Bad NPA is a symptom not a disease!!

It generally happens quite often that we try to cure symptoms rather than the disease and believe that the disease will go away. Same is the case with many of public sector banks’ rising Non-Performing Assets (NPA). When most of the media & experts are fixated on “NPA” trouble, much less attention is paid as to what has caused such escalating NPA situation in first place. In true sense bad NPA is symptom which is reflection of the disease called “Nexus of bad credit analysis habits & outdated credit analysis and appraisal processes with poor loan monitoring, hyper competition among banks (aggressive lending practices), political pressure on public sector banks to clear the loans and bribe for the loan”. Main focus in this bog is on bad NPAs which are created because of any of the above reasons. Good NPA is genuine case of company which is struggling to repay the loan due to some external and internal business factors. Imagine that you have taken a loan from bank and after sometimes for some reasons you are unable to pay EMI for 3 months, then your loan will be called NPA. Further, banks are required to classify NPA under sub-categories which are; 1. Substandard assets (If EMI is not paid for 12 months or less), 2. Doubtful asset (If loan remains as substandard asset for 12 months), 3.Loss asset (As per RBI, "Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted”). I shall try to highlight the bad NPA disease and possible cure for it.

1. Bad credit analysis habits & outdated credit analysis and appraisal processes with poor loan monitoring: When RBI governor himself stated that laxity in credit risk appraisal and loan monitoring is one of the reasons for rising NPA, he was just re-confirming & accepting what everyone knew for years. By no means am I saying that only public sector banks (PSBs) have bad habit of credit analysis & appraisal with poor loan monitoring. Many of private banks are also burying the credit analysis &appraisal process. We all have received calls from private banks for pre-approved loans or instant loans and what not, the question strikes me have they done proper risk analysis & appraisal in each of this case? PSBs which are known for its laxity this problem is much bigger. Many of the credit analysis processes are outcome of bad habits of the person in charge for credit analysis and appraisal. Many of the PSBs are still in love with typical financial statement analysis (majorly done through various financial ratios) and to an extent 5 Cs (character, capacity, capital, collateral and conditions) analysis of credit. This was good in old time but in changing credit risk dynamics and constantly changing economic/sector/company dynamics, it is not going to be enough. Poor loan monitoring (for quantitative assessment) and not keeping in touch with borrowers (for qualitative assessment) has always been welcome activity at PSBs.

Cure: Much needed proposal from government to create stringent appraisal system for infusing efficiency and transparency in government owned banks is a welcome step. This change will go long way to clean up PSBs culture in general and credit analysis, appraisal and monitoring specifically. Time is ripe to create CIBIL like institution which has similar set of work scope but for all type of loans (mainly corporate loans & others) taken by other than individuals. This CIBIL like intuition can generate CIBIL like credit score through centralize system which is created based on borrower’s past history with repayments of the loan and other factors. With the help of centralized neutral agency's credit score at least wrong selection of the borrower (happens with many PSBs) which is also contributory to NPA can be discarded. Many questions are raised at various forums regarding inadequacy of existing mechanism to identify NPAs. Many of the banks including private ones use third party verification agencies’ services as inputs regarding borrower’s financial information, loan proposal etc. These inputs are considered important for lenders. In this case role of third party when it can easily get influence under unscrupulous borrowers or intermediaries has to be put under a scanner. Both the components which are ability to repay theloan and willingness to repay (willful default) the loan should be evaluated. Much is there in terms of checking financial ability to repay but nothing much has gone into understanding and evaluating the willingness to pay. Very interestingly and so far successfully psychometric test designed to gauge borrower’s mind set regarding loan repayment has shown way out for checking willingness to repay. Many of the new generation financing companies are using services of the firms for customized psychometric test for their set of borrowers. Banks can conceive the idea of separate loan monitoring & review unit, which can works towards first establishing fool-proof digitalized platform for monitoring & reviewing the quantitative (financial) and qualitative position on quarterly basis of the key borrowers. Timely review can help generate red flag in advance for the banks to behave more proactively than re-actively. At last, banks should be given more teeth by RBI to recover the bad loans(especially from willful defaulters).

2. Hyper competition among banks (aggressive lending practices): Most of the PSBs have jumped into competition (willingly or by force) among themselves and also with fiercely private banks. There cannot be controlled competition, so as the competition increases all types of banks are going to fight to retain & expand their business which is primarily attracting more & more deposits and extending more & more loans. System can ignore aggressive lending practices at its’own peril, and we do not have to go much back in the history to understand how perilous it could be. Credit crisis of 2008 is fitting example where cheaper cost of borrowing coupled with extreme hunger for business led financial institutions and banks stand ready to lend to virtually anyone interested. We all receive one way or another “pre-approved” loans proposals every now and then. To control the competition in this regards, might not be the wise thing to do, but to put up set of measures to safeguard the larger economic system and bank’s equity stakeholders is required.

