Another panic – YES Bank

yesbank 05102018

Yet another example of a panic.  This time, it is YES Bank in India.  This time the stock lost a whopping 50% in the space of one month.  The stock had already started declining together with the rest of the banking stocks in late August/early September. It will take a while to explain the chain of logic that led to this but here goes … the markets were increasingly worried about a sliding currency, this in turn is due to recent problems with EM currencies as USD appreciated (as the Fed is expected to raise rates and as 10Y Treasury bond yields break 3%).  This is further compounded by the fact that oil price was increasing due to geopolitical problems (US threatening sanctions on Iran).  And India being a country with twin deficits and heavy dependence on imported oil became an easy target for short seller on the Indian Rupee.  A weaker currency would then lead to higher import prices leading to higher inflation which in turn necessitates higher interest rates.  Higher interest rates is brought about by reducing liquidity in the system and is therefore bad for banks because it increases their cost of funds.  A caveat to this is that this applies largely to banks who borrow from the interbank markets (so called wholesale banks).  Banks who have their own depositor base have access to cheap sources of funds (like HDFC Bank for instance) and are therefore less worried about rising interest rates, which might ironically be goof for them since they can charge their clients more while paying their depositors just slightly more interest on their deposits to appease/retain them.

Now the problem with tighter liquidity and higher cost of funds started becoming a problem to the weaker financial institutions.  One such institution was a lender called Infrastructure Leasing & Financial Services (IL&FS) who started defaulting on its debt in early September.  On 22 Sep, another Housing Finance company Dewan Housing also defaulted on its bonds (its stock tanked 42% on the same day).  This in turn led to a panic sell in the whole Non-Bank Financial Companies (NBFCs) but the panic inevitably spread to the banks as well. The regulators compounded the panic by asking all local fund management houses to declare their exposure to NBFCs as a whole.  I can almost imagine many managers selling down their exposure to the sector before reporting to the authorities.

In the context of what had happened, the Reserve Bank of India (RBI) suddenly announced that it will not renew the term of Rana Kapoor, the Chairman/CEO and Co-Founder of YES Bank.  In fact, Rana Kapoor IS the face of YES Bank, a bank that had only been founded in 2004.  The company was at the right place at the right time and in the next decade or so grew its loan books like crazy and made it one of the biggest financial institution in the country.  There is another long and convoluted story about why the RBI refused to renew his term.  But the short version of it is that the new central bank governor is finally getting serious about dealing with the problem of hidden bad debts in the financial institutions in the country.  Yes Bank and some of the Indian banks were found to have understated their problem loans and have ignored RBI directives to reveal the extent of the bad loans in accordance with RBI’s guidelines and definitions.  RBI finally decided to take a hard line and refused to extend the term of various prominent CEOs to signal to the market that it means business.  This sent the stock down 25-30% on 26 Sep, and more in the days to follow.

My own hunch is that the problem is far from over.  As with all  companies, there are lots of stories surrounding a crisis and YES Bank is no exception.  If you scour the media for news on its founder and other major share holder Madhu Kapoor (Rana’s sister in law and wife of his deceased brother and co-Founder), you will no doubt know of the bad blood between the 2 and the struggle between the 2 for control of the company and the Board.  In the process, it has been speculated that Madhu might in fact be the whistleblower, informing the RBI of the malpractices that have been going on in the bank in the past decade or so.  This may lead to more disclosures of the extent of the bad loans on its books which obviously might cause the stock to take another plunge.

Now the question for investors considering whether to buy the stock, the first question they need to answer is if this company is still going to be around in a couple of years.  If the answer is a YES (no pun intended!), what is the competitive advantage of this company.  Has it built itself a valuable franchise over the years that others might consider taking over?  Finally, the most important question is when is the right time to buy into the stock.  Normally for the case of a stock in crisis (I have written about My EG, Gabungan  AQRS in my previous entries), I would prefer that the valuation is dirt cheap, it is paying a decent dividend (which is a sign that the business is still generating lots of free cash flow and paying them out) and that even the major shareholders think that it is too cheap and are buying back shares with their own money.  So far none of these are true for YES Bank, so I guess right now, we can only wait to see what happens.  Oh of course, we will be watching for the chart to tell us that they are ready to move on by showing a change in trend (50 or 100 days SMA cutting the 200 from below).

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