Dhanlaxmi Bank defaults on interest payment on bonds

This is the first time investors in India have had to forgo interest on a bank capital instrument. We view this as a positive development for a system with a high expectation of support for banks and where moral hazard has developed around the assumption that support could be extended to regulatory capital instruments.

Fitch Press Release

In July this year, Dhanlaxmi Bank defaulted on interest payment on its subordinated debt papers.

This is probably for the first time that such an event has taken place in India. This indicates that even the banks could be vulnerable. The so called safe haven is no longer absolutely safe.

The troubles at Dhanlaxmi Bank started a few years ago when first the top management decided to leave the bank after disagreements with the board on the investment required for growth and then some frauds at the bank.


#RidingTheRollerCoaster – 219


Real estate investment or loan to builder?

In a recent development, the real estate firm Unitech was asked by the Supreme Court to refund the money to home buyers for failing to deliver the homes as per the schedule.

However, the firm’s lawyer told the Court that the firm has no money to refund to the home buyers. (See the news).

Many home buyers probably wanted to buy a home to live in, but some might be buying the property for investment. Having said that, this was a classic case of not understanding the risk one was taking. While these buyers were buying property, the investment would be considered an investment in real estate only after the said property is constructed, all legal approvals are taken and the possession given to these home buyers. Till that time, it was akin to a loan to the builder. If the broker defaulted on the commitment, getting the money back would take looooong time.

Here is a paragraph from the book:

Investors investing in “under-construction” properties are taking a credit risk by making payments to builders. Very often, they consider the property as their security. However, a property, yet not constructed, cannot be considered as a property. Someone would be required to complete the construction, whereas the builder has already got the money, and the chances are, already used it.

This is evident in the Unitech case going by the argument of their counsel. The company has no money to refund, which means the money the home buyers paid to the firm has been used already.

It is important for one to understand the risks associated before signing the cheque.

#RidingTheRollerCoaster – 218

Is it really Greek and Latin? Or is it just a game of musical chairs?

“The adoption of a common currency by these countries in 1999 (Greece followed in 2001) led to convergence of interest rates across the continent. Traders no longer discriminated between the euro liabilities of different Eurozone governments, believing that not only currency risks but also the credit risks that had once distinguished well-managed European economies from those with unstable public finances had been eliminated. …

… By 2007, yields on Greek government bonds were barely higher than those on equivalent German bonds. Several states, including Greece, took advantage of what appeared to be inexhaustible supplies of credit at low rates. …

… As European banks struggled with the global financial crisis, the quality of their assets was viewed more sceptically. Credit risks were appraised much more carefully, and interest rate differentials across the Eurozone widened again. Greek bonds appeared less attractive, as interest rates rose and the refinancing of Greek credit became more difficult. The country effectively defaulted on its debts in 2011.”

This is an excerpt from the book “Other People’s Money – Masters of the universe or servants of the people” written by John Kay.

The Greece government was playing the game of musical chairs. As we wrote in the book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, liquidity was the music in this game. The only difference is when the music of liquidity stops, there are no chairs to be found.

Rolling the credit over and over again is a dangerous game. So long as the liquidity is abundantly available and at cheap rates, the game continues. A few victories in this game makes one believe that one is skillful. However, history is replete with examples of disasters when the music stops.

#RidingTheRollerCoaster – 165

Understand the risk you are taking

Recently, we came across this news item involving two cricketers’ and their investment in a “assured return” real estate scheme. Yes, we are talking about the news involving the Pathan (Irfan and Yusuf) brothers. (Read the news article here).

We will not get into the specific case of what happened here. However, there is a clear lesson to be learnt. The Pathan brothers and many other cricketers have seen a lot of money through their cricketing skills – thanks to their success at the international stage as well as the IPL. When so much money becomes available, the question is, “Where to invest?” This is the time to exercise caution (Too much money, where to invest? Don’t invite the Pied Piper), but usually we tend to become more aggressive as the amount of money makes us feel comfortable and safe.

Some numbers from the said article give us some wonderful insights. Read the last two paragraphs about the price at which Irfan Pathan was picked up by various IPL franchises.

Year              IPL franchisee                       Price for Irfan Pathan

2011              Delhi Daredevils                                  Rs. 8.74 cr

2014             Sunrisers Hyderabad                          Rs. 2.40 cr

2015             Chennai Super Kings                          Rs. 1.50 cr

2016             Rising Pune Supergiants                   Rs. 1.00 cr

As you can see, this is a case of falling income. Some things happen (though I do not know for sure if that was the case; I am only assuming) in such cases:

  1. You anchor your earnings at the highest level and assume continuation of the same. So if Irfan Pathan might have thought in 2011-12 that his base price would keep going up or at least stay there. Did not happen, at least in this case.
  2. When you see the fall in income or anticipate the same, you want to take some chances to increase the income through some other source. This could be the possible thinking in 2013 when the investment was considered.

Whatever the reason behind the thinking, 12% assured return must have looked a mouthwatering opportunity in 2013, especially considering what all happened in that year. (Read our article as a reminder of what happened in that year:  Here are events that shook world in 2013). This was a very interesting combination – a lot of money at hand and the world looked scarier than ever. We seek guarantees in such cases. However, is the guarantee good enough?

Please understand the investment these brothers made was a credit risk taken on the builders. When someone guarantees some return, we are taking credit risk – we are taking the risk that the guarantees would be honoured. We are assuming that both the ability and the willingness are sound. However, we tend to forget the word “risk” when we hear the word “guarantee”.

Be careful. Understand the risk that you are taking. There is nothing wrong in taking risks, but everything wrong in taking it without understanding it.

#RidingTheRollerCoaster – 109


How we react to current events

“Vijay Mallya is a small defaulter as compared to many others” said a post doing rounds in social media. And then the post lists out some very large debtors to the banks. Some of the industry houses have debts more than Rs. 1 lac crores.

What level of financial illiteracy this is? The person who made this post should be sentenced to an accounting school for a period of five years.

There is a difference between debt and default, though the defaulter was a debtor once. But this is like blaming all marriages for the divorces and all deaths to births.

While Kingfisher Airlines has defaulted on its commitment to the banks, those in the lists have a timely repayment track record, at least so far. They are only debtors and not defaulters.

By the way, some people who circulated and forwarded this message live in houses purchases through home loans. Should they be called defaulters or are they just “small borrowers”? Some also trade in stocks on margin or trade in derivatives. This is debt.

How about Government of India, which is the largest debtor in the country? By the way, whenever this largest borrower wants to borrow money, we queue up. And by the way, I have also read about why LIC policies are safe, as the Government of India backs them. The tax-free bonds of some of the PSUs are selling like hot cakes – once again guaranteed by the biggest debtor of the country.

Debtor and defaulter are not the same. Whereas all defaulters were debtors, not all debtors would default.

Though Kingfisher Airlines’ troubles are not new and the default also was public knowledge, the moment the banks’ exposure to Kingfisher became public, people started to panic. Add to it the recent defaults by some other borrowers and that just added fuel to the fire.

Such reactions to current events or the news makes us commit mistakes. Often, these mistakes prove to be costly.

It is important to maintain balance, and it is not easy.

#RidingTheRollerCoaster – 99