Sunday, July 27, 2008

They just don't `get it'

It’s results season again. I glanced at the results of ICICI Bank and HCC.

For ICICI, the net profit for the quarter fell by 6.07% (Rs.728 crore) in relation to Q1-07-08 (Rs.775.08 crore). Nothing unusual, given the sluggish business sentiment tempered by high interest rates. But something else rankles. The bank’s non-tax provisions and contingencies (for bad debts / bond trading losses) rose nearly 43.5 per cent to Rs 792.49 crore during April-June this year, compared with Rs 552.27 crore during the corresponding period last year. The increase in interest rates and adverse market conditions hit the bank’s trading portfolio and treasury income by Rs 594 crore. This is for a bank that is quick to grab an opportunity, having an agile management that is high on financial savvy and in using sophisticated risk management systems. CFO Chanda Kochar can play down the worries on the lines that the provision levels are `nearly’ the same as in earlier quarters, but they are mistakes in a row just yet. An indication that they are clearly losing sight of the market risks.

For HCC, revenues grew 22% to Rs.895 crores (Rs.731 crores for Q1-07-08 quarter) but PAT slipped to Rs.31 crores as against Rs.34 crores. What stands out is a provision of Rs 50.6 crores on account of foreign exchange losses on foreign currency loans including FCCB. This is bad choice of debt since prudence demands raising Foreign currency loans only if you have foreign currency income to hedge its exchange risk. But construction companies merrily used FCCB route to bet on rising values of land banks and a seemingly ever appreciating rupee (so that they will end up repaying less as Rupee gets stronger). But the trends reversed, the tide ebbed and they realized they were swimming naked.

Where did they let up? Were they not forewarned of the risks by smart managers that signed up for such financial arrangements? The numerous credit crises from the past (remember the great depression, the asian meltdown) has destroyed the idea that unregulated financial markets always efficiently channel savings to the most promising investment projects. Several Indian companies took on unsustainable debts, pushed around by I-bankers and other “debt merchants” who made a quick buck by disregarding risks. While this happened, our central bankers though a little unnerved by the swelling forex reserves, were still marveling at the creativity of capitalism. When the bust came, most borrowers / bond traders aiming to make quick bucks on currency / bond appreciation were left catching the hot end of the rod.

So I begin to distrust the individuals in charge as also our macro economists. Neither `get’ the true picture of the flip side of risks they assumed. The I-bankers that peddled these instruments never really understood it themselves to explain it to the borrowing clients. Now I see the same pattern in the manner in which both RBI and Finance Ministry handle the oil price shock and resulting inflation in commodity prices. Finance minister can hide behind his oft-quoted statement `it is imported inflation’ only for so long. He may have to soon come up with a plausible defense. Clearly, arresting inflation and maintaining price stability is an important task of the central bank as is ensuring financial stability. But this dimension is completely absent from the macroeconomic models now in use. In addition, since financial stability these days also depends on avoiding deep recessions, stabilizing the business cycle should also be of the concern of the central bank.

But that is at a macro level and CFOs can’t rely on that to shield their individual risks. ICICI treasury has clearly goofed up by ignoring cyclical nature of bond yields. Their bet on junk bonds went haywire. HCC and other construction majors played fast and loose with FCCB for long gestation projects where eventual profits (as and when they come) might have already been eroded by the exchange risks they suffer here and now. Stock prices have also fallen so badly that the lenders would not want to exercise the loan conversion (into equity) option attached to these bonds. They are reeling the under grave liquidity crisis in their home markets and could do well with a cash pay back.
So here are the lessons. Never miss the wood for the trees. Look at the indicators. Stock markets don’t beat down stocks without reason; and you can’t blame it all on bad sentiment alone. So Ms.Kochar and Mr.Ajit Gulabchand, it's time to roll up your sleeves and begin to see risks from a mile. That’s when you can claim you're really `getting it’.

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