Karnataka Bank: Multiple levers on the card for re-rating in stock price
Karnataka Bank is a 92-year old franchise, with an extensive presence in south India, especially its home state Karnataka. Company has a respectable market share of 3%+ in its home state credit. It currently operates through 738 branches and 1334 ATMs spread across the country. The 62% of bank’s branches are in its home state and generates 42% of loan business from this state.
Regional banks are usually characterized by their lower CASA franchise, week employee productivity and limited contribution from non-interest income. Compared to is peers, KBL has fared well with a superior CASA franchise (26% in FY16), better employee productivity, efficient cost management. Steady rise in non-interest income and adequate capital consumption. Inefficient balance sheet management and lower loan to deposit ratio have led to low margins (NIM). This in addition to asset quality headwinds and provisioning thereon RoA and RoE numbers. However with the management efforts to accelerate credit growth without affecting cost ratios coupled with enhancement in overall CASA proportion and decrease in deposit rates will help in margin (NIM) expansion and increase in RoA.
Loan Book to grow at 15% CAGR over the coming three years:
The bank is directing its efforts towards increasing the pace of loan growth with a focus on the higher yielding SME and retail segments. During FY12-FY16, KBL has grown its loan book at CAGR of 13.1% against 14% CAGR of Karnataka’s overall credit. The lower credit growth in the recent past is an outcome of management’s cautious stance towards growth. During FY12-FY16, the bank’s home-state portfolio increased at 21% CAGR which led to increased market share in overall state credit to 3.1% in FY16 from 2.3% in FY11.
While the bank loaned a higher proportion of credit to the corporate segment over FY10-FY12, it considerably increased its exposure towards higher yielding retail – SME segments from beginning of FY13. This is mainly due to concerns over asset quality and the considerable slow-down in credit from large corporates. Thus, over FY14-9MFY17, the share of retail & SME loans increased to 52.9% from 47% in FY14. The reduced focus on corporate exposure also enabled the bank to lower its exposure towards stressed sectors. While the bank has maintained cautious stance towards growth in the past, with well-planned strategy and increasing its retail & SME portfolio, banks pace of growth is expected to accelerate. With the above mentioned factors, KBL’s loan book is expected to grow at 15% CGAR over the next three years.
Margin expansion to continue in the coming years:
While KBL’s margins have increased by 19bps to 2.6% over FY13-FY16, they still remain lower compared to its peers. This is due to inefficient balance sheet management particularly in the nature of lower loan-to-deposit ratio and limited reduction in deposit rates resulting in higher cost of deposits when compared to peers.
One of the factors that dragged NIM down was investment in RIDF. However, the exposure under RIDF instruments has been declining. In FY16 RIDF investments stood at 9.5% of the total investments compared to 20.4% in FY13. The reduction in deposit rates, and increasing share of CASA deposits, focus on retail-SME nature of loan franchise, rising loan-to-deposit ratio and decline RIDF exposure will aid in margin expansion. The NIM is expected to improve over 28-30 bps over next three years.
Cost-ratios to be stable and non-interest income to increase further:
KBL’s cost/assets ratio at 183bps is the best among its peers and is an outcome of its well-drawn strategy towards branch addition and the ability to quickly turn-around the same. While bank’s cost-assets ratio remained low, its elevated cost-income ratio (avg of 54.5% over FY14-FY16) is due to its weak income profile, especially due to its lower margin profile and lower credit off take over FY14-FY16.
Historically KBL’s non-interest income to total asset ratio stood at 1%. However this expected to increase on the back of superior asset liability mix driven by retail and SME on the asset side and CASA ratio improvement on the liability side higher credit growth leading to higher loan processing fees, increase in third party and distribution fees following a tie up LIC and Bajaj Alliance and 3-4 mutual funds for mutual funds distribution.
Asset Quality trend to stabilize, building in provisioning buffers:
In a bid to grow rapidly the bank adopted an aggressive stance towards growth over FY11-FY13. Consequently, over this period, bank’s exposure to stressed sectors transcended 20%. KBL’s slippages remained higher over FY14-FY16 due to its consortium based nature of lending especially towards stressed sectors. Slippages have increased to an average of 300bps over FY14-FY16 from 190bps in FY11-FY13.
In an bid contain the pace of bad loan addition, management has initiated various measures which includes separation of credit appraisal from branches to regional offices, setting up of credit monitoring team beginning FY16 and resorting to asset sale to ARCs. The trend in slippages to normalize over FY16-FY19 with the above mentioned factors. The GNPA is expected to decline to 3.3% by end of FY19E.
The banks concentrated efforts towards asset growth with a focused approach at curtailing overall interest cost will see NIM improve over FY16-FY19E. The share of non-interest income to improve further, cost/income levels to moderate at 51% levels by end of FY19E. The outcome of these efforts are expected to translate into RoA/RoE of 1%/15% by end of FY19E. Banks with improved earning quality, higher credit growth and efficient capital consumption tend to graduate into higher valuation multiples and the same re-rating is expected to happen in KBL’s stock price.