The current article in this series provides responses related to the following queries:
- Can we know the true financial position of a Bank by reading its reported financials?
- What should we look at while investing in Banks/Financial Institutions?
- Do we invest in PSU banks?
- How to safeguard stocks lying with Discount Brokers?
Can we assess the true financial position of a Bank by reading its reported financials?
Hello Dr. Vijay Sir,
I had done some little analysis on Karnataka Bank.
Net interest margin (NIM) was in the range of 2.5% until 2016-17. Now we are seeing NIM being an improvement in the range of above 3%. GNPA and NNPA are decreasing from a 2016-17 yearly peak of 4.21% and 2.64%.
Recently they have collaborated with BCG firm for the transformation of the bank. MD and CEO Mahabaleshwara M S looks aggressive to me. Moreover, they are intending to create some wealth for shareholders and investors now. Branches and ATM networks are at a good stage ~800 and 1382. Other operational efficiency numbers are improving quarter after quarter. Capital adequacy ratio looks somewhat concerning at ~12.2% in 2017-18 TTM. However, I think Bank is maintaining their CAR at ~12.5%. They do not have any aim to improve on that front. Biggest improve we see is in NIM margins and NPA improvement.
As we know, they have transformational targets of doubling their business and decreasing NPA percentage significantly in 2020. In addition, as far as I have seen their targets are being fulfilled in time. Some of the concern may rise for the banking sector while rising bond yield. However, I do not think KTK bank has much exposure to the bond side.
I agree ROA is lower than 1% at ~0.65% currently and ROE as well. However, if we see business improvement and NIM margins improvement steadily and loan growth at around 25%. They can go beyond 1% as well. In addition, the Bank, recently, had a rights issue that is why we see a drop in ROE percentage significantly; otherwise, they were in line with another old private bank ~10%. I believe going forward they will also improve to the original level of 10% and furthermore.
As we talked about business. Now let me come to the valuation of the bank.
P/E is around ~7 TTM at 9-3-2018 price. P/B is ~0.66 for the same date.
At this valuation, looks cheapest from privet sector banks. I would agree price might discount previous results hurdles. However, from the last 2 quarters, the numbers are good and are better than the banking sector numbers as well. I believe if they can go by their targets and doubling business, improving numbers efficiency, then after 2 years or so, bank valuation may also demand some premium, which is not there at all. I would like to know is this opportunity for great investment having great valuation safety in this costly market valuation. Or is this some of the traps. Any information/foreside that I do not know.
I request you to help me, with the little analysis that I have done. I would also like to hear what you believe about Karnataka Bank and about its business and valuation.
Hope to hear from you soon.
Thanks for writing to us and sharing your views on Karnataka Bank.
Looking at the outcomes in the banking companies in the last couple of years, it comes out that almost all the banks were hiding many NPAs/bad assets in their beautifully prepared audited financials, which were certified by the best of the auditors in the world. NPAs of banks initially always seemed to be within 1-2%, whereas now most of the private sector banks are accepting that NPAs are above 5% and PSU banks are accepting that NPAs are mostly above 10%. In addition, no one knows about the true extent of bad assets the banks hold in their books.
An investor will appreciate that until very recent times, one of the private banks, Yes Bank Ltd, used to report low NPA numbers. However, it turns out that the bank had a higher number of bad loans, which reached unmanageable proportions. As a result, the Govt. of India and RBI had to bail out Yes Bank.
Similarly, an investor would remember the cases of PMC Bank and other financial institutions like IL&FS and DHFL where despite audits by various agencies, the underlying issues remained undetected over time until these organizations could not cover them up anymore.
In light of the above developments, wherein the hindsight, it seems that almost all the banks lied to the stakeholders in their audited financials. Therefore, we believe that it is difficult to have an opinion on the financial position of a bank by relying on the audited financials prepared by it.
Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?
Almost all the analysts in different brokerage houses/research companies, who used to cover banks and used to read every line of the annual reports of the banks and used to have direct conversations with the management of the banks. Now the analysts also seem to have learned that it is difficult to opine about the health of the bank by relying on the information supplied by the bank.
Therefore, in light of these developments, we find ourselves unable to provide an opinion about Karnataka Bank and your analysis.
All the best for your investing journey!
Dr. Vijay Malik
Please give me a reference (any website, forum, books etc.) for analysis of micro-finance, finance and housing finance companies. I have gone through Peaceful Investing e-book. For the general case, it helped me a lot. However, I want to do an analysis of some housing finance company. I am not able to get any reliable material for this specific sector.
What fundamental factors should we look at while studying annual report and balance sheet of finance/housing finance sector companies?
I am from a science background. Nevertheless, I have a good interest in economics, especially in last 3-4 year. I need your help, please.
