Buyer Beware

Listen to This Lone Dissenter

A $2 billion fraud at state-run Punjab National Bank is casting a shadow on more highly valued private-sector lenders.
Photographer: Dhiraj Singh/Bloomberg
PUNJAB NATIONAL BANK
+1.10
As of 1:38 AM EDT
75.85 INR
ICICI SECURITIES LTD
-5.00
As of 1:38 AM EDT
375.00 INR

When the sole dissenter on a stock that has 50 buy recommendations ratchets up his bearish call with a "buyer beware" warning on the whole industry, you sit up.

When the stock in question is ICICI Bank Ltd., which on Monday had to downsize an initial share sale of its securities business amid lackluster demand, you take notice.

Among the 54 ICICI analysts tracked by Bloomberg, Bernstein's Gautam Chhugani is the only one who believes India's second-largest private-sector bank is a sell. (Three rate it a hold.) Bernstein's target price for ICICI is 220 rupees ($3.40) 1 ; it also has a sell on Axis Bank Ltd., another large corporate lender.

Bernstein is worried about the systemic ramifications for these lenders as investigating agencies widen their probe into a $2 billion fraud at state-run Punjab National Bank, or PNB. An uncle-nephew jeweler duo of Mehul Choksi and Nirav Modi are being investigated for colluding with a bank official who gave them letters of undertaking for cheaper foreign-currency debt, which they took from overseas branches of other Indian lenders. They posted no collateral, and upon maturity took out bigger loans. Now PNB is on the hook for the Ponzi scheme. The jewelers left the country before the bank could file a police report.

The scandal may not be limited to a state-run bank with poor risk controls. Agencies are also probing private-sector banks' loans to Choksi's Gitanjali Gems Ltd. as part of a consortium of 31 lenders.

Responding to media reports that its CEO Chanda Kochhar would be questioned, ICICI said in an exchange filing earlier this month that it's "part of the working capital lender consortium in the Gitanjali group of companies, along with several other banks wherein its exposure is not the largest." The bank "routinely and regularly cooperates with regulatory authorities who require information in the course of their investigation," it said.

Bernstein's Chhugani is right not to want to take chances. He's warning investors off all Indian corporate lenders.

That's a contrarian view. The consensus opinion is that India's problem of more than $200 billion in stressed corporate assets is in the rear-view mirror, and that banks' credit costs will fall as the country's new bankruptcy laws force big-ticket asset sales, particularly in steel.

Bernstein isn't buying this rosy scenario until the systemic risks posed by the PNB fraud are more fully understood. As Chhugani puts it:

This is a tail-risk event with an unknown probability. Investors should exercise tremendous caution on corporate lending names until there is complete clarity following a probe. Quality consumer lending names should continue to drive growth.

To me, the unfolding saga raises two related questions. One, was I right to conclude that the only way to tighten lax controls at India's taxpayer-funded lenders is to privatize them, so they're run better? Two, was Reserve Bank of India Governor Urjit Patel correct in saying that the central bank, as the industry's regulator and supervisor, was hamstrung by not having adequate powers to punish bad actors at state-run banks?

Not All Rosy

Loan losses and fraud have hammered India's state-run bank index

Source: Bloomberg

Note: Weighted index with base date of Jan. 1, 2004, with a base value of 1000.

Depending on the course the probe takes and what it unearths, the coming weeks could make both the positions -- Patel's and mine -- untenable.

Perhaps privatization isn't the panacea. Maybe having the power to fire a CEO or supersede an asleep-at-the-wheel board doesn't mean the RBI would actually wield it. After all, the better-managed and higher-valued private-sector lenders have also been caught lying to shareholders about asset quality. The regulator has let them off with pitifully small fines.

High-net-worth individuals only subscribed to 36 percent of their allocation in the share sale of ICICI Securities Ltd.; retail investors applied for 88 percent of their quota. The 40 billion rupee IPO had to be pruned to 35 billion rupees.

You could chalk that up to skittish global sentiment, or rich pricing.

Nevertheless, it's another worrying sign; and while it may be ignored by 50 bullish analysts, sometimes the lone Cassandra is worth heeding.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. ICICI closed Monday at 281.65 rupees. Its stock has fallen 10 percent this year.

To contact the author of this story:
Andy Mukherjee in Hong Kong at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net

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