Economic Hit Men and Various Bonds

23-Aug-10 8 Comments

Rishab asked me to write something about infrastructure bonds which I do later in this post but before that something about the fascinating world of economic hit men (cool phrase, right?).

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Just finished reading the book “Confessions of an Economic Hit Man” by John Perkins. Fuck. What a book. I’m not referring to the writing style (which is good) but the content – a detailed narrative of the ‘corporatocracy’ of the US and the role that “Economic Hit Men (EHM)” played in it. This represents the latest form of imperialism that has played about and for almost all of us, nearly the only one during our lifetimes.

The Boston Herald newspaper likened it to something like a conceptual love child of James Bond and Milton Friedman (Nobel Prize economics laureate and advisor to Ronald Reagan). And that is exactly how I felt as I turned the pages – I kept playing and re-playing the storylines of the latest Bond films in my mind. I don’t watch much movies so Bond films are the only flicks that I can relate to in this context. Please read the book (you must) and if you can suggest some other movies (other than “The Panama Deception“) that resonate with the theme please do let me know.

John Perkins now writes about a lot of stuff on his website but I think that this book will always remain his magnum opus. In a nutshell, this is what is the core theme that Perkins talks about, of the post Jimmy Carter US:

– As the US became more and more powerful, its apetite for natural resources grew larger and larger. It’s hinterland, being as rich as it is, was never going to be enough for this world leader which has 765 (!) vehicles per 1000 people. In comparision, China is at 128 and India is just about at (ha ha ha) a dozen (though it is touted to become the larest car market by 2030)!

– So the US has always wanted to look outside its borders (just like every previous empire building state has done in the past) to secure it’s supply lines.

– But new methods were needed in the post WWII, Bretton Woods era.

– So US interests would identify countries rich with natural resources and with possibly non-democratically elected governments. The phrase ‘US interests’ is used deliberately here since it would later allow for a possible detraction and an escape route to denial and a possible high moral ground.

– Pocket the leaders of such nationalities and send in a team of consultants to the country (these would NEVER be on the payroll of the US Government)

– Cook up statistics and IRR and all assorted crap about a development plan and come up with an investment plan.

– Get the Bretton Woods sisters (the IMF and the World Bank) to provide loans. ‘Engineer’ things such that work contracts (construction activity mostly) were always awarded to US companies. Ensure that such countries remain indebted.

It talks about the assasinations of President Aguilera of Ecuador and President Torridos of Panama. Then about the US invasion of Panama (Dec 1989) to extradite President Noreiga done despite severe international opposition and violation of internal law. Air strikes on a country as threating as Panama? The book notes that the then President George H. W. Bush was under pressure to shed the wimpy image that the US media was heaping upon him. It also questions if killing thousands (though US media reported far far less) to remove one man accussed of drug trafficking, racketeering and money laundering is anti wimpy. The book says that Noreiga was negotiating with the Japanese to build a second canal in the Panama. What was interesting for me to read is that another anti-EHM, Saddam Hussein was castigated by the US for violating international law when he decided to strike Kuwait less than a year of the Panama invasion! I guess we have different laws for different states. But this time I guess Bush was able to shed his wimpy image and see his popularity ratings soar to 90% amongst the Americans and get more international support since Saddam himself was quite a dark guy. I was preparing for my board exams and seemed to miss much of this – who cares anyways when you are the most important point of your academic life. But when the twin towers were felled, I was very much hooked on to the news feeds. I talked about causality in my previous post – and now I wonder if we can see some causal relationship between today’s threat of terrorism on US soil and the policies of post Carter US. Just thinking. Hope no causality exists.

The lure of lucre and the power of world domination is understandable. The English practised their own form of ‘corporatocracy’ using the East India Company as their front. The Portguese did it though the Spanish conquistadors were more infamous and direct in their methods. I am sure even the Gupta empire in early India did it when it touched places like the Malay peninsula, Singapore, Ceylon, etc.

Whatever be the motivation and regardless of the official stand of the Government the book is a must read. It took immense resolve on the part of the author to write the book. Read it.

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From cross border economic shenanigans that look like a lift out from Bond movies to real bonds closer home:

If you remember, the recent Union budget had the Finance Minister announcing the re-introduction of tax saving infrastructure bonds. I remember having picked up some tax saving infrastructure bonds issued by ICICI and IDBI during the period 2001-2003. To save tax. My salary was lower then than what it is now and therefore a penny of tax saved had greater marginal utility, though the opportunity cost was HUGE since the equity markets were shooting up like crazy, picking themselves up from the dot com destruction. Today the situation is different since according to me the opportunity cost has reduced (not too many bargains to be found in the secondary capital market). But regardless of that, saving taxes is a virtue which increases one’s take home pay.

