Saturday, May 30, 2009

Banking Loan Concepts - Demystified.

Banks have something called the benchmark prime lending rate, which is a reference interest rate that is used as a benchmark to determine the interest rate that is passed on to the customer. This will accordingly reflect in the EMI the borrower has to shell out to repay his loan. The interest rate that is finally passed on to the customer is X% plus or minus this benchmark prime lending rate and will correspondingly increase or decrease his EMI or loan tenure, at the time of applying for his loan.

Money lent by banks and financial institutions for various purposes come with a cost, which is known as the loan rate or the interest rate at which the loan is lent.
In recent times there has been a spate of CRR (cash reserve ratio) and repo rate cuts following which interest rates on home loans have been slashed. This has been a welcome relief for potential, first-time home buyers who have been waiting for this to happen for a long time.
So what do CRR, repo rate, reverse repo rate, SLR, et cetera mean in the context of your home loan interest rate? Well, all these factors have a direct impact on the PLR (prime lending rate), which correspondingly increases or decreases the interest rates of loans.
Let’s take a quick look at what all these terms mean to see how they affect the loan interest rates.
Prime Lending Rate (PLR)
This is the benchmark interest rate on the basis of which financial institutions decide the interest rates on the various loan products. For example, a bank might say a loan interest rate will always be 0.5% above the PLR. This means, if the PLR increases or decreases by a certain amount, the interest rates charged on the floating rate loans offered by the bank also increase or decrease by the same amount.
Cash Reserve Ratio (CRR)
It is the percentage of cash deposits that banks need to keep with the Reserve Bank of India [Get Quote] on an everyday basis. Increasing the CRR also means banks have lesser money to lend. RBI adjusts the CRR to change the amount of liquidity in the financial system, which helps to keep the inflation within reasonable limits.
Also, when CRR is increased, the interest rates also increase as the amount of liquidity in the financial system decreases. RBI has made frequent CRR cuts in the recent past to inject liquidity into the financial system. This is expected to impact the interest rates bunched with other favourable aspects for home loan applicants.
Repo Rate
This is the interest rate at which RBI lends money to the banks whenever they need to borrow funds from RBI. When the repo rate decreases its good news for the banks as they can avail more funds at a lower interest rate and vice versa.
Reverse Repo Rate
This means just the opposite! Here, RBI borrows funds from the banks and when the Reverse Repo Rate increases banks are very happy to lend money to RBI because of the attractive interest rates RBI offers to obtain the loans.
SLR (Statutory Liquidity Ratio) Rate
Every commercial bank needs to maintain a certain amount of funds in some form — which includes cash, gold, government bonds, etc — before they can provide credit to its customers. This measure helps RBI have control over the bank’s credit expansion, keeping it realistic.
The collective impact of all these rates influence the liquidity in the financial system and lead to an increase or decrease in PLR, which in turn affects loan lending rates.
Benchmark Prime Lending Rate (BPLR)
A while ago, those who had been subjected to steep interest hikes in the past eagerly looked forward to see the interest rate cuts from their banks. Some banks were planning to pass on the benefits to the existing customers while some others were cutting down interest rates only for their new customers.
What were the factors that came into play here? How are banks able to give the lower rates only to new customers while keeping older customers at a higher rate? Well, banks have something called the benchmark prime lending rate, which is a reference interest rate that is used as a benchmark to determine the interest rate that is passed on to the customer. This will accordingly reflect in the EMI the borrower has to shell out to repay his loan.
The interest rate that is finally passed on to the customer is X% plus or minus this benchmark prime lending rate and will correspondingly increase or decrease his EMI or loan tenure, at the time of applying for his loan.
This X% is termed a ’spread’, and is left to the discretion of the bank to set and depends on the other factors involved in loan eligibility like the credit profile of the loan seeker, for instance.
According to RBI regulations, banks are required to make changes in existing loans except fixed interest rate home loans, when they change their existing BPLR.
However, since banks are given the freedom to set the spread from the BPLR at whatever value they choose for new customers, they are able to provide attractive rates to new customers while continuing to charge a much higher interest rate for older customers.
For example, suppose Suresh took a home loan at a floating rate of BPLR minus 2% at a time when the bank’s BPLR was 9%. The floating rate of 7% that he received was attractive and it seemed to be the right decision to choose this loan.
Over time the BPLR of the bank increased to 15% and Suresh’s floating rate became13%. However, Suresh’s bank is now offering a floating rate of BPLR minus 3.5% to new customers, which means that new customers are paying a rate of 11.5%, while Suresh is stuck with an interest rate of 13%.
The irony of this situation is that Suresh signed up for a floating rate knowing that his rate would increase or decrease according to market conditions, not realising that his bank has the power to not share the benefit of a falling rate with him.
From the bank’s perspective this is profitable, as they will end up making more money off Suresh’s loan if they charge him a higher interest rate.
Banks have various clauses in the loan agreement that keep the best interests of the lender in mind as the money outflow from banks, even on an everyday basis is enormous. As shown in the example above, the clause that dictates banks can opt to choose the ’spread’ from the BPLR is the catch that loan consumers need to be aware of.
However, after what seemed like a long wait banks have started to effect changes in their BPLR in the wake of the current spate of repo and CRR rate cuts.
Every bank has a cycle to bring the benefit of this change to the existing customers. According to bank policies, this change or floating interest can come into effect on a quarterly or yearly basis or with immediate effect.

