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Just couple of weeks ago we were talking about Black Swan moment and to my surprise, ourselves and JK bank investors just witnessed that small black swan moment. To remind you once again, black swan moment is a rare event or we can say a random event that underlie our lives from the best things that can happen to us to the biggest disaster. Their impact is huge; they are nearly impossible to predict; yet after they happen we always try to rationalize them….

What happened with JK bank on last Friday was terrible and should have not happened. But as we can’t control the market, we also can’t control these situations. They are impossible to predict and their impact is huge.

Investors who sold shares in JK bank believed in that piece of news on Greater Kashmir paper and website (Click here to read it). Investors who still hold JK bank shares like us, either do not believe in that news or are scared to book losses. Let me confirm you our stand on this and take this further that we do not believe in that news.

We are sceptical about that information that was shared and we need more clarification about it. Not everything that we read is as good as to believe. So, I will go step by step, word by word and raise my questions in relation to that news. If you know the answers please share with me either by posting your comments or personally emailing it to me.

We own JK bank in our portfolio and we do not take our buying and selling cues from the news reported in the media. But we do not even ignore accusation by the media that resulted a massive 20% drop in Jammu & Kashmir’s stock price.

There are many answers required by us to believe in what was printed in the media and their accusations. In a matter of grave concern, a few directors and officers at the J&K Bank are putting the state’s premier financial institution to a grave risk by not declaring all the non-performing and stressed assets in its loan book…. That is really a very serious accusation for a bank with such a great management reputation. If there is any truth within it then not only the bank management but auditors as well as RBI will be in trouble water. A lot of questions will arise on the standards of auditors and many investors will be questioning the failure of risk management as a regulator of RBI. The whole banking sector will be in trouble water.

In its latest balance sheet, three loans amounting to Rs 1100 crore—which by regulatory and prudential norms are non-performing assets (NPAs)—have not been classified and declared so by the Bank. This is again really another serious allegation on the regulators, managers and also on the auditors of JK Bank. Is it easy to do that for any banks? What are the norms of reporting NPA’s of any bank? To get answers about this, we looked at the regulations and found this master circulation dated 1st July 2013 that explains about NPA’s norms (Click here). After reading that am very confident on how NPA’s are reported and what are not.

The Audit Committee of the Board has also not objected to this “fraudulent balance sheet management”, indicating their complicity. It is hard to believe auditors missing out on such frauds. If we also believe one off in it then what about routine inspections conducted by RBI on the banks? How can a regulator miss such a big miss management?

Among the three big loan accounts which, according to sources, are technically unsecured and non-performing assets include Rs 650 crore given to a Kolkatta-based company engaged in agro and ancillary business. The company’s accounts have been declared NPA by all other banks while the J&K Bank continues to show it as a standard loan. There are two types of loans, secured and unsecured. The reporter is talking about three big loans which are ‘technically unsecured’, what does he mean by that? Is he trying to say that it was issued as secured but they are not or the guaranty involved in the transaction were bogus? Is this Kolkatta based business is a listed business? Are all the accounts and assets of the business are worthless as other banks consider their guarantees are not worth so nothing is worthwhile? Let me share with you one classic statistic of real business, all the bankrupt businesses owe money some way or other to their banks and 75% of the time banks manage to recoup more than 50% of their dues from those businesses.

A bank outside J&K has filed a winding up petition against the company for non-payments of Rs 224 crore outstanding dues. As said earlier, banks are the first to knock your door if you are on the verge of bankruptcy. May be JK bank has a better security against their loans than the other banks.

J&K Bank’s loan to this company, sources said, is unsecured and is a fit case for “forensic audit.” Can we please get more details of these sources? I can think of only three people who would know whether they are secured or unsecured loans. Firstly, the loan manager, second, auditor and third, the borrower. How do we as a shareholders believe that you have a proof of what you are saying or coming to that conclusion?

 “A few members of the Bank’s Board of Directors are making desperate efforts to give the company a Stand By Letter of Credit (SBLC), an instrument recently banned by the RBI, to show it as a normal account,” sources said. If SBLC is recently banned by the RBI how auditors did missed this out in their year ending March 2014 report and RBI too missed it in its annual financial checks. You could be right but can you please share your sources.

In another instance, a real estate company of Mumbai has taken Rs 400 crore from J&K Bank and the cheques which the bank has purchased from the firm have bounced more than once. Another Bangalore-based Communication Company, whose promoter has been arrested for fraud, still continues to be a standard asset in the books of the J&K Bank. When you are saying that the cheques of Mumbai based real estate firm have bounced more than once, can you also please throw some more light on telling us how many times it didn’t bounced too. If it was once or twice in a year but ten times the cheques were cleared then the equation looks totally different. If bank has given a loan to firm and the promoter is being arrested on fraud case, I would like to know whether loan is secured or unsecured and is it personal or corporation loan. If promoter dies, does these loans automatically turns into NPA? No, is the simple answer. So do we have to worry if promoter is behind the bars? Also we are talking about tens of thousands of borrowers from this nationalised banks and 1% defaulters in volumes will be in hundreds of banks clients.

A Hyderabad-based company has defaulted on its interest payment. Pertinently, within three months of J&K Bank advancing Rs 100 crore, the company failed to meet the obligations of keeping the account standard. Surprisingly, the bank gave more money to it to service its debt obligations, sources said. Is this source is the ex-employee of JK bank? How many times did this Hyderabad based company defaulted on its interest payments? How do your source and you know that bank gave additional money to service those debts? Do they work for that Hyderabad based company?

