IndusInd Bank — no derailment but divergence points to higher scrutiny from RBI

For IndusInd Bank, the RBI divergence for FY17 was the only black spot in an otherwise predictable quarterly performance. Growth in profits for the March quarter was strong; as was the growth in operational parameters like advances, low cost deposits and interest margins. The healthy growth in deposits was one of the bright spots which appears to be helping the bank improve its market share, especially in corporate loans. While the bank has adequately addressed the divergence, greater scrutiny by the RBI is a point to note for the sector in general.

The stock is fully priced at 3.8 times FY19 book and a further rerating of the price earning multiple looks difficult. Hereon, the stock price would closely track the earnings growth that we expect in the mid-twenties.

Quarter at a glance

Net interest income (difference between interest income and expenses) grew 20%, driven by a 28% growth in loans and a stable margin of 3.97%. Non-interest income was soft as growth in core-fees was a modest 12% and treasury income declined (year on year) by 56% because of weak bond prices.

Strong traction in low cost deposits: The bank has been growing its low-cost deposit base at a healthy clip and the trend continued in this quarter as well. The growth in CASA (low cost current and savings account) has been much faster than overall deposits thereby taking CASA deposits to a respectable level of 44%.

Falling cost of funds partially counters drop in yields: The bank has been experiencing pressure on yields especially in lucrative retail lending. Still it has been able to maintain its margin, thanks to the strong low-cost deposit base.

Traction in loan book: The bank is witnessing good demand in corporate working capital market as well as in the commercial vehicle lending business. The vehicle finance portfolio grew 47% quarter-on-quarter and the medium & heavy commercial vehicles portion of the book grew 27%. The corporate book too has grown at a good pace during the quarter. We feel the strength of the liability is aiding the bank in capturing market share in the highly competitive high quality corporate loan market as troubled PSU banks are in retreat. In fact, the share of highly-rated (AAA & AA) corporate book is now 36.4%.

Market share gains: IndusInd Bank is well-capitalised (Capital Adequacy Ratio 15.03%) and has gained market share in incremental business significantly in both loans and deposits. The bank’s market share in the incremental business of deposits and loans in the past one year stood at 3.1% and 4.4% respectively.

Asset quality not yet a worry: The RBI’s audit report for FY17 highlighted divergence in recognising NPAs (non- performing assets), which is in contrast to the management’s earlier expectations of getting a clean chit. Still, we are not worried as the bank has duly recognised/resolved those observations.

Slippages in the March quarter was much higher at Rs 860 crore (Rs 408 crore in the previous quarter) on account of the divergence as bank recognised Rs 186 crore of assets under gross NPAs on account of RBI’s observation. Excluding this, slippages were a tad higher and would have to be monitored closely.

However, some of the positive developments in the quarter were a further reduction in restructured book and 65% provision coverage on the assets (Rs 385 crore) referred to National Company Law Tribunal (NCLT ) for resolution.

The bank seems to be executing a well-charted out strategy with a focus on building a strong low-cost stable liability and high yielding assets. In the near future, it is likely to complete the Bharat Financial acquisition which should be positive for its future earnings. However, the valuation at 3.8X FY19 book leaves little upside unless earnings growth continues to keep pace with the valuation.