IFCI has been the one first off the block in issuing these infrastructure bonds. Here is the term sheet of the issue. A lot of material can be found on the internet so I will not ham. Check out this post on finwinonline – it covers the topic well. I have the following observations:

  1. All should invest. Period. Currently there is no substitute to IFCI bonds today and this gives you an INR 20,000 additional deduction from your taxable income (Section 80 CCF). Invest till 20,000 unless you are unweight and/or love investing in fixed income instruments. You can invest more, but A) you’ll not get the tax benefit and B) the yield will not be mouthwatering.
  2. While the deadline is 31Aug’10 and you need to have a demat account to apply, no need to fret in case you still have not opened a demat account. Other similar issues will indeed follow but the question is will they be at par or under or higher? (in terms of interest offered on the bonds).
  3. Since India does not (yet) have a deep corporate bond market, the Finance Ministry has done good to institute a buy back option for the bond holders after the mandatory 5 year holding period. Presence of this exit option has definitely made these 10 year bonds quite attractive to investors.
  4. The other good bit is that since these bonds would be sold through the Bombay Stock Exchange (BSE), capital gains tax will apply on redemption (instead of the gains being taxed at the individual’s tax rate) and there will be no Tax Deducted at Source (TDS).
  5. The other important aspect about the issue is the generous waiver granted by the Finance Ministry of the necessity to procure and publish credit ratings of the issue/issuer as part of the issue. This is cool, right (sarcasm)? Is that why IFCI rushed in first off the block? So, according to me, you might not lose much in case you are a bit strapped for funds at the moment and are not apply to the IFCI issue. Also, I am not aware of the % of allocation in case the total retail appications are more than the bonds available. The reason for that is that A) you have a quota of INR 20,000 to fill; B) it is quite likely that local interest rates will rise in the near future; so C) even if you have other slightly stronger issuers (LIC, IFCI, IDBI, other NBFCs?) throwing out their paper, the dip in coupon induced by their stronger credit worthiness may be offset by the rising interest rates.
  6. Appopros my earlier post re IFCI (License to Bank, dt 5Jul2010), I guess I am in two minds now given this development. It may be possible that the banking license eludes IFCI. Some people are talking about the company selling out to a strategic investor. The Government of India has people on the board of IFCI and since extant shareholding issues are yet to be sorted out, I think the banking license trigger may not apply. While the position is 9.43% in the black for me, this is yet another instance where I’ve broken one of my resolves – to never put money on investment theories which have a digital event at the core of their persuasion.

Finally, the last word on the infrastructure bonds is the sense of equality it provides us common folk while our political leaders clamour for two successive salary hikes in two weeks – and get it as well. I think there is an outstanding demand by our leaders to make their salary tax free as well. If that happens, I know that I will puke on my pizza.

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License to Bank

05-Jul-10 1 Comment

The Finance Minister during his Budget speech for the year 2010-’11 had promised new issuances of banking licenses to private sector players and Non Banking Financial Companies (NBFCs). Which really seems to have lighted up hopes and share tickers in anticipation of the grant. It could very well be a grand party, but the RBI promptly stepped in on the back of this announcement (post the Budget ’11 speech and the subsequent soundbytes) declaring that all the norms of due diligence would be strictly adhered to and that a few more screws would be tightened. We all now await the screws. I have a feeling that the apex bank may not be too keen to dole out banking licenses to corporate houses and might toy with upping the net worth criteria (currently Rs. 300 crores). The policy announcement regarding these eligibility norms are now awaited – expected shortly.

I think such prudence is called for, whatever be its reason. The Indian banking sector has come out relatively unscatched from the global banking turmoil partly because of the fact that it’s still small in size in comparision and closed (to the outside world of free capital flows). Seeking a widening of base by inducting new players into the fold seems to be the right thing to do at this point, but will more of the same spread the roots? One of the most important functions that banks serve is to lower the cost of capital available for economic activity. They can do this since they have access to low cost funds – the interest that banks need to pay on current accounts and savings accounts (CASA) is lower that what an institution would have to bear if it were to raise the money from other sources. This therefore lowers the hurdle rate that the economic deployment of such funds should earn.  That explains, in part, what has got the NBFCs and the private financial institutions all excited. But apart from that there are other parameters which also might get considered by the RBI – those of geographical coverage and reach into the poorer sections of the society. I later pick on two institutions (towards the end of the post) which I feel are good candidates, each covering one of these two objectives with one of them also being a prime trading call from my perspective today.

