Sum of the parts - Value unlock or trap !
Key Terms in Lending Sector
Cost of Funds and Net Interest Margin – As banking works on lending the capital, earn the difference principle, lesser the cost of funds, more will be the difference. Thus difference post expenses is known as Net Interest Margin i.e. the amount of money that a bank is earning in interest on loans compared to the amount it is paying in interest on deposits.
Return on Assets - Return on assets is a metric that indicates a company's profitability in relation to its total assets.
Both ROA and return on equity (ROE) measure how well a company utilizes its resources. But one of the key differences between the two is how they each treat a company's debt. ROA factors in how leveraged a company is or how much debt it carries. After all, its total assets include any capital it borrows to run its operations. On the other hand, ROE only measures the return on a company’s equity, which leaves out its liabilities.
Gross NPA and Net NPA - What is GNPA and NNPA?
GNPA is an absolute amount. It tells you the total value of gross non-performing assets for the bank in a particular quarter or financial year as the case may be. NNPA: NNPA stands for net non-performing assets. NNPA subtracts the provisions made by the bank from the gross NPA.
Book value is the total tangible net assets in the balance sheet of a company after deducting its liabilities. In other words, it is the net worth per share. Price to Book Value ratio compares the market price of a stock to its book value to assess whether the stock price is over the book value and by how much or whether it is trading below its book value. This ratio is used for any business that is asset heavy like infrastructure companies and is commonly used in the valuation of financial stocks.
Slippage Ratio - When a standard asset becomes an NPA owing to the borrower not paying interest for more than 90 days. To put in simple words, when a good loan turns bad, it is termed as slippage.
Capital Adequacy Ratio - Capital adequacy ratio is the proportion of a bank’s risk-weighted assets and current liabilities that it is required to maintain as capital.
LCR - The liquidity coverage ratio is the requirement whereby banks must hold an amount of high-quality liquid assets that's enough to fund cash outflows for 30 days. Liquidity ratios are similar to the LCR in that they measure a company's ability to meet its short-term financial obligations.
Basel III is a regulatory framework on bank capital adequacy, market liquidity risk and stress testing. It is based upon three main pillars: minimum regulatory capital requirements, supervisory review process and market discipline
Net Stable Funding Ratio (NSFR) promotes Bank’s resilience over a longer-term time horizon to maintain a stable funding profile in relation to the composition of the assets and off-balance sheet activities.
Asset Classification and Accounting
Stage 1 - On initial recognition, all loans are classified as Stage 1. Subsequently, loans which are not more than 30 DPD(Days past due) on the reporting date are classified as Stage 1. It also includes loans which have been reclassified from Stage 2 or Stage 3 on improvement in credit quality as reflected in their DPD on the reporting date. Within Stage 1, there are 2 sub-categories
1 A – Accounts which never went to stage 3 earlier and accounts which went to Stage 3 but subsequently normalized and currently in 0-30 days
1 B – Accounts which were stage 3 earlier, and roll backed but yet to normalize though it has moved to stage 1 currently
Stage 2 - It represents loans which have significant increase in credit risk since origination. Loans which are more than 30 DPD and upto 90 DPD on the reporting date are classified as Stage 2. It also includes loans which have been reclassified from Stage 3 on improvement in credit quality as reflected in their DPD on the reporting date. Within Stage 2, there are 2 sub-categories
2 A – Accounts which never went to stage 3 earlier and accounts which went to Stage 3 but subsequently normalized and currently in 31-90 days
2 B – Accounts which were stage 3 earlier, and roll backed but yet to normalize, though it has moved to Stage 2 currently
Stage 3 - Loans with more than 90 dpd on the reporting date are considered credit impaired.
PD is computed separately for each of the sub-segment. PD of stage 3 loan is 100% as it is already under default.
Forward looking information with reference to external forecasts of macro-economic parameters is also considered in the estimation of PD by applying appropriate weightages to the most likely, optimistic and pessimistic scenarios.
Addition of Stage 1B, Stage 2B and Stage 3 will be the GNPA as per RBI norms with INDAS values.
Apart from ratios, lending business needs a robust risk management and agile approach. A balance of asset and liability side, focus on asset quality and enough buffer to fly away any black swan.
Banking industry has been one of the toughest to crack in India and much tough to keep a bank running with growth and corporate governance intact. Here I present an overview of one of the largest private sector bank -
Kotak Mahindra bank.
Number crunching:
Mcap-3,30,000 Cr
PAT- Rs.14,250 crores
The bank operates ~1,700 branches & ~2,700 ATMs in India.,
CASA-53% approx,
RoA-2.76%
Book Value - Rs.540/ share
NIM- 5.47
The bank had 32.7 million customers as at March '22 versus 26 million customers last year, a growth of 26% YoY.
