Robust profitability, good asset quality, healthy success in scaling up low-cost deposit base, and strong presence in under-penetrated markets, are key positives for Bandhan Bank.

For investors wanting a piece of the action in a somewhat differentiated banking space, Bandhan’s superior operating metrics — return on assets of around 4 per cent, return on equity of 25-odd per cent and low cost-to-income ratio of about 35 per cent — are a big draw.

Also, the transition of Bandhan — the largest micro-finance institution (MFI) then — into a universal bank in August 2015 and eight MFIs into small finance banks, has led to a tectonic shift in the way micro-credit is extended in remote hinterlands; banks are now the largest provider of micro-credit with a share of 37 per cent (as of December 2017). Bandhan, given its proven success, is well-placed to leverage the potential for micro-credit in India.

But the bank’s highly concentrated portfolio and geographical presence are key risks. Bandhan Bank’s dependence on the micro-lending business — about 87.5 per cent of loans as of December 2017— leaves it vulnerable to risks within the sector. While the success of the MFIs’ joint lending group model is well proven, it can also be a double-edged sword, triggering large-scale defaults as in the case of demonetisation.

While Bandhan Bank managed to weather the challenging times better than most other players, systemic and political risks continue to plague the sector.

In competing with other private sector banks that have a more diversified and secured loan portfolio, Bandhan Bank’s focus on micro-loans could be a concern. As of December 2017, East and North-East India together accounted for 81 per cent of Bandhan’s loans.

PO19IPOBandhancol
 

 

Pricey offer

Given these risks, the asking price for the initial public offer (IPO) is expensive. At the upper price band of ₹375, the valuation works out to about 4.8 times (post issue) expected book value for FY18. In the recent merger deal of Bharat Financial Inclusion with IndusInd Bank, the former had been valued at about 5 times FY18 book.

However, a better benchmark to compare would be the valuations of other private sector banks (Bandhan being a universal bank) with whom it would compete in the long run. By that yardstick, the premium valuation for robust financial metrics may appear a tad overdone, given the inherent risks and short term track record as a full-fledged bank. Private sector banks trade between two to four times book value currently. HDFC Bank that has a long track record of delivering sound business growth and healthy profitability trades at 4.5 times FY18 book value.

High-risk investors should temper their expectations, as high listing gains are unlikely. Long-term investors can wait until the listing and watch for sustainability of performance before buying shares in the bank.

The Bandhan Bank IPO is a combination of fresh issue of around 9.8 crore shares and an offer-for-sale (OFS) for 2.16 crore equity shares.

Robust financial performance

As Bandhan Bank began its operations in August 2015, financials for FY16 and FY17 are not comparable. Nonetheless, the growth in its advances and deposits have been robust. As of March 2016, its gross advances stood at ₹15,578 crore. This has grown to ₹24,364 crore as of December 2017.

In addition, because the bank’s priority sector lending (PSL) portfolio is significantly higher than the RBI’s requirements, it generates additional stream of income through sale of PSL certificates to other banks. As of December 2017, 96.5 per cent of the bank’s gross advances were PSL compliant. Hence, while interest earned grew by 21.9 per cent Y-o-Y for the nine months ended December 2017, the bank’s other income, boosted by sale of PSL certificates, grew by a robust 78 per cent. The bank’s growing PSL portfolio should continue to boost its non-interest income.

Bandhan Bank has been able to garner about ₹25,294 crore of deposits as of December 2017. Share of retail deposits and low-cost CASA stood at 85 per cent and 33.2 per cent respectively, as of December 2017.

Managing to substitute nearly its entire costlier bank borrowings with low-cost deposits, has helped the bank maintain a healthy net interest margin of 9-10 per cent. However, sustainability will be key, given that such progress on the liabilities front (deposits) has been uncommon. According to the management, only 6 per cent of the deposits are from its MFI customers. Currently, the average deposits per customer works out to around ₹1 lakh, which is on par with that of other private sector banks.

On the assets side, given the opportunity in the MFI space, growing its loan portfolio should not be a challenge. However, some amount of diversification into other loans (non-MFI) will be important to scale up. This could gradually add pressure on yields.

Increase in provisioning for NPAs could also turn out to be the joker in the pack. Inherent risk in the MFI business along with the bank’s geographical concentration make it vulnerable to sudden external shocks. As such, provisions and contingencies increased by 409 per cent Y-o-Y in the nine months ended December 2017. This was driven by an increase in GNPA ratio to 1.67 per cent as of December 2017 from 0.48 per cent in December 2016, due to the effects of demonetisation, loan waivers and GST.

Other risks

According to RBI norms, the promoter’s (non-operative financial holding – NOFHC) stake in the bank has to be brought down to 40 per cent within three years from the date of commencement. Bandhan Financial Holdings Limited (NOFHC) that holds 89.6 per cent in the Bandhan Bank (and 82 per cent post-issue) has to reduce its stake to 40 per cent by this August. The management has stated that it has approached the RBI seeking relaxation and advise on this front. Nonetheless, the imminent reduction in promoter stake hangs as a Democles sword on investors’ heads. If the reduction happens through fresh issue of shares, there will be immediate dilution. If the promoters decide to sell their holdings, pricing, which depends on the performance of the bank, will be key.

comment COMMENT NOW