A bank of many years vintage which still has not got its bearings right
From the banking belt
The Karnataka Bank Ltd comes from the 'banking' belt of the state - Mangalore, and it is fairly ancient to boot; having been incorporated in 1924. It is just 13 years shy of completing 100 years of service. The breakup of its current shareholding pattern reveals that the promoter groups - neither Indian or foreign hold any shares in the company. The outstanding paid up equity of Rs 1.9 bn is held by two broadly defined principal players. The Public institutions hold 30.6%, while non-institutional shareholders, including bodies' corporate and individual shareholders (NRIs included) hold the balance 69.4%. The management however caricatures the institution as a premier private sector bank.
It is not a very large sized bank in terms of deposits or even branches. Its operations are basically focussed in Karnataka, with the neighbouring state of Maharashtra holding on to the second spot. At year end it made do with 478 branches and 267 ATM outlets. It had deposits and borrowings totalling Rs 284 bn, while its advances and investments totalled Rs 288.5 bn. In the preceding year the corresponding figures were Rs 244 bn and Rs 244 bn respectively. In other words the bank has gone the whole hog and was fully committed on the lending front in both the years. Overall the borrowings rose 16.4% while the advances and investments rose 18%. The total of the advances excludes balances lying with banks and moneys' at call notice etc.
A breakdown of its operations
To give a further run down on its activities, the bank as stated earlier commits the bulk of its lending in the home state. Of the total exposure (fund and non-fund based) of Rs 201 bn, a slice over 32% was accounted for by Karnataka state. Coming in at a poor second is Maharashtra with 17%. Next in line surprisingly is Delhi with 12.6% and followed by Tamil Nadu with 9.8%. Though the bank operates in 22 states, significantly 84% of the total gross bank credit is accounted for by just six states. The other interesting statistic that the bank has furnished relates to the credit exposure by industry sector. The total lending to this sector at year end, both on fund based and non funded account added up to Rs 78 bn, with fund based lending accounting for almost 87% of the portfolio. (The total credit exposure by the bank to the industry accounted for 45% of all advances of Rs 173 bn). Its lending portfolio is quite unique and lopsided it would appear. Infrastructure advances accounts for almost 38% of all fund based lending. This is followed at a distant second place by cotton textiles accounting for close to 10%. Next in line is other textiles with 9%, and gems and jewellery with 8%. Its industrial loan portfolio extends to 27 categories, but a mere six industries in this potpourri hogged 74% of all such advances.
The profit and loss account
So what does the profit and loss account have to show for it all at the end of the exercise? It earned a gross income of Rs 26.6 bn during the year. This comprises of interest income of Rs 23.7 bn and Other Income of Rs 2.9 bn. The interest income in turn includes income on advances/bills of Rs 17 bn and income from investments of Rs 6.4 bn. There was also sundry income earned from balances with the RBI and Others. It is difficult to get a fix on the returns that it earns on the funds earmarked for term loans, advances and bills discounting, given the manner in which such incomes are earned. But one can hazard a guess on the returns that it garnered on its investment portfolio. On a rough estimate it would have earned a return of 5.6% on its investment portfolio, against a 5.7% return in the preceding year. The breakup of the investment portfolio shows that close to 60% of the total investments are earmarked in government securities, with a smattering sown in other approved securities. Surprisingly enough, 34% by value is invested under a head titled Others. What in heaven's name is this please? How could such a large investment by value be in un-denominated form? It also has trifling investments in share and debenture bond portfolios.