Friday, May 29, 2009

The Vicious Cycle of a Falling Dollar.

When it comes to the direction of the US dollar over the long run, all I can shout is "Watch out below!"

There's no doubt of the general direction and the powerful trend of the US dollar. It begs a very important, very relevant question:

So what's up with the strength in bond yields, oil, and other commodities? Two factors seem to be at work. First, China has begun a legitimate turnaround. In fact, some analysts see a “V”-shaped bottom forming.
However, while that's great for the Chinese, it doesn't do us much good. If rising demand from China drives oil prices higher, the effect resembles a tax hike for the American consumer. True, we might get some ancillary benefit from Chinese growth, but it will be minimal compared to the cost of higher interest rates and energy prices.
The second factor that could be pushing bond yields and energy higher is the unprecedented increase in the U.S. monetary base – the sheer ocean of liquidity being poured into the financial system. Investors, who realize that the value of an asset often comes from its limited supply, are growing nervous about currencies in general. As the world's reserve currency, the U.S. dollar will bear some of the brunt of that nervousness.
Put yourself in the shoes of a foreign investor. Which would you choose to own – a currency that is being printed faster than any other in history, or an asset that is rare and difficult to produce? No wonder investors are demanding bigger yields from T-bills and turning to commodities as stores of value. Certainly China has been investing in stockpiles of commodities, far above what they need.
Recently I received another very thoughtful missive by the editor of The Complete Investor Dr. Stephen Leeb. He's not always correct but he always makes me think. Here is what I thought was the best part of his letter:

"If foreign investors are moving away from the dollar and into commodities, they will give the U.S. economy one additional obstacle in its struggle towards recovery. Not only must we contend with deleveraging from the consumer side, in the form of banks still refusing to lend, but now we face higher interest rates, which will affect mortgages, and higher energy prices, which restrain economic activity.

"Speaking of interest rates and mortgages, the Fed has one more tool it can use to encourage home buying. It can directly buy up long-term bonds. This would push bond prices higher, and restrain yields and interest rates, making it easier for people to service a mortgage. In fact, the Fed has been doing just that.

"However, there is a risk. If the Fed finds it must ramp up its bond purchases, it will lead to more dollars being pumped into the financial system. That, in turn, will give investors even more reason to sell them. The result would be a vicious circle [cycle].

"We hope we are wrong about this, and that the markets are actually discounting a surge in consumer demand. If so, we will be pleasantly surprised. But that's not how it looks.

"Turning to energy, we feel obliged to make some comment on the current administration's policies. So far, the government has directed a piddling amount of money towards alternative energy development, with the bulk of funding going to energy conservation.

"Now, in one sense, there's nothing wrong with saving energy. However, in the context of a worldwide economy, it carries a few problems.

"America today still considers itself to be the world, which is a fatal error. Instead, one must recognize that the U.S. is part of an integrated worldwide economy.

"If Americans buy fewer gas guzzlers, that may make U.S. cities healthier. However, conserving resources which we will need to build an alternative energy system – one that is absolutely vital for the future – is a mistake. Here's why...

"If Americans conserve oil, that will keep worldwide oil prices low. Low oil prices make it easier for developing nations like China and India to grow their economies – and raise their oil consumption. That will drive prices higher in the long run anyway, but in the short run it is a zero-sum game in which we lose and they win.

"Instead, what we need is a positive game in which everyone wins. Our nation needs to get on its horse and begin building alternative energy. Otherwise, we will soon be faced with higher taxes, in the form of higher energy and commodity prices that will make it more difficult to build the alternative energy infrastructure that we will need down the road. The development of alternative energy infrastructure and technology now (which can also be exported) will deliver far greater benefit to the entire world."

Great points, Dr. Leeb. No wonder I subscribe to The Complete Investor .Oil prices will most likely rise in the long-term, no matter what happen with the Green Revolution, as demand exceeds supply.
Right now, as Dr. Leeb and many other conscientious economist and scientist agree, we must discourage the growth of total worldwide demand (not just American demand) and develop alternative energy sources while we can still afford to. That is the key, get sustainable energy sources going while there is still interest and the resources to do so.
Now a comment about the US stock market. In the short-term we are not particularly bullish on the stock market. We see the market caught in a trading range. Within the next month or so, we expect a top will form. After that, prices will fall and possibly retest their lows.
As for gold and silver, Thursday's movement showed silver closing above $15 and gold right around $960. This doesn't speak well when it comes to investor confidence in the value of the dollar. Some analysts speak of some impending profit taking just around the corner for the precious metals.
But in an interview from Hong Kong, noted market analyst Marc Faber went way out on a limb and said he sees the U.S. entering a “hyperinflation&... that will be “close to” Zimbabwe.

