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Kotak Bank: Stressed margins - Views on News from Equitymaster
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Kotak Bank: Stressed margins
Aug 29, 2005

Performance Summary
Kotak Bank had recently posted results for the first quarter of FY06, registering a negative growth in bottomline (on a standalone basis) after several quarters. While the bank seems to be going strong in terms of asset growth, pressure on margins and an unexpected jump in provisioning has dampened the bottomline expansion.

Rs (m) Kotak Bank (standalone) Consolidated financials
1QFY05 1QFY06 Change 1QFY05 1QFY06 Change
Income from operations 870 1,407 61.7% 1,644 2,440 48.4%
Other Income 274 360 31.4% 1,166 2,115 81.4%
Interest Expense 411 714 73.7% 709 1,071 51.1%
Net Interest Income 459 693 50.9% 935 1,369 46.4%
Other Expense 408 701 71.8% 1,488 2,547 71.2%
Provisions and contingencies 20 44 120.0% 56 71 26.8%
Profit before tax 305 308 0.9% 557 866 55.5%
Tax 85 111 30.6% 223 334 49.8%
Profit after tax/ (loss) 220 197 -10.5% 334 532 59.3%
Net profit margin (%) 25.3% 14.0% 20.3% 21.8%
No. of shares (m)* 59.5 123.3
Diluted earnings per share (Rs) 22.5 17.3
P/E (x)** 12.6
* Number of shares for 1QFY06 not adjusted for second bonus issue (3:2)†††** annualised

Aiming high
A flagship company of the well-known financial conglomerate Kotak Mahindra Group, Kotak Mahindra Bank was the first banking entity in the country created by conversion of a financial institution in 2003. The bank had 38 branches across 25 cities in India at the end of FY05 and plans to increase its network by 45 to 70 branches by FY07 across 40 to 50 cities. The capital adequacy ratio of the bank stood at 12.8% at the end of FY05. The bank has subsidiaries in diverse businesses such as securities broking, investment banking and life insurance. Besides Kotak Securities (46%), Kotak Bank is the only major contributor to the groupís bottomline (34% in FY05).

What has driven performance in 1QFY06?
Margins squeezed:† Retail assets, which comprise 32% of the bankís total loan book, continued to be the largest contributor to the bankís asset growth in 1QFY05 (89% advances growth). The concern, however, is that the bank continues to have a large exposure in the auto loan segment (albeit the fact that it has reduced from 58% of retail loans in 1Q05 to 40% in 1Q06), despite the interest rate sensitivity of this segment. The home loan segment of the bank has doubled on a YoY basis in FY05, although on a lower base. The corporate segment on the other hand, despite witnessing a decline in asset volumes, continued to be a significant contributor to revenue (28%). The pressure on spreads due to lack of sufficient low cost deposit mobilisation has continued to squeeze the bankís net interest margin. Given the higher credit offtake, the bank has reduced exposure on the treasury side and, resultantly, the credit deposit has increased from 81% in 1QFY05 to 89% in 1QFY06.

Kotak Bank (standalone)
(Rs m) 1QFY05 % of total 1QFY06 % of total Change
Commercial vehicles 13,450 58.4% 17,521 40.2% 30.3%
Personal loans 3,374 14.7% 6,396 14.7% 89.6%
Home loans 1,445 6.3% 5,219 12.0% 261.2%
Corporate + SME 3,162 13.7% 9,510 21.8% 200.8%
Others 1,583 6.9% 4916 11.3% 210.5%
Total advances 23,014 43,562 89.3%
Deposits 28,500 48,820 71.3%
Credit deposit ratio 80.8% 89.1%

Swelling overheads:† The overheads (up 31% YoY) have been a significant drain on the bottomline in 1QFY06. The bank attributes this to expansion initiatives and hopes to generate handsome revenues from the same going forward. This will, however, take a couple of years to fructify and until then, will continue to prune the bankís operating margins.

Healthy other income:† The other income for the bank continued to augment in the first quarter on the back of fee income (196% YoY growth) garnered by the cross selling of products of its subsidiaries. The bank acts a third party distributor for most of the products of the groupís asset management and insurance businesses. However, losses on the treasury portfolio have eroded some of the fee income gains.

Other income breakup...
Consolidated (Rs m) 1QFY05 % of total 1QFY06 % of total Change
Fee income 719 61.6% 1,408 66.5% 195.9%
Insurance premium 264 22.6% 570 26.9% 215.8%
Profit on sale of invst 132 11.4% (30) -1.4% -22.7%
Other income 51 4.4% 168 8.0% 329.2%
Total 1,166 2,116 181.4%

ĎStressed assetsí weigh heavy:† Kotak Bank acquired stressed assets worth Rs 10 bn from other banks during FY05. It claims to have acquired these assets at a substantial discount and envisages profitable recoveries from these. This is especially since no profit is booked until the entire amount paid upfront is recovered. However, given the RBIís latest guidelines on sale of NPAs, the same are expected to weigh heavy on Kotakís capital adequacy ratio and provisioning. While the bank is awaiting clarifications from RBI on the said guidelines, it seems to have already taken a proactive step by accounting for higher provisions in the first quarter.

What to expect?
The bank had announced a 3:2 bonus (3 bonus shares for every 2 shares already held) in 4QFY05. With this, the paid up share capital of the bank has crossed the minimum requisite Rs 3 bn mark for private banks. Also, the capital adequacy ratio of 14.7% seems adequate to support credit growth in the medium term without the bank having to resort to additional Tier II borrowings.

At the current price of Rs 211, the stock is trading at 3.5 times its FY05 adjusted book value. While the said valuations are certainly very rich in comparison to that of its peers, we do acknowledge the fact that Kotak Bank, being a well-diversified entity, holds considerable potential going forward. The bank seems to have been very conservative in terms of asset quality (net NPA to advances 0.3%). Also, the fact that the bank despite being a relatively new entrant in the private banking space is not a novice in dealing with the dynamics of the financial sector, acts as a comfort. However, we would like to reiterate the fact that the stock is currently skewed towards risk on the risk return matrix.

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