Thursday, June 27, 2013

Mortgages: An Introduction!

With the kind of publicity the term sub prime crisis and mortgage lending is generating, getting an idea about mortgages and its various types should be a good idea!

So, what is a mortgage? The term mortgage is defined in the Transfer of Property Act, 1882 as follows:

A mortgage is the transfer of interest in specific immoveable property for the purpose of securing the payment of money advanced or to be advanced by way of loan, on existing or future debt or the performance of an engagement which may give rise to a pecuniary liability.

Whoa! What was that? So, what basically is a mortgage? In Simple terms, A mortgage is a loan to buy a home. Like any loan, interest is charged on the amount you borrow (the principal). Each mortgage  payment consists of repayment of the principal, plus interest.


And if you are one heck of an investor, this should light up your eyes! 

Mortgage is  debt instrument that is secured by the collateral of specified real estate property and that  the borrower is obliged to pay back with a predetermined set of payments. Mortgages are used by individuals and businesses to make large purchases of real estate without paying the entire value of the purchase up front.

So, one fine morning, you decide you need to buy a flat and go to your favorite bank ask them for the loan. Now an amount this big (Combine that with the burgeoning real estate price and the amount of money the sloth is always ready to gobble up!) will not be loaned without any collateral (Some Kind of security that gives the banker the satisfaction that even if you happen to default on the payments, he will be able to recover his money! ). Now, what would you secure your loan against? You and both the banker hit upon a great idea: Why not secure the home itself for which the loan is being taken! And that's where the idea of mortgages starts. You become the mortgager since the property, the home, is yours, even if you have borrowed the money to buy the same and the person/bank which lends you the money is the mortgagee!


Talk of fancy names! :D

Now, of course, life is not that simple with mortgages and is not simple collateral borrowing. There are various kinds and types and some fancier names and terms associated with it. Let's start with the simplest of them, the Simple mortgage. The mortgage is simple because possession of the mortgaged property is not handed over to the mortgagee. However, the mortgager accepts personal liability to pay the mortgage money (principal plus interest. After all, you are in debt dude!).

If the mortgager does not pay the dues, the mortgagee has the right to approach court for a decree to sell the mortgage property. This right of the mortgagee may be expressed in the mortgage deed or implied. As is logical, the mortgagee does not have the right to receive rent or any other proceeds from the property (Imagine where and what the rent business in NCR would have been if not for this clause! We would have been spared the tyranny of paying the ever increasing Rents, which you ever happen to tell your parents, they will flip!). The Rents and any other such things would belong to the mortgager.


Another type of mortgage is mortgage through Conditional Sale. Here, the mortgager “sells” the mortgage property, but subject to conditions:
• The sale becomes absolute only if the mortgager defaults on paying the dues by a specified date; or
• The sale becomes void if the mortgager pays the dues by the specified dates. In that case, the mortgagee will transfer the property back to the mortgager.

Now, on the face of it, it would look better than a simple mortgage to the bankers since he is getting the property, in theory. However, a big, legal technicality is that the mortgagee cannot sue to sell the property, but he can sue to foreclose the mortgage deed. Once court grants the foreclosure, the mortgager loses the right to claim the property. Thereafter, the mortgagee can sell the property to recover his dues. But this is a long procedure and banks do not want to get into such long, potentially loss making pursuits. 

The Problem is, in a standard form of such a mortgage, there is no personal liability on the mortgager to pay the dues [he only (presumably) has an interest in paying it, so that he will get the property back]. If he does not pay,  and the asset sale does not fully cover the mortgagee’s dues, he cannot claim the balance from the mortgager. Therefore, bankers typically are not comfortable with such a mortgage. If you are here, you might remember the Prime and the Sub-Prime Lending crisis that the US went through, which actually pushed the US economy on recession! Imagine the kind of pressure a bank would be if the amount that he has lent to someone for such a home actually turns out to be way more than what the value of the home is actually! It is a disaster and this is what happened in the US market! People simply stopped paying EMI's since  legally they could simply let go of the property and have more money and, interestingly enough, buy new and better homes!! 