The Auditors while scrutinizing the loan accounts of borrowers outside J&K have found ‘shocking’ transactions in scores of such accounts, revealing the “clandestine” intent of the loan sanctioning and disbursing authorities. How the outsiders did have access to those banking transactions to scrutinize? They might be shocking from borrower’s point of view but maybe not by bankers point. Don’t forget every bankrupt business is a client of bank and banks know how to tackle when such situation arises.

Sources said such ‘technically unsecured and non-performing’ loan totals to around Rs 2500 crore.From independent market information, these accounts may not be able to repay the interest or the principal, thus causing a huge financial loss to the Bank. “By not classifying these loans as NPA, the bank runs the risk of serious financial instability in near future,” sources said. so now these so called sources has converted so called secured loans into ‘technically unsecured’ and labelled it as a non performing loans worth around Rs 2500 crore from independent market information. Let me explain these sources that if business gets bankrupts, the biggest loss is to the stakeholders not to the banks and financial institutions to whom they owe money. For example, when Kingfisher was grounded and was not doing any business, JK bank recovered almost 90% of their loan money back.

Sources disclosed that the auditors have marked many such loan accounts ‘to be kept in special watch category.’ Among such cases, a pharmaceutical company was extended a fund-based and non-fund based finance facility of Rs 49.04 crore and Rs 15 crore respectively. The company was allowed to avail the loan facilities without complying with the terms and conditions of the sanction. “Charge over fixed assets was not created. Since there were no repayments till December 30, 2013, all these loans accounts were non-performing assets from 01.4.2013 to 30.12.2013. The bank facilitated another installment of loan of Rs 18.38 crore as packing credit facility to the company during the year. Here again the bank disbursed the amount without asking the company to fulfill conditions mentioned in the sanction letter in December 2013 and March 2014,” the sources disclosed. RBI has given a mandate to all the Indian companies to follow while reporting their NPA’s. Auditors have all rights to create ‘special watch category’ and keep the track of their business for 12 months. This does not mean that once business is in this special category they can’t be given any additional loans. Businesses are never static, circumstances change for both, good and bad. If they are changing for good, any loan manager will help them by giving more, so that they can recover their dues in future. If auditors missed out in reporting that, there is no way the kind of banking technology these days we have would have not picked up those discrepancies before auditors.

The auditors have observed that the borrower made repayments in its accounts only in December 2013 and March 2014. It was also found that the export shipment for which packing credit facility was disbursed has not been shipped till March 31, 2014. ”Looking at the series of above transactions, it is suspected that the repayments in the accounts of borrowers have been met with the funds disbursed to it in the form of packing credit,” reads an observation made by the auditors who have recommended to “keep these accounts in special watch category.”  Auditors are not running the bank, their job is to mitigate the risk and disclose that to the management and shareholders. It is hard to believe in such half cooked stories, where we only know that repayments were done only in December and March and those loans are in ‘special watch category’.

Another shocking revelation, which surfaced during investigations into the loan accounts suspected to fall from grace, puts some auditors of the bank under cloud. During the course of auditing of the accounts for the financial year 2013-14, the auditors had declared some large loan accounts including those of three companies—one dealing with road development, another with software and yet another with data services—as technically unsecured and NPAs. Surprisingly, the auditors reversed the NPA classification of these accounts to ‘standard’ classification. This U-turn of the auditors, according to sources, has put a big question mark on credibility of all auditors.  So did we get more clarity on why auditors took U-turn? Can you please get us more details? And I still don’t understand when you say ‘technically unsecured’.

“The stressed assets of around Rs 2500 crore are over and above Rs 783 crore of Gross NPA that the bank has declared in its balance sheet. In addition, the bank has restructured loans of Rs 1575 crore. Even with an industry mortality of 33%, this means NPAs of another Rs 500 crores, taking the Gross NPA to around Rs 4,000 crore. In reality the total amount of NPA of the bank could be five times more of what the bank has shown. This takes the NPA ratio to nearly 5 per cent, which will be among the highest in the industry,” the sources said. What you are thinking as NPA’s are basically not NPA’s. Rs 1575 crore are not considered as NPA’s, even if I take your 2500 crore as stressed and re-structured loans than with your industry mortality of 33% of 4000 crore will be 1200 crore. There might be something sure to recover from your so called 2500 crore.

Meanwhile, experts say instead of showing inflated profits of Rs 1182 crore, the Bank management should have declared these accounts as NPAs and made the required provisions. “Even though this would mean lower profits for now, it would be in the long term interest of the Bank. Instead, the Bank is keen to show inflated profits,” said an expert. It will be in the interest of shareholders that you do not post or print baseless reports and damage shareholders value.

If the reporter has any evidence about any wrong doing by any staff, then it will be appreciated if he comes up and helps the management. What accusation he is saying about wrong doing by management are serious and can take a face of biggest bubble in our banking sector. Which to my belief is not in existence.

If you think that my sceptics against that news are worthwhile and if you are JK bank shareholder, please pass on this message to everyone you know who deals in stock market. Let me add disclaimer here that by supporting my rationale in regards to this news, you will be helping me to re-gain value in JK bank shares on Monday and also to other shareholders of the bank.