Lending is investing
Banking is a good business if carried out properly; but can turn into a bad business if key principles of investing, primarily lending, are not followed.
When you lend, whether by buying bonds of a firm, or by giving loan to the firm, these key principles remain the same. In investing the primary expectation is safety of capital and secondary expectation, albeit an important one, is profit. Remember someone put it aptly, return of capital is more important than return on capital.
When you breach the rules of the game you end up with a bad investment. When banks do it, it is called non-performing assets. When a loan turns bad you lose all those so-called benefits of debt. You neither get the promised principal nor periodic interest payments, nor you have any control over the firm or its assets. It really does not matter whether the assets are pledged as security against loans.
That a lender has rights to the property and equipment pledged against the loans is good on paper; writing covenants is of little help; in reality is very difficult to realize those assets. It is not a new story, but just ask the banks, they are fresh in (bad) memory these days.
For the firm, debt is considered good because it can increase its return on equity and earnings per share, and also give tax benefits. But then debt has to be good, i.e. the firm should be able to service both principal and coupon payments. Otherwise those ratios can go for a toss. When they do, it is nightmare for the lenders.
Debt investing should begin with an analysis of debt capacity of the firm; in other words, the firm should be able to generate sufficient cash flows in both good times and bad times. If there is no earning capacity during a weaker economy, chances are that both interest and principal payments will be affected. Instead of analyzing earning capacity if the investor relies on the brand of the firm or the promoter, or pledged assets of the firm, he is heading for disaster. This is exactly what happened to the sub-prime loans in the US and also to our local banks sitting on NPAs. If banks rely on appreciating value of the pledged assets alone, it is not good banking, not good lending, not good investing.
Banks seem to be always in a hurry to increase their asset base, but fail to understand that it is the quality of assets that is important not the size. If they have to write-off most or all of their NPAs, they wouldn't be doing any justice to the depositors and shareholders.
Some instances of NPAs: Kingfisher Airlines, GMR infra, Deccan Chronicle, Manappuram Finance, Suzlon, RCom, the list goes on. It is amazing that the lenders were prepared to, and continued to, lend to these firms only on two counts, i.e. to increase their asset base, and assumed that assets pledged will back them during bad times.
Buying stocks of a lender
May be the shareholders themselves are not following the principles of investing when they buy stocks of banks. Banking is a highly leveraged operation that is subject to regulation. But a few bad transactions can wipe out a bank's equity. It makes sense to keep away from such banks. A thorough analysis of the banks' book is a must before investing in their stock - because bad lending by banks will lead to bad investing by stockholders. This analysis is not an easy task; more often, you will know the bad book after it goes bad.
Look around the globe
What is happening around the world currently is primarily because of bad lending. Any lessons learnt? You must be joking, never heard this......what we learn from history is that we do not learn from history.
No comments:
Post a Comment