Cure: To curb aggressive lending practices which are not that prevalent perhaps among PSBs but more in private banks, apart from regulatory measures there might not be much in arsenal to directly control it. Guidelines by RBI as to what types of corporate loans with various features & customized structures can be issued to what type of eligible borrowers can be first step. Linking person in charge & the credit team’s performance appraisal directly with portion of bad loans (which turned into NPA) approved by them, which may lead to negative appraisal can really curb blind aggressive lending practices. Even sales force’s performance appraisal can be linked with how many sound/bad borrowers they brought to the bank.

3. Political pressure on public sector banks to clear the loans and bribe for the loan:  What if Government sponsored a study report which has intention of identifying to what extent loans in PSBs are granted because of some sort of political pressure or with motivation of some sort of bribe.( I guess I am daydreaming!!!) When one sees that there are around 27 PSBs with the branches spread across India, one would drop the idea of trying to identify to what level the motive behind sanctioning the loan is due to some sort of political pressure or personal favor. Unfortunately, there is no way we can say how much of bad NPAs is getting contributed from this. But we don’t need proof for this, based on our personal experience we know, it has significant contribution to bad NPAs.

Cure: Best cure is to reduce GoI stake over some specified time period below majority from PSBs which can easily eradicate the political influence altogether on PSBs. If government continues to be the owner of the PSBs, then it will certainly burden country’s fiscal deficit as huge capital infusion is need to capitalize these PSBs against NPA and also for compliance with Basel III norms. Another interim solution until reducing GoI stake in the PSBs below majority becomes reality, is hire outsiders (Non- PSBs) at top management level and at mid- level to run the PSBs. One path breaking step taken by government is to separate the Chairman and the MD post which is in sync with global best practices to divided the power for better management supervisory & control.

Bad NPAs is a reflection that when ingredients like bad credit analysis habits with outdated credit practices coupled with aggressive lending practices come together what kind of distasteful dish is created which has garnishing of unending political favoritism and insatiable personal greediness. But this can also change!

Corus Plc Acquisition leaving bad taste in the mouth of Tata Steel

Tata steel emerged victorious after series of heated bidding rounds (final bid (the first bid was made by Tata steel at 455pence/share) from Tata was 608 Pence / share, against Brazilian rival CSN’s bid of 603 Pence/share) for acquiring Corus Plc for around $12 Billion, only to see that after some 9 years it has to start disinvesting Tata Steel UK in whole or in part. One of the key plants (Scunthorpe steel plant) is sold to Greybull Capital Llp for nominal value of £1 which includes investment commitment of £ 400 Million and financial packages from Greybull. Undertone has changed in last nine years, from everyone was being so euphoric talking about advent of new era where Indian company was (Tata Steel) taking over global giant (Corus Plc) and becoming hot topic for every other research article and case study, to critically appraising bad acquisition and being pragmatic by cutting the loss and adding yet another story piece to library/case study/research article on how acquisitions go wrong. Let’s try to do quick anatomy of this acquisition deal. The idea is not at all to criticize or disparage this deal because that’s easy & so many mindless (and few genuine) are doing it (I admit honestly it’s very easy to comment or to do post-event analysis of anything and being Indian we love to be judgmental about everything!) but just to touch upon few points which may be interesting to explore further.

Though the potential benefits of the Corus deal were widely appreciated at the time of deal, but I’ll be focusing on few downsides.

1. Biting off more than one can chew – Competency to manage larger & diversified organization: It is always enchanting to see David taking on Goliath in business world. In world of acquisitions unfortunately just winning over Goliath (by exorbitant premium payout) is not the end of the story, here David (Acquirer) has to actually manage the Goliath(Target) profitably over longer time frame to be considered it as true victory. Imagine one company is trying to acquire another company which itself is the product of two companies merged eight years back and trying to settle down. Well, this is the real story of Tata steel acquiring Corus Group Plc which was new entity coming into force in 1999 as merger of British steel and Koninklijke Hoogovens. One of the very reasons of this merger was to put life into dying British steel which was incurring losses. After the merger of two entities, Corus Group Plc was consisting of huge diversified product portfolio (Diversified product portfolio is considered to be one of the foremost reasons for acquisition, but what acquirers forget is whether they can manage effectively this diversified product portfolio or not especially when they are lacking expertise of this, based on no such experience in the past) having four divisions and the core business comprised of manufacturing, development and allocation of steel and aluminum products, variety of services like; design, consultancy, technology etc. Corus Group was 2^nd largest steel maker in Europe having revenue of £ 9.2 Billion, having 42,600 employees spread across 40 countries before acquisition. Tata group might have got too much of confidence & guts from group company Tata tea’s successful acquisition of giant Tetley- four times bigger company in the year of 2000. But it seems Tata steel never got the competency and expertise of managing huge, diversified, and culturally complex (within Corus Group there was internal conflict going on between British arm and Dutch arm) organization, this kind of organization itself reduces probability of success in the long run. It would be interesting to see and explore why Tata Tea -Tetley was successful as compared to Tata steel – Corus Group, specifically from perspective of managing larger organizations after acquisition.