NNPA-1.3% vs 0.6% (Q1FY23)
Diversified Subsidiaries-For Q3 FY23 PAT -
KM Bank 2792 Cr
Kotak Prime 225 Cr
Kotak Securities 240 Cr
KMCC 28 Cr
Kotak Life 330 Cr (Total premiums for FY22 = 13015 Cr with PAT 425 Cr)
Kotak General Insurance - (27 Cr)
Kotak AMC 150 Cr, 7.4% AUM share,9.1 Billion Rs SIP, Total AUM - 405269 Cr
BSS Microfinance - 82 Cr
Lending Book - 2,71,000 crores
Capital Reserves and Surplus – 1,07,670 Cr
Source-Kotak Q3FY23 PPT
Diversified Loan book:
Home loan & Loan against property - 23%
Working capital loans - 9%
Personal loan, consumer Durables - 3%
Credit cards - 2%
Comm. vehicle, construction equipment - 8%
Agriculture Division - 10%
Tractor finance - 4%
Corporate Banking - 23%
SME - 8%
Credit substitute - 6%
Others - 2%
30% of the profits come from the subsidiaries approximately (5% from AMC, 8% from Insurance, 7% Capital Markets and rest 10% from other lending related activities) and 70% of the profits are the standalone bank.
Focus - Risk management, ROE and growth as a balance. DNA - low-cost and sustainable liability
FUEL – “We think that once we make up our mind, we will get the liability engine also firing even faster because at the core of it, it is something which has been deeply in our DNA which is low-cost and sustainable liability. We don't start in a bad place with 53% CASA ratio and 130% LCR.”
Digital banking - In volume terms, more than 97% of the savings account customer transactions are now non-branch in volume terms.
About subsidiaries –
The two NBFCs, Kotak Prime and Kotak investments put together have a capital adequacy each of over 30% with together having Rs.10,000 crores of capital and RoA excess of 3%. Kotak Mahindra Investments Limited, it is the NBFC arm, primarily into CRE and corporate structured lending.
The Life Insurance Company has a solvency of 2.7x with a networth of 4.4 thousand crore. VNB margin grew by 29.5% to Rs.895 crores for '21-22. VNB margin industry leading at 31.1%. (More on it in the Life insurance Sectoral Analysis)
AMC - Total average AUM grew 22% year-on-year to reach Rs.2.86 trillion. Equity average AUM supported by market bounce grew 53% year-on-year to reach Rs. 1.44 trillion. Total average AUM market share increased to 7.4%. (More on it in AMCs Sectoral Analysis)
The full year PAT for Kotak Securities was Rs.1,001 crores versus Rs.793 crores for last year. The cash market share for this quarter was 11.5% against 9.7% for the same period last year.
The market average daily volume for this quarter was Rs.47,82,000 crores against Rs.22,47,000 crores same period last year, a real serious jump, and the increase which happened was predominantly in the options market, the cash market has remained more or less the same.
DIY banking, Mobile-First strategy and Pay Your Contact (UPI) along with 811 marks the digital services which continues to grow with very good numbers. Digital transactions through net mobile continue to grow deposits, lending, service, payments and in-app shopping, 97.8% of savings transaction volumes were in digital or non-branch mode.
Kotak Mahindra Capital - KMCC is a leading, full-service investment bank in India offering integrated solutions encompassing high-quality financial advisory services and financing solutions. The services include Equity Capital Market issuances, M&A Advisory and Private Equity Advisory.
KMCC successfully completed 36 transactions, including 19 IPOs, 4 QIPs, 9 Block Deals, 2 Rights Issues, 1 OFS and 1 InVIT raising a total of ₹ 1,16,556 crore in FY 2022. Kotak continued to be the Left Lead Banker of Choice having led large IPO transactions like Zomato, Star Health, FSN E-Commerce Ventures Ltd, PB Fintech, Sona BLW Precision Forgings etc. KMCC was ranked No. 1 in IPOs more than ` 1,500 crore having led 16 out of 20 such IPOs. KMCC had a 55% market share in FY22 across all ECM transactions. (Source: Prime Database)
Going forward - Alternate asset business crossing more than $5 billion as assets under management, making it probably one of the largest Indian alternate asset manager. And in all these alternate asset pools, they are committed to putting around 15% of the firm's capital, of the group's capital alongside
Digital Banking bottlenecks-
You have to keep upgrading the back-end also as capacity planning and resilience planning. Now that volume increase capacity while you will increase your front-end has to be matched with equal investment at the back-end. So that investment will keep happening
On the tech side, the other digital investments really where as you acquire larger and larger base of customers and a lot of these customers are really mass retail customers, it is extremely important to keep them engaged which requires high opex.
INFLATION AND LENDING SECTOR –
Good risk management, focus on different segments, secured - unsecured mix, producer- consumer relative position. These are the key drivers which works during inflationary period and the top quality lender sails through. “Good risk management is at the core of financial services.”
It is like in good times all boats are lifted. It’s only in tough times that boats, which can swim better will show better.
Loan Book Mix- Fixed rate type - 16%-17%, about 48% EBLR (Repo linked) linked and the remaining 18% MCLR linked.
Guidance – “At this stage, early days, we cannot take a call that growth will slow down, but we have to watch the tea leaves carefully.”
