Asset Quality and health

I have been pretty busy with my work for the last two months (OK I was too lazy to write a post) but the current happenings in the world economy has forced me to comment on the ongoing crisis.

Based on a bit of research ...I have found the following to be the reason of the current crisis .. more clear info on this page


1) A shakeout of the investment banking business model... Where people went long on long term mortgages with short term debt from more aggressive investors or banks
2) Lack of transparency on the value of the underlying assets ...More complexity in reporting
3) A fundamental premise that real estate assets have only one way forward...UP

Now wat lessons can we learn from this crisis situation (especially from an Indian economy point of view)

1) Health and value creation is key --- at the end of the day from a "Layman's" point of view ...you need to look for the balance sheet health before looking out for growth... companies with better balance sheet are more likely to weather this credit crunch period as compared to companies dependent on bank Overdrafts for fueling operations.
Verify ratios such as debt to equity and interest coverage ratios before looking out for income growth rate and revenue growth rate

2) Retail and Mortgage loans are intrinsically more riskier as compared to corporate loans...Although the returns might not be commensurate with the risks for banks.To further stress this point let us consider the case of ICICI BANK (the god of all banks in India)...The banks asset composition is as follows




As shown in the figure RETAIL FINANCE accounts for a whopping Rs 1,292 Billion (or 65.2 percent) of its assets.The below figure shows the composition of the retail finance loans




Out of this Personal loans, Automobile loans, credit card and Home loans combined together contribute to 80 percent of the total loans.The underlying assets for these loans are not "self income generating" meaning unlike enterprises , capital loans or commercial loans the underlying assets in case of these loans are used for luxury purposes and are repaid by individuals whose "credit quality" are questionable or subjective and depends on several uncertain factors such as economy, employment and "repayment capability"


In its most recent quarter the Company reported about Rs 60 Billion in Non Performing Loans i.e approximately 10 percent of its total retail portfolio size . This ratio is pretty high when compared to its total NPA to total asset ratio of around 3.5 percent...The Company is also not that gung ho about retail loans anymore...infact they have
reduced on their retail loans as per the Company management

As we have said we
stopped doing business on the small ticket personal loans in
the month of November 2007 and that book is still running off.
So, once that book runs off say by the end of this calendar year,
one would see a lower impact in terms of provisioning on that
count. Overall we continue to be quite cautious on the retail
lending which I guess would be apparent from the retail loan
growth that we have seen in the current quarter and may be in
the last two or three quarters. We have tightened our credit
screens over the last six or nine months and we think in the
current environment with interest rates rising, inflation at a
higher level, we would not want to aggressively grow on the
retail side right now.

Clearly, retail loans are a pain area for banks.And banks with utmost exposure to the retail side of the business are likely to get fucked up in near to medium term.

3) Are we seeing a situation similar to sub-prime crisis here in India?

Ans: the real estate industry has clearly peaked during the last 3 years and is expected to dampen. Banks have become more cautious about their credit screens...and every Tom Dick and harry in a software Company with a total experience of 2 years wouldn't be getting housing loans for now....previously they used to get loans

But wat will happen to the loans already dipersed...only time can tell...depends on whether the employee taking the loan is leveraged (a typical leveraged employee earns approximate 70,000 per month but has EMI of 45 K for home, 10K for car ), the chances of him becoming unemployed ( once he becomes unemployed the risk of him coming under the NPA list is very high), income growth and as such the income generation capacity of individuals.


In a recessionary environment the chances of all this happening is pretty large . Consequently, although, a situation like the sub prime crisis appears to be far fetched, it does'nt look impossible.We would be able to analyse this situation in a better way once we have data on

1) the token size of each loan provided, te corresponing loan provided and the income generation capacity of each loan taker
2) the industry served by the loan taker (software, investment research and other service oriented industry might be risky currently)

I would get all the relevant data in a later post and analyse the gravity of the situation ....

As of now ...be careful...keep your cash, job... buy commodities and stock them and weather this downturn....

The Sky has started to fall

i feel like bitching about the current status of the economy today

The last ten- twenty days have been pretty eventful ...what with the international summit on oil prices,more evidence of a global slowdown, increase in interest rates and the tanking of the fundamentally strong indian growth story...Guess the reality stocks and Banking stocks were the most affected...

whatever...My line of thoughts started with this small EMI calculator provided in QVCs website ...(a pretty useful one)

http://www.qvcrealty.com/resources/index.html...a pretty cool resource for calculating home loans....and repayment schedules..

My line of thought flew like this ...Let us assume I take a home loan worth Rs 35,00,000 from a bank at 11 percent (the current interest rate)for a duration of 15 years...My monthly EMI falls around Rs 37,000 per month for the next fifteen years...(I for one would be daunted by the nature of this recurrent payment)

Let us assume that an average software-engineer cum houseowner has taken this liability...he will have to pay about Rs 37,000 every year for the rest of his productive life to repay this loan(25- 40 years) ...All is well when things are going smoothly...The problem with this guy is...he is highly leveraged

Let us say the current economy plays the villain and jobs are slashed (the likelihood of it looks more probable as days go)...any job loss would have a direct impact on the guy's repayment capacity and inturn NPA figures of banks...Key things to be noted
1) Current salary levels are the highest in the industry...I dont see any significant increase going forward (what with new taxes and a depreciating dollar)
2) While the education industry pumps lakhs of software engineers into the economy the number of jobs in the IT industry are likely to remain same if not decline in the medium term.
3) Approximately 30 percent of ppl in the industry are on the bench (currently)

In short, highly leveraged lifestyle of SW engineers, volatile economic conditions , stagnating industry structure and chances of job slashes are directly pointing at a looming housing loan fiasco.

Of course dual income families can safely wade through this threat...but overall the Sky is falling :)

US Deteriorating?

Last weeks news involving

1)The bankruptcy of more than four airlines within a single week
2)the rescue of more than 200 childrens from the poligamist church and
3) of course the news of Bears and Stearns planning to sack a considerable chunk of its employees in the coming quarters

makes me wonder if the US is losing its touch.It is intersting to note that a country known for upholding the rights of women has left the poligamist cult survive this long even after arresting its head during 2001.

Being a hardcore believer in capitalism I have always liked US for its cultural values...but recent news about the crumbling capitalism in the country is pretty disturbing.

Jim Cramer--- Bears Stearns is safe and healthy :)

Randy Pausch - a great man who I always admire

The Reason for the crisis explained in a funny way