2. Mountain of Debt: Intolerable burden of debt is capable enough to break backbone of the business. Let me dramatize this whole high premium pay out eventually leading to high debt scenario for Tata Steel. Imagine with aim of satisfying the hunger need you entered in Pizza outlet, here Pizza outlet which was big but having really tough times, seeing you and another few fellows entering the outlet the seller suddenly created big hype and said, “I have only one Pizza left which is of the finest quality and having it will give you some super natural powers and you will be the greatest!” “Whoever bids highest will get this last on earth Pizza”. You started bidding at Rs. 100 for this Pizza, another person also starting bidding up over and above Rs. 100.  Meanwhile, some shrewd fellows understood the whole gimmick and left the outlet. Furious bidding was going on between you and another person in run up to have this miraculous pizza and in hope of converting yourself from Bollywood Krrish to Hollywood Iron Man(Many companies go through this notion of becoming larger than life entities by making grand acquisitions).So much blinded by this elusion highest bid was made by you at Rs. 133.60 which is 33.6% higher than first bid made by you. Only to realize that you have won the so called miraculous pizza but you have only Rs.44(roughly 33%) in your pocket and for the rest Rs.89.60(67%), you have to take loan from the banks at interest rate of around 8% p.a. Just to add more spice, imagine the similar pizza you bought was sold at around Rs.89 previously. So, actually you have paid roughly 49 %( From Rs.89 to Rs.133.6) premium over the previous price of the Pizza. Now just take a pause and think, take yourself out from the above drama & put Tata Steel in your place (Where Pizza is Corus Group). Tata Steel paid 33.6% premium per share for Corus over first bid. The final bid of 608 pence/share was around 49% higher than the Corus share price as on 4^th/Oct./2006.And the fun part is almost 67% of total $12 billion of acquisition amount has to be funded through external debt. Around $725 Million (including $400 million of Corus’s existing interest burden) was projected to be paid as interest obligation after acquisition. Funding larger part of the acquisition through external debt (Fancy name is Leverage Buy Out – LBO) has caught up the fancy of every another company but it is forgotten that it is double edged sword which can kill/ severely damage the company and same has happened with Tata Steel.  One can see Quick financial data charts comparison.

3. Curse of buying commodity business at peak of commodity cycle:

If we observe the global commodity cycle for steel, it picked up at all time high during 2007-08(Steel, other metals and materials were huge in demand thanks to Global economy on its pick and 2008 Beijing Olympics) where steel price was recorded $1265/MT in June of 2008. From this pick due to demand of steel waning off (Due to prime reason of late 2008 financial crisis of unprecedented scale - nobody could have got this right so no fault of Tata Steel) price has been falling to as low as $ 90/MT in March of 2016. Tata Steel bought Corus Group in year 2007 where steel pricing was sky rocketing thanks to mammoth demand from China and other parts of the world. Entire demand projection for steel based on this 2007-08 pick (which was important ingredient for projected revenue calculation for acquisition) went for a toss due to huge crackdown in demand as aftermath of financial crisis. Problem of buying commodity business at the pick of the cycle is that Acquirer Company must have while deciding valuation of the Target Company incorporated this pick demand & high price in future projection of revenue which leads to higher valuation of the Target Company & easy justification to pay premium over and above existing market price of the share. It is important to build valuation on worst-case scenario projection basis or mixed of different scenarios based average valuation. Buying commodity business at the pick was never a good idea as once commodity cycle turns down, falling prices create huge pressure on profit margin & sustainability of business. Especially when it is known fact that commodity prices move through different phases of super cycle it becomes very imperative to see that as acquirer you are not caught at the wrong end of the cycle.