“I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

Faber added that, “I don’t think that gold will run up right away. I never sold gold and I’m still buying gold … [because it] has been an adequate hedge against inflation … If you bought it in 1980 at the price of $850, then it hasn’t been a good hedge against inflation, but if you bought it in 1999 at $251, then it has done very well.”

Inflation? No way, Nadler says. He might as well have been responding to Faber when he said: “Where is inflation? A speck on the horizon.”

Nevertheless, the funds continue to pile into metal. Hedge funds and other large speculators increased their net-long position in New York gold futures last week, by 7.7% over the previous week, according to CFTC data.
Candidly speaking, with massive layoffs coming in autos, auto-parts and the accelerating demise of hundreds of banks, unemployment data will keep rising, and within a brief time, credit card and other consumer debt defaults will start escalating.
There's a truck load of really bad, toxic-smelling "delayed news" that's about to hit the fan. My most reliable sources tell me that there is more downside coming for the S&P in the coming weeks and months, and the "vicious cycle" of the break-down of the dollar is far from over.
The US Treasury faces a rapidly rising risk of a really embarrassing auction of new debt that may shock Wall Street. And gold stocks as measured by the Market Vector Gold Miners ETF (NYSE:GDX) indicates gold isn't done rising. The following chart doesn't even show the addition 4% jump the GDX made on May 28th.
You can see more of these kind of charts by looking at a great closed-end fund like ASA Ltd (NYSE:ASA) or by seeing a chart of a medium-size gold producer like IAM Gold (NYSE:IAG).
This is a time to be a stock picker, a very patient stock picker. Stick with quality and stick with what you know and believe in. Own enough shares of commodities and commodity producing companies.
And make sure you use any pullback in gold and silver to add to your position. Gold remains our number one inflation hedge, and silver, which may in the long-run outperform gold, is every bit as important.


Tuesday, May 12, 2009

How Much of Banks' Earnings Are Real?

How Much of Banks' Earnings Are Real?
by Thomas Tan

Last month, many banks reported strong earnings. Market sentiment has changed substantially. Only a few months ago, the collapse of the whole US banking industry threatened to bring the whole global economy down. Now, suddenly, the picture looks rosier than ever and this financial crisis seems to be over. Or is it?

With very limited transparency of bank earnings, there are several so-called earnings areas investors should question whether they are sustainable, and a few other areas investors should ask whether they are even real. They are as follows:

1) The sudden increase of financing activities on residential mortgages. Thanks to the historically low mortgage rates at Q1, some home owners have been refinancing their mortgages, resulting in both spread and fees contributing to bank's earnings. This trend could spill into Q2, but unlikely further. About one out of 5 home owners in this country are under water, meaning their home value falling below their mortgages, which in turn means they are unable to refinance. I also believe real estate has another three years to fall, until 2012, at the national basis (see my previous article "The Real Estate Apocalypse" here), further discouraging any new home buying and sending more home owners under water. I expect this part of the bank earnings is temporary and short-lived.

2) Bank analyst, Michael Mayo said last month, "Mortgage-related losses are about halfway to their peak, while credit-card and consumer losses are only a third of the way to their expected highest levels. While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class". He also estimated for the whole US banking industry, the total bad loans could be at the range of $7 - $11 trillion, or 3.5 - 5.5% of all loans, worse than the 3.4% peak at the great depression. We have written off only about 2% so far, about the 4th inning of a 9 inning game. There will still be a very long and dark night ahead. Same as real estate, I believe it won't be until 2012 that banks would be getting close to the end of the asset write-off process.

3) Banks postponing charges to earnings for their loan and credit losses. Write-off due to their loan and credit losses by banks is a very discretionary, arbitrary and dedicated process. Most importantly, it is a delayed process. When rates fall, their portfolio rise in value immediately which they reflect in their Q1 financial statement, but they delay to mark down the value of the credit losses until they can't hide them anymore. They realize if they really reflect the real and true losses, their equities, including the huge investment by US government bailout money, will show up as a negative number. In other words, all the taxpayers' money disappears from this money pit of the banking industry. Neither banks nor government wants to show that to the public. So it is totally normal to hear that the head of US Treasury and the Chairman of Fed actively engaged and fraudulently threatened Bank of America NOT to disclose losses at Merrill Lynch to their shareholders.

