March 6, 2008

ICICI bank news - some comments

Deepak has posted on the current news around ICICI.

See - ICICI's Disclosure See-Saws: Openly Making Fools Of Us

Following is my comment . You can read the discussion and all the comments on his blog

Deepak - Although it would be good to have more disclosure, it may be risky for a bank to do so also.

In addition the changes in the loss estimates seem to be consistent with what is happening in the market. For derivatives, accounting requires that the losses of mark to market are passed through the P&L even if the contracts are held to maturity (see this year's berkshire hathaway AR for some discussion on this)

So as the markets are deteriorating, the mark to market losses could increase and the bank will have to recognize them. This is also consistent with the banks claims that these are held to maturity and may not have losses (similar to a goverment bond portfolio where you may have mark to losses, but if you hold the bonds to maturity there may be no losses).

I am not saying that is case with icici, but it may be possible. Also icici may be communicating only required information, but i really doubt they can fudge the data without a serious consequence.

Regarding the solvency, the bank has a networth of almost 12bn USD. Even if they lose 50% of their derivatives portfolio, you are looking at a drop in the CAR from 15% to somewhere around 13-14%. Not good for the stock, but definitely not a solvency issue. In addition the bank has a lot of assets on the books at book value like their insurance subs, icici direct etc. so they do have some hidden assets too.

disclosure - i am neither long nor short this stock

Additional points

The above discussion does not mean that I think ICICI is a good investment or otherwise. A 250 Mn USD loss is still less than 1% of the asset base of the bank. The bank has a 1.47% Net NPA on its books. I am not sure if a 1% increase in NPA would have created such a hysteria.
On the contrary the bigger risk for the bank is the retail portfolio and NPA’s which can develop in the future or other hidden liabilities on the balance sheet.


Anonymous said...

Hi Rohit

Agree completely with your views.

We are amidst a classic bear market syndrome where every piece of bad news is magnified 10x times. Nobody commented on this when ICICI made provisions in the previous quarters. There seemed to be no sub prime crisis hitting our shores when stock prices were going up.

As credit spread have widened ICICI has to make MTM provisions. Till the time the credit goes bad, these are pure accounting provisions and I dont think anybody is talking about credit going bad. If we are then the probability of a credit going bad on a CDO is as high or low on a plain vanilla balance sheet lending that ICICI would do.

Coming to the more interesting part. The stock has lost about 15% post this news. Its market cap if I remember right is about 1 lac crore now. So we have lost about 15,000 crores of market cap bcos of a potential additional 200 crores of provisioning ( and not loss ) that they would do in this quarter. Welcome to the world of efficient markets.

I m sure a value investor/ special situations guy who rub his hands in glee :-) provided we assume that the stock was at fair value before this news.

I own some stock but looks like a good time to pick some more.



Gaurav said...

Spreads in UK and US are suggesting a 1929 style depression, which is unlikely to happen. I will bet ICICI will write back most of these MTM losses when spreads narrow. Unless of course, ICICI is lying about their underlying collateral and have dabbled in mortgage stuff. With an international book of $25bn out of $100bn total, it is possible. Even then, this is not Citi - any quarter net profits are more than sufficient to cover the losses. So there wont be any -ve net income and no decline in CAR ratio.

Rohit Chauhan said...

Hi gaurav / ninad

i have been avidly following the credit crisis in the US and other places. not that i understand all the complexities involved.

what is find interesting the is the tendency to draw a link between citi / meryll and indian banks. i would draw that link only if a detailed analysis of icici or any other bank showed that their books carry a lot of CDO/CDS and other derivatives.

ninad - i have not done that analysis myself and hence cannot be sure if icici is undervalue or not. but at the same time i am not taking the news reports on face value ..they have a more shock element than facts

i bought icici bank way back during the was a simple to understand the operations then. however i moved out around 2003, when their NPA's became high and the bank started getting more and more complex.

icici, citibank and these financial instituions generally fall in my 'cannot be sure' pile most of the times because they are opaque, too complex and one has to depend completely on management

Deepak Shenoy said...

Thanks for the comment Rohit. There's more dirt coming around. They have CDO exposure in which approximately 65% are Indian cos (they won't say who) and 35% non-Indian. CDO structures are such that even in senior tranches, more than 15% defaults will result in losses. even if you consider Indian companies have NO risk, the others pose a problem.

This is not a solvency issue to me - it's more like overpricing. ICICI isn't a value pick anyhow, it's doing 2% (pre MTM!) EPS growth and has a 30 PE, even at current prices.

To Ninad: I had noted this problem much earlier, when they had mentioned the write downs. I've been talking for six months or so about how we will eventually get hit with Subprime, and I was not alone - so it's not like no one was looking.

Anonymous said...

Hi Deepak

To be honest I havent gone thru your earlier blogs on ICICI. My comment was not directed at your blog but a more generic level statement on the current phase of fear that is all pervasive in the markets as opposed to the greed that we saw a few months back.