4. What’s true goal? Larger than life/Ego-feeding V/S Long term profitable sustainability:  HP’s $11 billion acquisition of Autonomy Inc., Google’s acquisition of Motorola for $12.5 billion, Alcatel-Lucent deal and many more have one thing in common these deals failed massively. There is constant tug of war between whether merger/acquisition fits into long term profitable sustainability of the firm as objective or over-inflated egos (of CEO/Top Mgt.) which compel to do merger/acquisition so that they can have even bigger companies to manage, even larger role to play and justified in front of the BOD that they are doing this for better future growth of the company, and being covered and discussed by every other top media houses & intelligentsia. Many important and eye-opening articles/researches are done on the matter of how over-inflated ego of CEO/Top mgt. has created nasty failures in M&A world and wasted billions not millions of wealth of shareholders. The crux is till what point shareholders are ready to allow their acting agents to go for M&A as per their whims and fancies, how BOD can put control over this. It has been seen that in the heat of limelight and ever increasing expectations from all stakeholders for higher growth even genuine/rational CEOs tend to go down the path of going for disastrous M&A deals in this case strong BOD guidance and control should be in place. Perhaps, Tata Steel also went down this same path where Tata Group’s hunger to be in top ten players by acquisition route in steel industry and setting the benchmark of a sort that how small company from developing nation can still go for giant from developed nation, played big role.

 To sum up, it is very paradoxical to observe that in M&A world which has seen so many failed mergers and acquisitions and relatively very less successful deals in long term, still companies and high profile CEOs get tempted by this mirage and record M&A deals are created. Interested reader can explore this book on failure of M&A.

It is high time to device proper control system for vigilance over decision makers where deal value is huge from stock holders’ perspective. 

Truth is more dramatic and thrilling than Fiction (James Bond movies): The inside story of Mossad - Book Review

Book review:

Book:  Mossad the greatest missions of the Israeli secret service

Authors: Michael Bar-Zohar, Nissim Mishal

Publication: ECCO Publication,2012.

I confess the moment I finished reading up this book, I am no longer a fan of James bond like movies. If I was not cognizant of the fact that, this book is collection of daring & most dangerous missions (at the heart is unbelievable plot-lines of the missions) by the Mossad- Israel Secret service, the book could have easily been considered as one of the superb spy novels.

Consider this, on shores of Gaza suddenly boat appeared which was carrying Palestinians and they were followed by Israeli soldiers in torpedo boat. Eventually, Palestinians managed to escape from the shore with some help from local Gazan youngsters. Rescued Palestinians who claimed to be members of the Popular Front for the Liberation of Palestine, coming from Tyre refugee camp in Labanon. Leader of rescued Palestinians requested to the local Gazan if they can arrange meeting with Popular front commanders of “Beth Lahia”(Terrorist organization) in Gaza, as they have weapons & other vital information to share. Very next day, Rescued Palestinians were called in isolated house, where they met with Popular front commanders of “Beth Lahia”. The moment they sat facing one another, Leader of rescued Palestinians raised his hand and looked at watch. It was signal. All rescued Palestinians pulled out handguns and opened fire, all commanders of “Beth Lahia” in that room were killed. The entire rescued Palestinians team escaped, only thing was they were not Palestinians (members of the Popular Front for the Liberation of Palestine). The Leader was Captain Meir Dagan, Commander of the IDF’s(Israeli Defense Forces) secret Rimmon Commando unit and others were his team. Adding more spice, now imagine this seemingly “movie thriller” plot was not played out in today’s ultra-modern spy world but in the year of 1971. That’s true.

Many other missions like above is the soul of this book. My favorite parts are Ch.1(King of Shadows),Ch. 6 (Bring Eichmann Dead or alive), Ch. 10 (“I want MiG-21!”),Ch.11 (Those who will never forget), Ch.12 (The quest for the red prince) and so on, actually all of the chapters.

One of the most famous missions, the hunt for the terrorists who were responsible for attack on Israel athletes during Munich Olympic in 1972, on German soil is covered in this book. Similarly one of the most secretes and covert operations of bringing “Adolf Eichmann” the cruelest face of Nazi and the leader who orchestrated the holocaust, is simply breathtaking as it unfolds. Eichmann was considered to be responsible for extermination of 6 million Jews.

The chapters in the book are very much detail-oriented yet crafted like script to keep you on your toes all the time. Michael Bar-Zohar and Nissim Mishal have taken a great care by providing sources of information for every chapter, to make it as nearer to the reality as possible. But in my personal opinion reader is advised to take content of the book with grain of salt, as veracity of every content in no way can be validated. Certainly as it happens, there could also be hidden propaganda of putting Israel into “right frame” in world’s eye, so reader should be wary of that too.

In my personal opinion…. (Sorry if it sounds like too patriotic, but then that’s what it is !):

Informative & daring stories of Mossad and Israel, has certainly one thing to teach our country India (and Indians, especially those pseudo secularists) that country itself is responsible for its fate. India should stop begging and crying for help from other nations when dealing with enemies-terrorists. (as every nation has its own political agenda and such help is not free of cost). Every Indian should read this book at least just to understand to what extent the county and its people goes to stand, fight and defend its sovereign and its people no matter wherever they are in the world.