Now think of what the effect would be if that same somebody who could do it over and over again and actually make money in the process! The big problem was: There were huge numbers of these somebody's!

Now, since we are discussing Mortgages, let's jump to some other types of the same. We will talk about the Sub Prime and the US Mortgage Crisis in coming articles.

The other type is usufructuary Mortgage. This is a mortgage where the mortgagee has the right to recover rent and other incomes from the mortgaged property, until the dues are cleared. Thus, repayments come from the property rather than from the mortgager! So the rent a tenant pays actually goes for EMI's. Directly to the bank. As with Conditional Sale, there is no personal obligation on the mortgager to pay. The banker has to keep holding the property for an indeterminate period of time, until the dues are cleared. Therefore, bankers are not comfortable with such mortgages, as you guessed!

Yet another type is English Mortgage. In this form of mortgage, the mortgager transfers the property to the mortgagee absolutely. However, the mortgagee will have to re-transfer the mortgaged property to the mortgager, if the dues are paid off. Since the mortgager assumes personal liability to repay, the mortgagee can sue the mortgager for recovery of dues or seek a court decree to sell the property. This gives comfort to the banker. :D

There are others also, such as Equitable Mortgages and Anomalous Mortgages, with different and interesting properties and clauses!

There are various issues with Mortgages and it will be great if we could discuss that sometime, later on maybe! For the purpose of an introduction, this should suffice!!


PS: Hypothecation and Pledge are next!

Monday, June 17, 2013

An Introduction to Non Performing Assets

So, with all the hoopla around the NPA and the ongoing debates about how banks should deal with, I too couldn't resist the temptation and decided to find out what the entire story is about!

So, what is an NPA? Or a non performing asset? Simply speaking, an NPA is something which has stopped giving profits to bank and more often than not, has become a liability.  Just remember your college days when you took a small loan from one of your friends, say 500 and forgot to return it. There could be many reasons, you might have forgotten it or simply didn't want to return the money! That, my dear friends, is some sort of an NPA for your friend.


Now amplify the amount involved by a huge proportion, say, 10000 times and replace your friend with a Bank that you took the amount from in return of a promise of a regular interest and of course, returning the whole booty, albeit after a relatively long time. Now something happened and by some strange turn of events, you are actually unable to pay back the amount and default on the loan taken, which is just a banking term to mean you stopped paying bank the money. Or you are a simply a jerk and decide, one fine morning that enough is enough and stop paying bank, even though you could do that, in theory!

              
                                          
                                                   
That again, my friend is what we and more importantly, the mighty banks call an NPA. Though this is not so common as one might think, some debts do turn sticky. The borrower is unable or unwilling to pay. Now, to get into more details, there can be different types of loans such as home loan, personal loan, vehicle loan, crop loan and so on. However, for this discussion, we will categorize a loan into two major types: Secured and Unsecured loan. Secured loan is where you pledge something in return for the loan amount advanced to you! This is where mortgages come in (Another article, I believe!) This is the kind of loan which bank prefers since they would be having something to fall upon, if the loan turns bad. This is also known as collateral loan!  And the other kind is, well you guessed it right, unsecured loan! I don’t think I need to explain what it means now! 

Now, without wasting more time, let me explain how a loan/advance turns into an NPA! Well, let’s get back to our example when you loaned some amount of money from your friend. Now, obviously, it will not turn into an NPA or your friend will not consider that you will not pay him back if you fail to him the very next day/week. He will start getting worried if you don’t pay him, after, say 2 months. He will really get sticky if you fail to him for the next 30 days also! And even after that, if you fail to pay, he will give up his hopes and forget about the money! Or in banking terms, write off his debt! There you learned a new term! 

Banks (All financial institutions except regional rural banks!) actually follow something very similar to what your friend has done! It will not classify you as defaulter or write off its loans the first time you fail to pay your installments!  It will wait for some time and that some time is actually dictated by none other than RBI! And that some time is 90 days! So if you fail to pay your bills or pay your interests/installments of principles, then bank will classify that loan as an NPA. There are other technicalities like crop season, a loan cannot be classified as an NPA if collateral is any govt. bonds such as KVP, NSC and like, but the general idea is of 90 days.