When one reads some of the financial dailies and the so called experts on the channels, it amuses me on how views toggle from one extreme to another. The media never noticed provisions made my ICICI in the previous quarters and now all hell seems to have broken loose.

Also one can take a view whether ICICI is overvalued or undervalued and to be honest I really cant comment with certainity on the same, but it looks irrational for me that it should loose 15,000 crores of market cap for a potential 200 crores of additional provisioning this quarter.

It is irrational how the entire banking pack has got hammered down 15% thru the week. I dont think the second level PSU banks know what a CDO is leave alone having exposure to the same :-).

On that lighter note I would sign off saying that there could however be a potential black swan hiding somewhere in the banking sector and might catch all of us by surprise.


Deepak Shenoy said...

Ninad: Interesting point - do consider that the market cap loss has more to do with the overall market (which fell what, 9% this week?) and the subprime issue was only supplementary. ICICI deserves to fall a lot more.

Also the provisioning of 200 cr is just fallacious. They need to provision at least 700 cr., and since January the spreads are up nearly 20%. By March end we may see a provisioning need of over 1000 cr. 1000 cr. is pretty much all of their quarterly profit.

I think the press was right to ignore the provisioning earlier - it wasn't a big deal because the amount was so small (100 cr was revealed in one q and then 160 cr. in the next) Right now, it's like 1000 cr. which does send alarm bells ringing.

Btw, Bank of Baroda is a "second level PSU" - it definitely knows about CDOs, given that they have just announced exposure. Most PSU banks are aware of securitisation, as most of them practised it as "factoring", a concept that has lost favour since the Harshad Mehta scam.

Yes, there are surely black swans waiting to hit. We'll never know what's hidden out there. Know if ICICI took a Yen denominated loan? The rupee just weakened 3% against the dollar, and the dollar weakened 15% against the yen. ICICI is supposed to have $1.5 billion in yen loans taken in September - the hit on that just moved up by nearly 680 cr. Interesting times! Point taken though - we just don't know what else is in there!

Rohit Chauhan said...

hi deepak/ ninad

great points. i think all of us agree that there a lot of risks and unknowns with icici bank and maybe other banks too.

that is one of the reasons for my discomfort with banks. the more i have read on financial institutions, the more you realise of the unknown risks. In the end banks are leveraged institutions with opaque balance sheets. you have to trust the management to be honest and intelligent risk takers.

as buffett has noted, it is easy to lose money if you are leveraged 10X times your equity (as in banks). so black swans are more likely for banks due to the leverage

In case of icici the NPA have increased by 1300 from mar 31 to dec 31 2007. this after provision 1100 crs in the 9 month period (which would include the above derivatives related provision).

deepak - 1000 Crs of additional losses per se are not catastropic . but the market thinks that this may be the tip of the iceberg for icici and as you point out, there may be more losses on the way.

Also the mcap losses is not limited icici and other banks alone. almost all companies have crashed. so if you had some good companies on your radar, they may start getting tempting

Rohit Chauhan said...

i know a lot readers may not like what i say - but there several banks and companies which sell at very high valuations.
these are good companies , doing fairly well. but based on their recent performance, expectations are high.
a small change in sentiment, even for the sector such as banking, capital goods could hurt the stock price badly

Anonymous said...

Hi Deepak / Rohit

Let me at the outset apologise to taking up space on your blog to having this tete-a-tete with Deepak :-)

Rohit, I agree we are going to see further PE contraction in sectors where a lot of expactation froth is built up like capital goods, power, real estate etc

Its becoming a self fulfilling prophecy. Banking is down bcos markets are down and markets are down bcos banking and power is dragging it down. We are building up a downward spiral similar to the upward spiral that we built a few months back.

BOB to me is a frontline PSU bank for me akin to a PNB, Corporation. I meant the vijaya bank varieties.

Also the securtisation market in India is largely a recourse market and I dont think the quality of retails assets in this country is as bad. I must admit that RBI as a central banker has done a commendable job of being always ahead of the curve.

The yen loan arguement is fair however one needs to factor in the duration of the paper and hence not look at short term currency movements. It could also be currency neutral depending on the currency that the money has been deployed in.

Clearly the twin focus at ICICI bank at this point is Rural and International business. As the bank spreads it exposure internationally, it is fair that along with all the other risks that the bank takes up, one would also get exposed to currency risks.

Lets look at the US subprime crisis. You will agree that all of us ( and i m not saying this out of hindsight) knew over th last year that what was happening in the US was not sustainable. The question wasn't about whether the party will end but when the party will end.( Its like the last drink that u keep having wanting to experience a higher high till u finally get sloshed and the associated hangover). There was a fundamental problem and now its time to pay the bill.

Do u see a fundamental problem in the quality of ICICI managment, its disclosures or the way it is doing business. If u do then time to quit the party and go home. But if u think this is just a temp blip in the radar then a 1000 crore provision wont alter the long term story of the organisation.

What price to pay for the stock in terms of value is a different story. I might not buy the stock but I m not willing to write off the organisation.

On a different note guys i think good time to start putting money back into stocks.