Jammu & Kashmir Bank: Sell

Jammu and Kashmir Bank has been in the news recently for the wrong reasons. First, there were rumours of discrepancies in the reporting of bad loans, which was denied by the management. Then, in the June quarter results, the bank reported a spurt in bad loans, as two large accounts slipped into the non-performing category.

This led to a 58 per cent decline in the quarter’s profit compared to the year-ago period. Consequently, the bank’s return on equity, which had been among the highest in the sector at 24 per cent, fell to 9 per cent.

Over the last three months, the stock has lost close to 21 per cent. At ₹1,489, it now trades at a comfortable 1.2 times its one-year forward adjusted book value, in line with its historical average. While valuations seem to have factored in the recent deterioration in asset quality, upsides in the stock may be limited, given the risk to earnings and possible slippages from the restructured book.

From our previous buy recommendation in October last year, the stock is up 25 per cent. Investors can book profits at this juncture.

In May, following news reports, the management had indicated that stress in one or two accounts was likely to impact June quarter performance. This played out, as expected.

The bank’s gross non-performing assets (GNPAs) as a percentage of loans went up by about 250 basis points, from 1.6 per cent in the March quarter to 4.2 per cent in the June quarter.

The increase in bad loans was primarily due to slippages in two loan accounts — REI Agro (₹700 crore) and HDIL (₹290 crore).

As a result, the bank’s provision cover fell from 90 per cent in the March quarter to 55 per cent in the June quarter.

REI Agro is likely to get restructured under CDR and upgraded to a standard asset, and HDIL will be upgraded once the operational issues in the account are sorted out.

While this may lead to reduction in the quantum of bad loans, and earnings may go up in the short term due to reversal of provisions on these accounts, the stress is likely to remain on the bank’s books.

J&K Bank’s restructured assets at 3 per cent of loans, are likely to increase, with the REI Agro account in the pipeline. The bank also has exposure of about ₹400 crore to Bhushan Steel which is a restructured account.

The management expects the GNPA to moderate to 2 per cent of loans by the end of 2014-15. But, since the bank lends under consortium arrangements to corporates outside J&K, it may be difficult to gauge slippages on a quarterly basis.

J&K Bank’s loan growth slowed down from 18-19 per cent in the previous four quarters to 13 per cent in the June quarter.

Within the state of J&K, the bank’s loan book primarily consists of personal and agriculture loans. In the June quarter, agriculture loans grew by 42 per cent. But this is risky, given the high delinquency rate in the segment and looming state elections. Outside J&K, the bank’s lending is predominantly to high-rated corporates. At 9 per cent, growth in this segment remained muted in the June quarter.

Net interest margin (NIM) also took a knock in the June quarter, primarily due to lower interest income as accounts slipped into the NPA category. But the bank has been able to maintain a strong low-cost deposit ratio (CASA) at 41 per cent.

This should aid margins. Also, the bank earns a higher NIM within J&K, than outside the state, where lending is predominantly to high-rated low-yielding corporates. With continued focus on lending within J&K, the bank should be able to achieve better margins — 3.8-3.9 per cent by the end of 2014-15.

While near-term risks on asset quality may be an overhang, J&K Bank’s high margin profile is a plus. Also, it is the dominant player in its home state, with market share of 62-67 per cent in deposits and loans. The bank is also well capitalised with capital adequacy at 12.9 per cent.

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