Now NPAs are actually categorized into three parts, Sub-Standard Assets, Doubtful Assets and Loss Assets. A Sub-Standard asset is an asset that has remained NPA for up to 12 months, doubtful assets is an asset that has remained sub-standard for up to 12 months and the baap of all, a loss asset an asset that the bank or its auditors or the RBI has identified as a loss, but the amount has not been written off entirely.

In exceptional cases, such as fraud by the borrower, the above mentioned stages of NPA can be skipped. The asset can directly be treated as a doubtful asset or loss asset. 

Now, coming back to security that you have deposited with the banks, if the realizable value of the security (The amount that the bank will get if they sell the security) is less than 50% of the value assessed by the bank or accepted by RBI at the time of last inspection, and then the asset will be treated as doubtful.  If the realizable value of the security, as assessed by the bank or valuers or RBI is less than 10% of the amount outstanding, then the existence of the security is to be ignored. The NPA asset will be immediately treated as a loss asset. 

Now, this I believe is a fair introduction of world of NPA’s.  There are a few things left, such as provisioning an NPA and restructuring. Let’s jump on them after we have digested this one!

Sunday, June 16, 2013

Why RBI and GOI Wants to Keep Gold Imports in Check?

So, I am due for an article on Fundamental Analysis and I am working on the same. Meanwhile, let’s get our hands on one of the burning issues, why our govt. is trying so hard to keep gold imports down!

If I have to say in very simple words, the answer would be to not let the money rot and be engaged in something, which even though is a very good (That too, is subjective) investment instrument for some people, is actually not so good for the economy. Let me illustrate this.

Suppose you, by some chance, happen to own some 10 Crores rupees. Now, you fear investing in Stock market and the returns on savings account or fixed deposit is something which you really don't fantasize. You talk with your parents about the same and lo, they advise you to buy gold with whole lot of that money! You do the same, sit on it and wait for your turn to sell again when the prices go up, which, you were told , will always will!

Now, let's say we ignore the current situation of dipping gold price  and assume it does go up and you pocket a handsome profit of some 3 Crores!

Cool enough for you!!



Now, let's take another situation Instead of being the kind of person depicted in the first situation, you are an entrepreneur and willing to invest the money in opening, say, a mineral water factory which employs 100 people. You buy equipment for the same, hire some people from your area and start bottling water. And in the process you do get some really nice returns, say a clean profit of Rs.2 Crores after you have paid everyday and this goes on for years!

Now, in the second scenario, not only you made profit, you generated employment for 100 people and if you take into account their families, you fed more than 300-400 people and also bought machinery, which in turn must have provided somebody more employment! Actually, you contributed to the society! Money begets money and you, in the process, created and helped economy grow!

That my friend, is the reason why the RBI and the Govt. so wants to keep gold imports in check. The money which could have been gone into economy is now lying idle and this causes problems for any govt. more so in India where we are so in love with gold.

Let's do some serious thinking now.

Gold is the second biggest import item for India, after energy. In 2011-12, we imported $56 billion worth of gold. That is bigger than the total money India spent on education that year (And that includes everything level--schools to Post graduation). Apart from this $56 billion, we are also employing a good chunk of labor & resources for designing & selling jewelry. For a growing economy, this statistic is simply unacceptable. 

At this stage of development, India should be using the money to buy machinery, build infrastructure, spend on education and create enterprises. Instead, a huge chunk of our money is wasted on an item that sits in people's lockers. 

I'm not against gold as an investment actually, but what India has is a gold addiction. We are spending a big part of our wealth on gold, instead of employing that money in growing our economy.

The RBI and the Govt. recognize this and that's why they are trying to block the imports by raising taxes. In fact, if you see the gold imports in past few years, you will know why they are so worried.


We should be, too!


