BANKSTRAGEDY OF GROWTH

Growth & Banks

When analyzing the business growth for Banking companies , one has to be wary of growth concentrated in some asset class or industry.

Rapid credit growth flowing to a particular ‘asset class’ results in: Surge of bad loans

Bank failures in different formsWrite offs

Large equity dilutionsBail outs

Bankruptcies

EXAMPLE ONE: Indian Banks

During the period between 2005 and 2008, loan growth was well above historical norm

Source: RBI

Growth Of Indian Banks

As can be seen NPAs have started rising.

Also, “Restructured Loans” increased from 1% of Mar ’08 loans to 6% of loans as of Mar ’13.

NPAs have started rising

Source: RBI

Indian banks: NPA picture

2005-08: Overall GDP growth was

high and Infrastructure

saw large amount of

investment.

NPAs were trending lower,

but, loan growth was

concentrated in infrastructure.

Post 2010-11, the overall GDP

slowed down and

infrastructure projects started facing hurdles.

NPAs are gradually

increasing since then.

Example two: Australian Banks

Australian banks are facing a possible risk from fast growth in Housing prices and a Mining

sector boom. Australian-owned banks’ mounting claims in New Zealand is a rather

daunting figure too.

Australian Banks: Analysis

The Australian banking sector is extremely consolidated with four large banks holding the majority of loans issued.

High LTV (loan to value over 90%) approvals have been more or less stable but interest-only type loan approvals are quite high at around 40%

Post 2008-09 crisis, NPAs in the Commercial property segment increased and started declining by 2013. The housing space has witnessed a boom with high debt to income.

Long Term Total Asset Growth and NPA Picture

Total asset growth (YoY) has been trending below average

Source: RBA reports

Long Term Total Asset Growth and NPA Picture

NPAs and Impaired loans as “Printed on paper” still don’t depict full cycle impact as:(a) Loans will get

seasoned and (b) Underlying collateral

prices will revert to mean

Commercial Property Segment

Commercial real estate exposure

stayed constant at major banks.

Commercial Property Segment

Around 2013, commercial realty loans as a part of

total share of loans have declined

Commercial Property Segment

Increase in banks' impaired assets was mainly driven by their exposure to commercial property

Banks' impaired commercial property exposures continued to fall markedly over the second half of 2013.

Housing Segment

Period 2000 to 2010 saw a

sudden boom in housing prices

Housing Segment

Interest paid as percent of household

disposable incomehave remained low and

there has been an increase in household

debt-to-income

Housing Segment

Aggregate share of banks' housing loan approvals with high LVRs is around 13% and has remained fairly steady.

Source: RBA financial stability report Mar 2014

Housing Segment

Interest-only share of new lending has been trending above its peak.

Fixed rate Interest only OtherLow doc

Source: RBA financial stability report Mar 2014

Mining

Australian banks are facing a possible risk from the mining sector

boom.

As can be seen, with rapid growth in capital expenditure, an abrupt

disruption in demand may cause a spike in commercial & industrial

sector NPAs

New Zealand

Of Which: Banks

New Zealand

Given that New Zealand is witnessing its own housing boom and a rise in debt-to-income ratio, Australian-owned banks’ mounting

claims in the nation is a rather daunting figure.

Example Three: Japanese BanksIn 2009-12, major banks accumulated Japanese sovereign debt at the rate of 25% CAGR, which reached a level of near-5x or more against their tangible net worth.

In recent years, 50%+ pre-tax earnings came from trading on these bonds as interest rates kept declining.

In 2013, as the central bank started hoarding government bonds, there was a move towards overseas loans.

Japanese government bonds still constitute a high leverage when measured against the net worth of banks.

Growth In Japanese Government Debt

Japanese government bonds pose several interest-rate and credit risks (in the event of a downgrade or default)

Conclusion

• Most of the things in life & especially in markets are cyclical: growth is not always value additive and in majority of the cases its based on optimistic funding with unsustainable assumptions.

• Many a times valuations will also be optimistic during such ebullient period of history- not leaving any Margin of Safety

• So an investor should be wary of putting value on growth, especially in finance business.

TerminologyRestructured loan: New loan that replaces the outstanding balance on an older loan, and is paid over a longer period, usually with a lower installment amount.

NPA: Non-performing asset (NPA). According to Investopedia, NPA is a classification used by financial institutions that refer to loans that are in jeopardy of default. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered to be a non-performing asset.

Interest-only loan: According to Wikipedia, an interest-only loan is a loan in which, for a set term, the borrower pays only the interest on the principal balance, with the principal balance unchanged.

LTV (Loan to value): A ratio of the outstanding debt on a property to the market value of that property

Impaired loans: A loan is impaired when, based on current information and events, it is probable that an institution will be unable to collect all amounts due according to the contractual terms of the loan agreement.

Sovereign debt: According to Investopedia, sovereign debt is bonds issued by a national government in a foreign currency, in order to finance the issuing country's growth.

Shinkin banks: According to Wikipedia, Shinkin banks are Japan’s cooperative regional financial institutions serving small and medium enterprises and local residents.

Thank You