But some history first: RBI seems not to be too inclined towards this policy and looks like it has had to toe the line cast by the Finance Ministry. The last time that this was done was in the early ’90s. In fact, no new Indian bank  has been set up since the advent of liberalisation in 1993. Some of the NBFCs that were allowed to get converted into banks were Yes Bank, Kotak Mahindra Finance Limited and 20th Century Finance. While Kotak diversified into full service banking services, 20th Century Finance became Centurion Bank and was eventually taken over by a bunch of private equity investors only to finally land in the lap of HDFC Bank. HDFC Bank itself started life in the early ’90s and along with Axis Bank (formerly UTI Bank) has become a very successful private Indian bank. Then there was the case of UBS that had to wait for nearly 3 years before getting its banking license from the RBI. The matter had to do with disclosure norms and UBS being a Swiss Bank (perceived to be stolidly protecting of its customers’ interests and assets) may not have been too comfortable disclosing certain information about its customers, including Hasan Ali Khan, the Pune based stud farm owner. Standard Chartered Bank was not allowed to sell off its Mutual Funds business to the UBS Securities. SEBI had barred UBS Securities from issuing offshore derivative instruments for one year.  Was this a tactic to delay, we know not, but for sure what comes out is that the Indian banking scene is tempting enough for global players, burnt from the sub-prime arson, to ignore. Recently, the Credit Suisse group received the green signal to start core banking activities. In December of last year, the RBI finally accorded its assent to convert the Orissa State Cooperative Bank into a full fledged bank. It had to wait for 43 years till it became eligible to sit on the high table. Interestly, of the 31 state co-operative banks, only 15 have managed to secure banking lincenses. The deadline for them expires in 2012.

Given that backdrop, lets look at the names published in the media regarding the current hopefuls: Reliance Capital, Bajaj Auto Finance, Mahindra & Mahindra Finance, L&T Finance, IFCI, Indiabulls, Religare, Aditya Birla Financial Services, SKS Microfinance et al. The CEO and MD of IDFC has ruled out his company from applying. The news certainly seems to have set the shares of some of these companies on fire – with a promise of more to come.

There are two companies that I want to mention. First being SKS Microfinance, which has submitted its (draft?) Red Herring Prospectus (RHP) for its IPO that is soon due. I guess it should also be keen to apply for banking license. While I don’t know what happens in such cases – i.e. when the objects of business change drastically enough to warrant a re-look at the financials, prospects etc, then does the RHP have to be pulled back and re-submitted? While there may be an ethical debate regarding SKS Microfinance and the threat of defaults on micro-lending activity might be higher, the logic that such companies can reach the poorer sections of the society and introduce banking to them is impeccable. The fact that N.R. Narayana Murthy’s Venture Capital (VC) fund Catamaran Investment Pvt. Ltd. may also dip its toe will definitely make people eye the IPO.  Is the Bangladesh based Grameen Bank a full fledged commercial bank? Need to check, but to borrow a line from my previous “Hot Pani Puri” post: Micro sized sales units sold at low prices but in large numbers is the essence of India. But I do not apply for IPOs so no show there for me.

The second company being IFCI. It has been playing quite a tango with the Government so far and seems to be a prime candidate for receiving a banking license this time around – solely for that reason alone. The Government had wanted to divest its stake in IFCI and had made an announcement in early 2007 but the front running joint bid from Sterlite Industries & Morgan Stanley got stopped in its tracks since the Government would not come clean on what it proposed to do regarding the conversion of institutional debt (that IFCI held on its books). If this was to be converted to equity, then it would obvisouly be less attractive to the winning party. So the party was called off. The Finance Minister (Chidambaram) must have smarted privately and had promised to make amends in the future. Given that the banking licenses are now to be handed out, interest in IFCI has peaked and the stock has moved up well. IFCI had earlier made an attempt to make itself into a bank, but that earlier attempt had failed. All others (ICICI, UTI, IDBI, HDFC) went ahead while IFCI was left out. But It looks likely to pass muster this time. What will happen if it becomes a bank? Its cost of capital will come down improving its profitability and new avenues of business will open up. It would be fair to compare it with the valuation ratios of other banks and expect the market to crank up its valuation of IFCI to match these levels.

For the year that ended Mar, 2010, the equity base is Rs. 738 crores and its net worth is Rs. 3,152 crores. Given the face value of Rs 10 per share this gives a book value of (3,152/73.8) = Rs. 42.7 per share. The Current Market Price (CMP) is Rs. 56.75 (before opening bell on 5th July, 2010) giving us a P/BV ratio of 1.32. The PAT for the previous financial year was around Rs 671 crores giving us an earning of 671/73.8 = Rs. 8.55 per share. This implies a trailing 12 month price to earnings multiple of (56.75/8.55) = 6.64. Lets compare that to the number that other banks are reporting:

Incidentally, the reason I’ve highlighted Karur Vysya Bank in red is because that was a trading call I’d entered into at Rs. 475 on 27May’10. Translates to a 25% return in 39 calendar days. The reason I’m digressing is because I am now faced with a decision on whether to hold or sell. Which will be the subject of one of my future posts. When to buy is not the important thing, when to sell is the most critical piece. What do you think? Should I take the money and run?

Now, coming back to IFCI, its logical to expect the share to jump up to a 10x earnings multiple if it becomes a bank and increase its P/BV ratio by 50% to bring it somewhere in the middle of the table. Therefore, lets watch it up to Rs 70 per share giving a return of 23% or so (hopefully). I’m getting in given the above logic, however will be ready with an appropriate stop loss should something spook the banking license party.

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