On the expenditure side of the revenue equation, the biggest component is interest expended. It amounts to Rs 17.6 bn against Rs 17 bn previously. This component has been expended on its deposits and borrowings portfolio, and based on a back of the envelope calculation would average out at 6.2% against 7% previously. So there appears to be an attempt at containing the interest outflow. Then there are the operating expenses which grew a robust 42% to Rs 5.5 bn and provisions and contingencies which grew at an even faster clip by 61 % to Rs 1.5 bn. The principal culprit in the operating expenses head is payments to employees which rocketed 67% to Rs 3.4 bn. This is an expenditure outlay that will be difficult to control given the bank's plans to expand rapidly. At year end the bank had an employee strength of 5,795 numbers. The bank also notes very carefully that the business per employee improved from Rs 73 m to Rs 77 m during the year. So in effect it is employee positive. The sharp increase in provisions and contingencies is probably a pointer to the unfolding scenario. As stated earlier the advances portfolio and the investments portfolio grew 18%. In this context the mega increase in the bad debts portfolio appears to suggest that the defaulter list has risen sharply. The bank has not addressed this position adequately in the directors' report.
Segment reporting results
There is also the flip side to the bank's financials. For segment reporting purposes it categorises its income under four heads of account. There is treasury, corporate/ wholesale banking, retail banking and other banking operations. The biggest income earner is retail banking bringing in a slice over 36% of all income. This is followed by corporate banking with 33% and treasury operations with 28%. Bringing up the rear is other banking operations with a piddling 2%. Retail banking also brings in the vast bulk of the bottom-line, though as a percentage of revenues the winner by a mile is other banking operations - whatever that is. A profit margin of 80% on revenues is a whopper by any yardstick. The treasury operations, however, appear to be a no brainer incurring large losses in either year - a loss of Rs 1.7 bn on revenues of Rs 7.5 bn for the latest year. How can this be? Treasury management by its very definition means the management of the surplus funds of an organisation, and in the case of a banking institution the funds under management can be humungous. The objective of treasury management is to insulate it from other adverse possibilities. The Karnataka Bank appears to be unable to get the point.
In the case of a bank, treasury management includes in the main three different operations - carried out either on a proprietary basis, or on behalf of a client base, or a mixture of the two. It involves the fixed income or money market desk which buys and sells interest bearing securities. A foreign exchange desk which buys and sells currencies and a capital market desk that deals in stock market listed risk securities. The management does not appear to have any explanation to offer for this dismal state of affairs. The corporate banking division too appears to be out of pocket. In 2009-10 it had incurred a segmental loss, while in the latest year it scraped through with a profit. All in all it does not for a pretty picture make.
How the profits really add up
Like all the banks surveyed to date, The Karnataka Bank too appears not to be making any money from its mainline operations. Take a look at the figures. It reported a net profit of Rs 2 bn against Rs 1.7 bn previously. The other income for the year, which is a constituent of the net profit, amounted to Rs 2.9 bn against Rs 3.8 bn previously. If one nets off the two it would appear that but for the other income, the bank would have reported a bottom-line steeped in red ink. The point is that other income by definition has no revenue expenses. In this instance the other income is made up of several bits and ends. There is the profit on sale of investments, profit on exchange transactions, commission, exchange and brokerage (which is the single biggest individual component), and miscellaneous income-whatever that is. Why should such a situation prevail? Why is that banks are unable to turn a trick or two from their mainline operations? There are no immediate self evident answers.
The management has one side kick activity going-but it may be a very marginal business. It has a 15% stake in an insurance JV called Universal Sompo General Insurance Company. The financial details of this venture have not been spelt out, and besides, such ventures take years on end to turn a profit. The bank's equity stake in this venture is not known. Sompo is a giant Japanese insurance company, and the Indian venture includes several other bulge bracket investors including Allahabad Bank, Indian Overseas Bank, and Dabur Investment Corporation.
The future imperfect
The management says that it has envisaged a total business turnover of Rs 540 bn, comprising of deposits of Rs 325 bn and advances of Rs 215 bn for the year to end on March 31, 2012. In other words, an advances to deposit ratio of 66% against the ratio of 61% for the year under review. But given the manner in which events are moving, the scene is unlikely to change for the better from the shareholder point of view. This is definitely not an investment option for the investor.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.