Is Mohnish Pabrai Too Early In His Contrarian Pick J&K Bank?

Unlike other investors who bought J&K Bank in its heyday and are helplessly seeing their investment melt away, Mohnish Pabrai knows what he is getting into. He bought a truckload of J&K Bank after it was known that it would be badly affected by the floods in J&K and the high risk advances that it has given would become NPAs.

So, Mohnish Pabrai’s investment qualifies as a classic contrarian investment.

Being a contrarian investor is the most difficult thing in the World. You need a high level of conviction and you need nerves of steel. You will be constantly assaulted by a series of bad news concerning your investment.

Also, as we saw in the case of Prof. Shivanand Mankekar’s example of Financial Technologies vs. MCX, a contrarian pick can lead to heavy losses (at least in the medium term).

The latest bad news to hit J&K Bank is the downgrade by CRISIL.

In a grim note dated 22nd October 2014, CRISIL has stated that it has downgraded its rating of the fixed deposits of J&K Bank to ‘FAA/Negative’ from ‘FAA+/Stable’.

It is stated that the rating downgrade reflects the ongoing stress in the bank’s asset quality and the expected impact on its profitability. The stress is on account of two factors: weakness in some large corporate accounts following the economic downturn, which has resulted in sizeable slippages during the quarter ended June 30, 2014; and the potential impact of the devastating floods that hit Jammu & Kashmir (J&K) in September 2014. Both developments are likely to result in J&K Bank’s financial performance being below-par for the previous rating level, notwithstanding restructuring packages that are likely to be announced by the central bank.

It is also stated that there have been material slippages in J&K Bank’s large corporate book in recent months owing to exposure to high-risk sectors and borrowers and that this weakness in J&K Bank’s corporate loan book will be compounded by the impact of the recent floods.

It is further pointed out that around 45 per cent of the bank’s advances are to J&K. As the borrowers have been affected by floods, recovery from them will be a difficult task. This will constrain profitability & the return on assets is expected to be less than 1 per cent for the next few quarters.

At this stage, we have to raise a couple of questions:

(i) Was Mohnish Pabrai too early in buying J&K Bank? Should he have waited for a couple of quarters to pass before making his purchase? If the quarterly results are bad, he could have got a better price for the stock.

(ii) Should Mohnish have deferred his purchase? He appears to have bought his entire quota worth Rs. 159 crore in one lot. If the price slips more, he may have no more money to invest in the stock.

One answer to these questions is that if Mohnish had waited too long and the Government announced an attractive relief/ bail-out package, he would have lost the opportunity of making a “worst-case-scenario” investment.

It could also be argued that the CRISIL downgrade does not present “incremental” bad news. It is already factored in the price. It could also be said that the bad quarterly results is also factored into the price and so Mohnish’s timing is as good as it can get. Things can only get better from here for J&K Bank.

The other question that we have to watch out is how much more one can hope to make out of a contrarian bet like J&K Bank as compared to a regular bet in a peer bank like South Indian Bank or Federal Bank. The difference has to be substantially more to justify the torment that one goes through.

Also, how long will the entire process take? A couple of quarters, a couple of years?

The answers to these questions will help shape our investment philosophy, hopefully.