There is an upward trajectory in NIM showing the robustness and agility of the bank.
On M&A –
Mr. Uday Kotak explains it as a –“The front-end operating cost increase for underlying unit economics we will go ahead and do it. And the second is we are also clear that the strategy of asset growth leading to some increase in liability growth by putting the hooks including some of the spends related cost, we are ready to do it because we want both the engines now to fire significantly as we go forward.”
As the numbers speak about itself the bank is like a ship with multiple growth engines.
Not only in banking but also fintech and life insurance the company provides vertical integration for all banking and related services clubbed with management quality like no other.(Uday Kotak, Nilesh Shah).The operating leverage is in the management which gets translated into numbers QoQ, YoY. These thesis pointers makes Kotak one of the robust businesses in the country. Kotak not only brings a diversified business mix with deep focus in fintech services. Robustness ratio, contrarian management's vision and tough to copy services makes it an apt Nick Sleep kind of pick.
Sum of the parts valuation –
Total Capital Reserves – 1,07,670 Cr.
Kotak Bank – Commercial, corporate banking division with PAT 8573Cr. Assuming P/E multiple of 20x. Fair Value – 170,740 Cr.
Kotak Life – EV = 11,000 Cr. + VNB 865Cr.
Comparing the valuation with peers like HDFC Life and ICICI Prudential, 2 times EV seems to be a reasonable number.
Fair Value – 24,000Cr.
Kotak Prime and Kotak Investments – Again taking a conservative number of 15x P/E, PAT – 886+371 Cr. Fair Value – 18,855 Cr.
Kotak Securities – PAT = 1000Cr
Comparing it with peers like, assuming 10x P/E for cyclical business like broking.
Fair Value = 10,000Cr.
KMCC – Investment banking division, primarily driven by IPOs, assuming a P/E of 25x due to limited peers and dominant market position, fair value comes out at 245*25 = 6125Cr.
Kotak AMC – With low amortization and depreciation expenses, lower operating leverage and huge market opportunity, AMCs were often valued at 40-50x P/E, but to keep our assumptions conservative, we assume 25x P/E multiple. Fair Value = 11,350
Another matrix that can be used is P/AUM 6% = 6% of 288669Cr = 17,320Cr.
Fair Value = 11,350 + 17,320/2 = 14,335 Cr.
Kotak General Insurance – At present it is a loss making segment, but the future remain optimistic. To maintain conservative assumption, we are ignoring the book value of thus business.
Other Subsidiaries – International Subs + BSS Microfinance + Others = (118+83+92) * 10 = 3000Cr.
SOTP = 1,70,740 + 24,000 + 18,855 + 10,000 + 6,125 + 14,335 + 3,000 = 2,47,055 Cr.
Another parameter - 3 times P/B and management quality of this level Kotak not only is a growth but also a value bet in Indian listed space.
The numbers not only establishes the fact that it is one of the most expensive but well diversified bank with multiple growth engines.
Some antithesis pointers include any whistleblower activity can create panic in banking industry, Cyclical businesses like brokerage and wealth management and difficult to understand accounting are some issues.
Forward looking approach-Home and retail loan book, Customer acquisition and experience, Tech growth and right talent. 70% of the advances linked to floating rates while 30% pegged at fixed interest rate.
Microfinance is one segment where the management seems a big aggressive.
With organic growth, inorganic aspect can come handy as the size grows. Using Goldman Sachs case study let us try and understand the rationale for M&A.
M&A at GS
Broad strategy – Mid size deals one, three, five, ten billion dollar companies which goes inline with company’s inhouse business i.e. Banking and wealth management. As Solomon suggests the regulatory environment is now quite difficult to sign and incorporate large, transformative deals.
Greensky and NN Acquisition case study:
NN - NN is a much simpler integration rolling into asset management platform more assets, more capability in Europe, some new distribution channels. And obviously a significant portion of that business is a contract with a large insurer, the parent that sold NN Investment Partners.
Greensky – Will help GS in expanding the network inorganically and long term transformation of GS to digital banking platform.
“Merchant network that they have, and we thought that was very, very important for our digital consumer bank. We thought it would take us 7-10 years to build a comparable merchant network. It took GreenSky almost 15 years to build that network.”
David Solomon
“And so certainly from a regulatory perspective, especially on large transformative deals, I think the regulatory environment has gotten a little bit more difficult.
“When you're thinking about transformative M&A, that's playing a role. On the other hand, if you look at all the M&A activity last year, it was a record year for M&A activity. Broke the previous record which was 2007. A lot of it comes from what I'd call, you know, midsize deals. You know, one, three, five, ten billion dollar companies. Consolidating, being bought, buying other businesses.”
“It really was that part of the world that drove all this M&A activity, not big, large, transformative deals. I mean, the tech sector has been relatively constrained from doing big, large, transformative things. The banking sector has been relatively constrained from doing big, large, transformative things. And so you've got this mix and this match where the regulatory environment is tougher, but there's a lot of underlying consolidation going on in a lot of businesses.”
Disclaimer - This is not any investment advice.