Thursday, June 13, 2013

Starting with Investing

So one fine morning, you wake up and decide to see what all your investments are. You are aghast and a little saddened to know that the Mutual fund that you have invested into has actually been giving negative returns and the paltry 8-9 % returns that your govt. bonds (such as the famous Kisan Vikas Patrika) and the fixed deposits are giving is nowhere close to the corpus you would be needing when you will propose to your girl. What do you do next? You think a lot and finally decide to invest (or play, that’s what we generally call investing in Stocks here in India) in stock markets. You call up that dude friends of yours who have been into stocks since you were roomies and he asks you to learn a bit about investing first before he could give you a list of hot stocks to invest in. He mumbles something about Alpha and Beta of a stock, returns, some analysis and stuffs and you do decide to find out what this hoopla is all about.

 
There are two kinds of analysis that is done on a stock: Fundamental Analysis and Technical Analysis. Fundamental analysis of any stock is done by using accounting principles and is concerned with estimating what the fair price of any stock is at a given point of time, using concepts such as book value, market form hypothesis, Greeks, volatility, time value of money and discounted cash flow. It estimates the price of any stock based on these parameters. I will be discussing these in detail in the next article on Fundamental Analysis.
 
The other kind of analysis, which is generally considered to be better than Fundamental Analysis, is technical analysis. In layman terms, it is a system of predicting the trend and movements of a stock based on its past volume and trend. Intuitively, this is what all of the stock traders do, be it on the Dalal Street or somebody like me, who invests every morning studying trends and predicting where the prices will move. 
 
So, coming back to you. You decide to do what every stock investor does: You start to study the past trends of a stock, say X, and go to some online sites and start tracking it. Most probably you will encounter a graph like the one shown below.


 

You start observing how it has done in the past, say one week, one month, a year and so on and start seeing some trends in the graph, since this is the format in which most of the sites will show you the data and suddenly, without any previous knowledge of stocks, you will start thinking and formulating in your mind, how it might behave in the coming days. This, my friend, is what we call Technical Analysis!
 
So, you see that this particular stock has been very volatile in the last 7-8 months, with spikes (what we call high) and troughs (what we call lows) alternating very frequently. You also see that past 4 months have been kind of bad, in fact very bad for the investors.  You also start thinking of the returns that you might have got if you have invested over a particular time or on a particular date. You might also think of the average return that you might have got had you invested over some period and the like.
 
There are various parameters used in technical analysis, various kinds of averages such as moving average which is nothing but a graph plotted for the closing price of a stock averaged over last n days. Candle graphs are used to show the prices, bar graph and volume line are also used for the same purpose. Be it any representation, I hope you have got an idea what technical analysis is. In the next article in the series, I will be taking up some basic terminologies and fundamental analysis.
 
Happy Investing!

Derivatives: How are OTC products Priced?


How are vegetables in a vegetable market priced? Or Grains in a village market?

Or how do you sell a video game to that friend of yours?

Yes, by the forces of Demand and Supply. 



Now, that would be very simple. Of course, with the evolution of banking system and the prevalent use of Rate fixing and all, things are not that straight and simple.

Say you want to buy a forward, which is an over the counter product. Say, the Forward is for Oil Rate. Now, the rate futures rate for the same is say, 1$ per lot, whatever be the lot size. And this comes with Exchange insurance and all.

Say you are betting that the barrel rate will go higher from what it is presently. However, the whole world thinks that it will  go down, essentially making your bet more riskier. Now, since the other guy from whom you are buying the forward (The bet that rates  will go down)thinks the opposite of what you are thinking, he will readily sell you those forwards, at a price more agreeable to you 
than him. So, you might have to pay less than what the exchange rate is for the same product! Say, 80 Cents! 

And now, consider the opposite situation. You want to buy essentially what all others are buying, meaning it's supply is way less than what the demand is. So, the person having the products (or the Bets) will not be willing to part with it easily.And hence you  would have to pay more for it! Say $1.20.

So, it all comes down to what the majority thinks and how the predicted movement is! Various rates are fixed by the govt. to regulate
these, but the major force is the Demand-Supply one. 

PS: There are other ways to get this, but this I found the simplest!

Is Inflation good for Economy?

Yes and No. Both.