Thanks for writing to us!
We believe that it is very difficult to assess the true financial position of any financial institution by analysing its reported financial numbers. Almost the entire analyst community has realized this aspect by looking at the sharp rise in NPAs reported by almost all the banks/financial institutions (FIs).
We are until now, not able to differentiate below two cases from the annual reports of financial institutions (FI):
1) Cases where FIs give genuine loans to one borrower, collect interest and principal repayments and then give genuine loans to other different borrowers and
2) Cases where FIs first give the loan to one borrower, are not able to collect interest and principal repayments from the borrower as the borrower is under stress. Therefore, the FIs indulge in evergreening to give more loans to the same borrower/any of its related companies, so that the money goes to the first borrower and then he pays back to the bank. In this fashion, the bank saves the NPA recognition of a stressed loan.
Hope it clarifies our views on Banks/financial institutions including HFC, NBFCs etc.
All the best for your investing journey!
Dr. Vijay Malik
Then what should one look at while investing in banks/financial institution/non-banking finance company (NBFC) stocks?
From the above discussion, an investor would note that it is difficult to assess the real financial position of any financial institution by analysing the financial data provided by it in the public documents. Investors would remember many instances where the financial data reported by banks/NBFCs did not present their actual financial position like Yes Bank, DHFL.
Despite spending hours analysing the annual reports etc., investment analysts could not decipher that the position of the loans given by these financial institutions was worse than what was disclosed by them in their disclosures.
It is not only a limitation of the investment analysts who get access only to the public data. An investor would note that in certain cases, even the regulators (RBI) could not ascertain the real financial position of the financial institutions despite having access to all the insider data of the banks and financial institutions. e.g. PMC Bank.
Therefore, an investor would acknowledge that the disclosures of any bank/financial institution/NBFC leave a lot of room for the management of these companies to hide the actual poor performance. If an investor/analyst is not able to detect the misrepresentation by these institutions, then she should not take it on herself as it may not be her incompetence, but the nature of the business of banks/financial institutions that makes the analysis of their real business position difficult.
Therefore, investors should always keep this fact in front of them, that despite the best of their efforts, whatever conclusion they might have arrived about the business position of any financial institution, it might be proved completely wrong in future.
Therefore, in such cases, the only parameter that an investor can analyse and take comfort before investing is the management of the financial institution.
If an investor can not rely on her analysis of the financial statements of the banks/financial institutions/NBFCs, then it becomes essential that she should do a very thorough analysis of the management of these institutions.
In case, after the putting in the best of her efforts in the management analysis of a bank/financial institution, an investor is convinced that the management of the bank is honest, has integrity and is minority shareholder-friendly, then she may invest in the bank/financial institution/NBFC.
Even after making the investment decision, an investor should always be open to accepting that her analysis of the financial position of the company may be completely wrong. This is because of the nature of the business in which financial institutions operate. Investors have been wrong in their analysis of these institutions in the past and more often than not, will be wrong in the future as well.
Therefore, if an investor wishes to invest in any bank/financial institution, then she may invest only after doing a thorough management analysis of the financial institution.
An investor should acknowledge that an investment in a financial institution is blind faith in the management of the financial institution because whatever efforts an investor may put in her financial analysis; if the management of the financial institution is determined to misrepresent their numbers, then she would not be able to identify it in time.
All the best for your investing journey!
Dr Vijay Malik
Do we invest in PSU Banks?
Your site is good and informative.
I have invested in SBI and would like to know if I should continue for the long term.
Thanks for writing to us!
I do not prefer investing in PSU banks due to a number of reasons.
PSU banks do not have long term CEO/Chairmen tenors. Every person on the top comes with a fixed tenure of 3-4 years and in order to keep his/her record clean, he/she tries to show the result in the joining quarter (resultantly, also the joining financial years) as bad as possible. All the provisioning is usually done within one quarter in order to wipe the slate clean.
This by no means should be interpreted that provisioning should not be done or is to be avoided. However, the way PSU banks show a cyclical trend of bad to good results and then again bad with a frequency of 3-4 years. It indicates that something else other than shareholders’ interest is also at play.
Most of the times, the management of PSU banks seems to be motivated by short term vision. SBI shows the same trend with years of chairman changes 2011, 2014 etc. showing exceptionally bad results.
Due to certain reasons, PSU banks always seem to have higher non-performing assets (NPAs) than their private counterparts. Higher NPAs hurt shareholders’ interests. SBI also has higher NPAs than most of the private banks.
Currently, I am not invested in any PSU bank. In future, I may or may not. However, you should decide about holding or selling SBI, for your own reasons. I have presented you with mine.
Hope it helps!
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
- I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
- Currently, I do not own stocks of the companies mentioned above in my portfolio.