Karur Vysya Bank – small but getting smarter with end of asset quality woes near

Karur Vysya Bank (KVB) ended the year on an indifferent note, as higher provision resulting from from increased bad loans caused a steep decline in net profit. However, the directional roadmap of the Tamil Nadu headquartered mid-sized private sector bank appears to be encouraging. KVB’s strategy is to diversify its loan book, increase share of low cost deposits, increase fee income and use technology more effectively. The new CEO (ex- Citi banker) is focusing on new hires, technology implementation and risk management to give the institution a more agile and modern look.

Asset quality issues might linger for a quarter or two, but the problem is nearing an end. Given that it is well capitalised, KVB can strengthen its presence in the segments where PSU banks are giving up market share. The attractive valuation at 1.1 times FY19 book and 1.4 times FY19 adjusted book makes it an ideal candidate for accumulation.

Difficult FY18

The decline in profitability in the final quarter as well as in the fiscal FY18 was attributed to a spike in provisioning as asset quality worsened. The bank’s credit book grew in line with the industry trend and it maintained its interest margin, leading to a 11 percent rise in net interest income (difference between interest income and expense). The reported jump in margin in the March quarter was due to one off revenue receipt of Rs 60 crore.

The non-interest income component was supported by decent rise in core fees while treasury income was much lower. The surge in operating expense was on account of Rs 26 crore provision for change in gratuity. We expect the cost to income ratio to stay a tad elevated as the bank implements its strategy of technology adoption and employee addition in key functional areas.

NPA problem to peak out shortly

In FY18, slippages rose 57 percent year-on-year to Rs 2092 crore. In the final quarter of FY18, bulk (87 percent) of the total slippage of Rs 589 crore came from the corporate book. The management recognised Rs 175 crore of slippages under RBI’s February circular on revised asset quality norms.

Going by the disclosure, it doesn’t appear that the saga of elevated slippage is over in this quarter. The bank still has an outstanding problematic pool of close to Rs 663 crore (watch list of Rs 325 crore with close to 50% non-funded exposure, standard restructured advances to the tune of Rs 262 crore and exposure of Rs 76 crore in a special 5/25 restructuring scheme). Hence, brace for at least one if not two quarters of elevated slippage.

However, post this recognition, the bank is hopeful of bringing down the slippage to a more normalised rate of 1.5 percent of advances.

De-risking the lending book

Source: Company

The bank has a diversified loan book and it is working towards increasing the share of its granular exposure through better adoption of technology. It is consciously bringing down the average ticket size of its corporate as well as commercial banking exposure. Internal risk management is being strengthened to improve the quality of the portfolio. The focus is clearly on risk adjusted growth and it expects a near-term growth in the mid-teens.

Source: Company

Trying to build a more robust deposit base

The management is working towards improving the share of low-cost deposits (CASA) although it hasn’t so far adopted differential rate (higher rate than 4%) on its savings accounts. In the year gone by, while the overall deposits grew by 5.9%, the low-cost deposits grew by over 11%. The management, while acknowledging the relatively lower CASA compared to peers, is targeting to take its CASA share to 31.5% by FY19 end and expects the roll out of digital banking and improvement in transaction banking to aid this effort.

Source: Company

Making the organisation smarter under the new head

The key initiatives are in the areas of technology adoption like home loan & working capital loan renewal live and roll out of the digital bank. Dedicated sales force has been created to facilitate retail asset growth and third party product sale. Risk management practices are being strengthened. Finally, without compromising on the flexibility of a branch-centric model, the same has been strengthened with technology to make it more robust and full proof.

Adequate capital and reduced competition from PSU augur well

The bank has a healthy capital adequacy ratio of 14.4% and seems well positioned to capture market share especially since PSU banks continue to vacate the market. We expect revival in earnings in FY19 riding on a much lower credit cost.

While Q1 FY19 is likely to be another soft quarter for KVB, we are building in a revival in the second half of FY19. At 1.1 times book and 1.4 times adjusted book of FY19, the consolidation phase offers a great opportunity to accumulate this stock for the long term.