Inflation is something which is a good indicator of growth, to some extent. A moderate amount of inflation, pegged to  be at around 1.5%-2.5%, depending upon the state and condition of the economy is always good and considered so. It spurs spending, which in turn raises demand and it leads to more production and a healthy economic condition in all with demand and supply in balance. All in all, a win win situation for both the consumers and producers.  If there is no  inflation , growth will be impaired since spending will be low and companies will be loathe to produce, less money in market and interest rates will rise.

Now, if inflation is higher, say more than 2.5% for argument's sake, the value of money will decrease faster than the value of the goods produces, there will be  more money in the market than required which will lead to price rise and it will turn into a vicious circle, requiring measures to be implemented by central banks to contain the liquidity flow and as such, contain price rise. Extreme case would be what happened in Zimbabwe.



The real problem occurs when there is something called Stagflation.  It's a mixture of inflation and stagnation, where price rise is on a roll, there is high unemployment and  the  economic growth rate is slowing fast. It raises a dilemma for the economic policy makers since actions designed to lower inflation may exacerbate unemployment, and vice versa! We are in such a situation, right now!

Why we don't produce Entrepreneurs...

Last night, while having paranthas with some of my friends, our discussion took an interesting turn: Why don't we produce tech start ups like, say Facebook or google!
 
It’s not just tech start ups that we have failed to produce. If we contemplate on the issue, Generally  we have been short in producing any sort of entrepreneurs and this can be traced back to, more than anything else, our low risk appetite and  risk aversion. We and our society place a huge emphasis on ideas like job security and a settled life. Consider the expression when somebody gets married; “The guy is settled now”. We as a nation avoid anything which is uncertain and place and we avoid untested waters like a thief avoids getting caught.


We grow up getting scolded and punished for doing anything new. No Marks if you write something which is not endorsed by the teacher.  Even our epics dictate following the rules and denounce anything creative and new. Just remember how Ram is said to be the perfect man, who obeys his father, dose what he is being told to do! And think of what was done to Eklavya when he did something which he was not supposed to do! Our whole culture promotes a system which is not conducive to thinking independently and being creative. We are supposed to be dictated to. Be it our Caste System or the education system. Add to that the education system that was designed to produce clerks and workers and you almost have a recipe not to produce entrepreneurs of any degree, let alone companies like Apple and Google. 
 
The whole thing starts very early. The school system that we are exposed to, makes a big deal  out of rote  learning and anything which doesn’t conform to the established practices is looked down upon and  This is when a kid, no matter in what amount he/she posses creativity starts getting scared of  anything new and on his own.  When he grows up, his world starts revolving around marks and those marks are very much dictated by what he reproduces, not what he can think and create. I remember times when I was not given any marks by my teacher, even though I pretty much wrote the same thing, it was just not similar to what she had told us to write! In fact, sometimes it went to such an extent that I was declared to be plain stupid and not able to learn! Not to mention the fact that all this was very conveniently forgotten when I topped Class 10th with more than 95%! Cutting to the chase, a kid learns throughout his early years that copying and reproducing anything is what constitutes intelligence! 

      
            

                                   
Growing up, getting good grades in college takes center stage and this invariably leads to bland and rote learning. Even at college, though the situation does improve a bit (I am from an NIT, so this might be biased), most of the professors are still fans of 'You will write what I ask you to write or forget grades'. All this kills any iota of creativity and zeal for entrepreneurship even before it gets the chance to blossom.
 
Once one gets out of college, his success is measured by the 0's he got in his salary and that is be all and end all of the Indian idea of success.  Almost all of the Indian parents would have a heart attack if their sons and daughters were to tell them they are quitting their job to pursue their dreams! Think if Madhavan’s parents facial expression in the movie 3 Idiots when he announces he is going for an internship in Wildlife photography instead of the plum job he was supposed to land into!
 
The other major issue with we Indians which prevent us from venturing into and chasing our dreams is the notion of what others will think! Chaar Log Kya sochenge is the second biggest impediment and in fact the first one of risk avoidance stems from this concern of what the neighbors and the uncles and aunt will think! The best way to stop this is to not to let this concern creep in and not to voice any such concern for anybody. Let’s each one of us mind our own business and never let anyone else mind our own!  I am sure, it would help a lot in removing these kinds of questions from Quora and our mind!