters is perception, particularly in the Banking sector which relies on trust more than any other aspect of macroeconomics. And that perception has to be improved now. One way we can do that is to bring to book people like Mallya, because if we do that, that is news and that is perception. Simultaneously we should be injecting capital into the PSBs. The Supreme Court has also taken suo motu recognition of the Indian Express report in March about bad loans written off amounting to Rs.1.14 lakh crore and directed the RBI to submit to it the list of such loans, rejecting RBI's argument that the information sought violates the fiduciary nature of the Banker-Borrower contract. It is to be hoped that like in the earlier cases like 2G and Coal cases the Supreme Court would let the light of Law to shine on the shady goings on in write offs of large loans of well connected borrowers. The outcome of all this may bode well in the long run.
We all owe a word of appreciation to the International Consortium of Investigative Journalists which has released the Panama Papers due to which at least one country's Prime Minster has resigned and another had to answer in Parliament, and many other political/financial power holders are becoming increasingly aware that this millennium is all about whistle blowing and 'hacktivism' of a positive kind resulting in social and financial justice. These power holders will graduate to a higher level of integrity as a whole. It is only a question of time. Maybe Banks the world over so far have been milked by these power holders resulting in the common man bearing the resulting financial burden. This also will have to change. Again this also is a question of time. We also should acknowledge the work of people like Shri Shanti Bushan who initiated the Public Interest litigation regarding Bank loans and write offs and Dr. Subramaniam Swamy who doggedly pursues his legal battles against the political elite ( top echelons of politicians, bureaucrats and businessmen). They may and do have their drawbacks but theirs is a cause the intelligentsia should empathise with and give a leg up with constructive criticism, rather than destructive criticism in acerbic words, all for the larger good.

Like (1)


May 19, 2016

Banks have two primary functions i.e., 1 Accept Deposits and 2. Lend to borrowers. The cannot stop either of these responsibilities.

Banks cannot be faulted for systemic defaults. It will be interesting to note that the unscrupulous Corporates stopped servicing loans since the NDA Government came to power.

Like (1)

N Nagaraja Rao

May 19, 2016

I applied for an ATM card in Canara Bank where I have an account on 29th.February this year. I was told that it will take 15 to issue the card. One month passed by and nothing happened. I wrote to the Chairman hoping for a tough call. Nothing happened and my mail was forwarded like a postman. It took me two months to get me an ATM card. If this is the state of affairs what can you expect from these PSU banks other than NPAs.

Like (1)

Moiz Tankiwala

May 18, 2016

Always analysis are to the point and easily understandable. You may refer to Mr Vivek's observations on Vijay Mallaya loan Credit Rating. Hence Credit Rating agencies are also equally rather more responsible for bank's NPA increase and performance.

Like (1)


May 18, 2016

I strongly condemn your wording "the bank's fraud management systems could not detect the fraud".
You have to understand one thing. The trouble started after the great economic slow down. If you do a manufacturing business and you are unable to sell your product either domestically or by export, then you shall know how to repay the bank loan.
1)You name any product; there is a duplicate at half the price is available in the market(these are produced by evading tax. I hope you shall agree). For example, just make a look around Mc donald outlets in Mumbai. How many food chain around and their business is more than Mc donald. Similarly in every industrial and electronic products.
2)India is the dumping ground of Chinese products.
China produces more than the world needs.
You are the media.
You can easily bring to the attention of our government.
Rather than criticizing, please bring to the notice of our government.

Like (1)


May 18, 2016

If what an expert says, holds like a math problem with simple and unique solution, there could never be political instability, there could never be speculations, there could never be business...... We all see through is a smokescreen each day!!! Till there is no clear vision of future, our future is secured!!! Remember me as Jayesh Shah

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