4) Changing the mark-to-market accounting principal. This process is now further delayed from coercive efforts by both banks and government to deviate from mark-to-market accounting principal, letting banks to assign favorable value as they want to their portfolio which will be written off in future days. Banks are deliberately running write-offs behind the actual defaults, contrary to at the beginning of the banking crisis when they at least were at little more honest about the real losses. Now during Q1, when banks raised the value of their toxic assets, they book them as earnings. For example, Bank of America last year took over Merrill Lynch and in Q1 it increased the value of Merrill's assets to prices higher than Merrill kept them, booking a $2.2 billion gain in the process. They are all paper "gains" for one accounting period for the sole purpose of painting a rosy picture.

5) Taking advantage of "creative" accounting loopholes. One loophole is to book earnings while your debt is actually losing value. A good case here is Citigroup, which last week ended a five-quarter losing streak, took advantage of an accounting rule that allows companies to record declines in the market value of their own debt as an unrealized gain. That turned a $900 million loss into a $1.6 billion gain. It is a scam of being rich by losing money, and we can't call it Ponzi scam anymore and have to find a new name for it. Another trick is to set aside lower loss reserves. Well Fargo set aside just $4.6 billion for potential loan losses. According to banking analyst Paul Miller, the real losses should be around $6.25 billion, which helped boost its earnings by as much as $824 million. Miller said that the bank was "under-reserving for expected future losses", adding that investors should "demand better disclosures".

6) Switching to calendar year reporting. The best award for accounting abuse, however, goes to Goldman Sachs. But switching to calendar year from a fiscal year ending November, suddenly the credit losses of $780 million disappeared from both 2008 report and Q1 2009 report, nowhere to be seen in the future. Of course, this has driven the stock price way up, a perfect timing to dump more shares to the public as far as they are suckers out there. This happened before when Blackstone was conducting IPO dumping shares at the peak of the equity market with many investors so hungry about putting money into private equity firms. Bankers are really smart and public is pigs waiting to be slaughtered.

7) Using credit default swap (CDS) to book earnings. In one of my old article "Why Wall St. Needed CDS?" here, I indicated how banks have used CDS to book fake earnings, now they have found another way to use CDS, even better than the accounting trick of negative basis trading. The unwinding of CDS contracts related to AIG led to huge gains for the major banks for Q1. Those profits have been shown in fixed-income trading, gains that will not be reproduced for future quarters. This is why most of the "earnings" are concentrated under trading "profits" at their financial statement, since they can't manipulate banking fees (relying on number of deals being done), which is public information. But trading activities are not required to be transparent and reported to the public. However, if you check activities of the trading desks at major banks, there was little trading volume during Q1 at all, so where were the "profits" coming from? CDS handily came over to help one more time. Most these "profits" are actually coming from AIG, or our bailout money given by government to AIG, now being funneled through and then recorded as "earnings" by major banks during the unwinding process of CDS wild bets between AIG and major banks in past years. This is really a special time for capitalism; public taxpayer's money suddenly becoming private earnings for banks. It is again time to pay more bonuses out to bankers for such a great creativity.

Many people argue that banks will eventually "earn their way out" of their losses. First of all, the record lower interest rate, thus the huge spread earned by the banks today, might not be sustainable. Interest rate will go high, and spread will shrink to squeeze any such earnings left.

Even at the best case scenario for banks, the interest rate and spread stay this way forever, the current debt is still about 4 times of our GDP. If we use 3.5-5.5% losses estimated by Michael Mayo, the total losses are about 14-22% of our GDP. In order to fill this giant hole, a fund manager made a quick calculation with the best scenario of record corporate profit margin and zero consumer savings, like the good old days, and it will still take over a decade for banks to complete this so-called "earn their way out" process. In my previous article here, I indicated that the banking industry will stay flat at this level at range bound for the next 20 years, which now doesn't seem to be far-fetched at all.


Wednesday, May 6, 2009

Assam Company: Q4-Loss.

Assam Company reported that the loss for quarter ended March 2009 has widened. During the quarter, the loss of the company rose to Rs 193.31 million compared with a loss of Rs 163.34 million in the same quarter previous year.
Interest cost increased 21.41% to Rs 45.42 million while depreciation cost fell 20.72% to Rs 16.30 million over previous year period.

Net sales for the quarter jumped 46.23% to Rs 280.66 million, while total income for the quarter rose 12.61% to Rs 280.66 million, when compared with the prior year period.

It posted loss of Rs 1 a share during the quarter compared with loss of Rs 1 a share in prior year period.

As at Mar-09 Mar-08 %Change

Net Sales 280.66 191.93 46.23

Net Profit (193.31) (163.34)

Basic EPS (0.62) (0.53)

Shares of the company gained Rs 0.44, or 4.91%, to trade at Rs 9.40. The total volume of shares traded was 170,929.00 at the BSE (2.39 p.m., Tuesday).