Verdict: An Expensive Bond
Bandhan Bank is entering the primary market on Thursday 15th March 2018 to sell up to 11.93 crore equity shares of Rs. 10 each, 82% via fresh issue and 18% via offer for sale (OFS) by World Bank’s IFC, both in the price band of Rs.370 to Rs. 375 per share. Representing 10% of the post issue paid-up share capital, total issue size is Rs. 4,473 crore at the upper end of the price band, of which, OFS portion is Rs. 811 crore. Issue is scheduled to close on Monday 19th March and listing is likely on 27th March.
India’s largest micro lender, Bandhan Bank is a commercial bank, having commenced operations on 23rd Aug 2015, after getting RBI’s in-principle approval for new bank license in April 2014, along with IDFC. Bandhan Bank’s operations span both general banking (887 bank branches, 430 ATMs serving 21 lakh customers) and micro lending (2,633 doorstep service centres (DSCs) serving 99 lakh micro loan customers). Geographically, distribution network is concentrated in East and North East India, with 3 states - West Bengal, Assam and Bihar - together accounting for 57% of branches and DSCs as of 31-12-17. Due to limited operating history, not much financial information is available for comparative purpose.
For FY17, bank earned interest income of Rs.3,909 crore and other income of Rs. 411 crore, aggregating to total income of Rs. 4,320 crore. On net interest income (NII) of 2,404 crore, its net interest margin (NIM) was very strong at 10.4%, as micro loans yielding 18%+ annual returns accounted for 88% of total lending. Thanks to tight check on costs, its low cost-to-income ratio of 36% is a competitive advantage, which lead to net profit of Rs. 1,112 crore and an EPS of Rs. 10.15 for FY17.
For 9MFY18, interest income and other income stood at Rs. 3,452 crore and Rs. 503 crore respectively, leading to total income of Rs. 3,955 crore and NII of Rs. 2,169 crore. As operations expand, margins are slowly but surely under pressure, with NIMs slipping to 9.9%, from 9MFY17’s 10.3%. Moreover, Bandhan’s bad loans, a torment for any lending business, are on an upward trajectory and especially so, at a rising pace. Gross NPAs which stood at 0.15% on 31-3-16 rose to 0.51% on 31-3-17 and to as high as 1.67%, as of 31-12-17. Asset quality woes is seconded by sharp jump in provisions and contingencies to Rs. 265 crore in 9MFY18, from Rs. 88 crore in FY17. Banks’ net NPAs, as of 31-12-17, stand at 0.8%.
It’s been seen that most banks and NBFCs in India have lower relative presence in the East corridor (both in terms of physical outlets and disbursement) and negligible presence in North East, which has been Bandhan’s area of expertise. Till now, this differentiator has come to the bank’s advantage. However, as it expands away from its home turf, in addition to complying with RBI regulation of minimum 25% bank outlets in unbanked rural areas (currently fulfilled with 29% ratio), sustainability of industry-leading margins remains a question, on account of competitive as well as operating cost pressures. Although current margins are healthy, they are definitely headed south, with RoE contracting to 25.6% during 9MFY18 from 28.5% in FY17 and from 27.9% in 9MFY17.
As of 31-12-17, bank’s total deposits stood at Rs. 25,294 crore, of which, low-cost current and savings account (CASA) comprised of 33.2%. On balance sheet size of Rs.33,219 crore, bank had advances of Rs. 22,931 crore. Its net worth stands at Rs. 5,404 crore, translating into BVPS of Rs. 49.3, as of 31-12-17. Fresh issue proceeds of Rs. 3,662 crore will augment bank’s tier 1 capital base and propel BVPS to about Rs. 80, as of 31-3-18.
Current equity of Rs. 1,095 crore will expand to Rs. 1,193 crore post IPO. Parent Bandhan Financial Holdings’ stake of 89.62% will shrink to 82.28% (assuming upper end of the price band) post listing, which has to ultimately fall to 40% as per regulatory directive. IFC, holding 4.94% direct stake in the bank, acquired at Rs. 43 per share via primary infusion in Feb 2016, post commencement of the banking operations, is pruning its holding to 2.72%, making an eye-popping 8x return (or 195% CAGR) on its 2 year old investment.
The bank’s MD & CEO Mr. Ghosh is also making some handsome unrealized gains, as he bought 14.7 lakh equity shares, representing 0.13% pre IPO stake, at Rs. 180 per share, just 3 months ago, on 22nd Dec 2017, from the parent company. Wonder if there is any justification for 100% hike in IPO price vis-à-vis the last transacted price, although secondary in nature! Other shareholders include Singapore sovereign fund’s Caladium 4.99% holding and SIDBI’s 0.32% holding, on a pre-IPO basis.
At Rs. 375 per share, Bandhan’s market cap will be Rs.44,730 crore, which leads to one year forward price-to-book value (PBV) multiple of 4.0x, which is the highest among all Indian listed banks currently. Most expensive listed bank in India (so far), based on the PBV metric of valuation, is HDFC Bank, ruling at FY19E PBV of 3.8x, enjoying premium multiples due to its large balance sheet size of Rs. 9.5 lakh crore (against Bandhan’s Rs. 33,219 crore), high CASA ratio of 45% and low net NPAs of 0.4% (Bandhan’s 0.8%). Another leading private sector lender Kotak Mahindra Bank, with diversified presence across banking, insurance, broking, consumer finance, private equity, wealth management, proven track record of over 2 decades, 4 times the size of Bandhan with market cap of Rs. 2 lakh crore, delivering consistent growth rates in high twenties for the past few years, and a comparable asset quality (net NPAs of 0.9%) is trading at one year forward PBV multiple of 3.6x. Both these banks make Bandhan’s IPO pricing appear stretched.
Although not an apple-to-apple comparison, if one were to draw parallels with another micro finance institution (MFI) which transitioned into a bank in Feb 2017, albeit a small finance bank, Ujjivan Financial Services with smaller size (gross loan book of Rs. 7,100 crore) clocked higher NIM vis-à-vis Bandhan, of 11.79% in Q3FY18, due to 95% of its gross loan book comprising of micro loans. Although its profitability took a hit for the past few quarters post transition to a bank, Q3FY18 was its turnaround quarter and its current PBV multiple of 2.1x, based on FY19E, makes Bandhan’s IPO pricing over extended.
To summarize, while Bandhan’s transition from a NBFC to bank has been smoother than peers, advantage of high NIMs is not unique. Its banking model may be differentiated, but present advantages of low cost of operations and exceptionally high NIMs are not sustainable, once it penetrates deeper in SME lending and in its non-home geographies.
Since Bandhan is yet to establish a track record and prove its ability to diversify as scale of operations enlarge, one must wait for an attractive price point. Meanwhile, due to the market meltdown, more established and larger banks are available at much attractive valuations. Hence, citing expensive valuations and declining sheen of BFSI sector in the secondary markets, one is advised to skip the IPO for now and review the stock post listing.
Disclosure: No interest.