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How Will Banking Turmoil Impact Agency M&A Trends?

By anyone's standards, these are tough times for the banking industry.  The subprime credit crisis and record losses in trading activities are among the issues that have taken a heavy toll on recent bank financial performance.

Why should these problems matter to independent insurance agents?  Because in 2007, when many of these problems first hit the headlines, the number of agency acquisitions by banks was down one-third from its peak reached in 2000.  It's yet to be seen if the banking industry will return to its previous level of agency deals.

Will the lessons of this challenging period change the banking industry's interest in the insurance distribution business?  If so, will we see a surge in agency acquisitions by banks, or will we see declining interest?

First, let's take a hard look at how bad it really is for the banking business these days.  The following are a few indicators of how deep the impact has been.

• Industry Bottom Line:  Net income for the fourth quarter of 2007 was the lowest reported by the banking industry in 16 years.
• Margins:  Nearly 60 percent of banks saw a decline in net interest margin during the fourth quarter of 2007, as the average NIM fell to 3.3 percent - the second-lowest level reported since 1989.
• Individual Earnings:  Over half of all FDIC-insured institutions reported a year-over-year decline in net income in 2007.  For those with assets over $10 billion, one-in-four reported a net fourth-quarter loss.

Another example of the challenges facing the financial markets is the stunning collapse of Bear Stearns earlier this year.  Though not a commercial bank, Bear Stearns once was one of the nation's largest investment banks.  It was also one of the largest underwriters of mortgage bonds.  Its enormous exposure to mortgage-related risk was its ultimate undoing.

To be fair, performance has not suffered for all banks.  But it has for many, and the end of the suffering will not come quickly.  Credit problems in the real estate market will take time to unwind.  There will be ample time for reflection.

So, as banks lick their wounds and prepare for the future, what effect will we see in terms of the impact on the acquisition of insurance agencies?

Evidence over the near term may be difficult to interpret.  As the banking industry wrestles with current bad-loan write-offs and the expectation of more to come, conventional wisdom is that most banks will be in a capital-preservation mode.  This suggests that merger and acquisition activity will take a back seat. 

But agency deals are usually less capital-intensive than bank deals.  Will this exempt them from the M&A respite?  Probably not.  The uncertainties of the current economy, combined with balance sheet pressures for banks, are enough to diminish M&A activity across the board.

For now, expect less focus on deals of all types-including agency deals.  Therefore, don't look for a surge in bank-agency acquisitions in 2008.

However, what about the longer-term effect?  Some banks are using this time to reconsider their growth strategies, and they are rethinking and challenging some old beliefs.  Here are two conclusions reached by more than a few banks as they consider the current state of their industry.

A "Stick to Your Knitting" Strategy is High-Risk.  In recent years, as banks have ventured beyond the traditional loan-and-deposit world of traditional banking, there have been plenty of naysayers.  Critics charge that banks should stick to their knitting, focus on the business they know best, and not venture onto less familiar turf.  It's too risky, these observers warn.

However, ironically, the current problems for banking originated largely from their lending practices.  That's their core business-their knitting right?

Therefore, defenders of the stick-to-your-knitting approach must now acknowledge both the inherent risk of the lending business and the difficulty posed by the largest net interest margin in 19 years.  They then must argue that the risk-reward ratio for bank can't be improved upon through greater expansion into fee businesses.  This is a tough argument to make.  As one bank executive put it, "strategic revenue diversification is no longer a luxury."

Lower-Risk, Fee-Based Business Are Key.  Understandably, "risk management" is a current catchphrase in banking.  Revenue diversification will be part of the solution.  But to improve its risk-reward scenario, a bank will need to take a thoughtful, strategic approach to diversification that fairly anticipates the impact of entry or expansion in a particular line of business. 

There is not a one-size-fits-all answer.  Diversification into fee-based businesses in which they believe they can achieve meaningful scale while maintaining reasonable risk.  Against this scorecard, the agency business gets mixed results.

• It scores well on risk, it's a one-sale business that produces recurring revenue.  Banks understand this since the lending business operates the same way:  Get the business on the books and expect revenue for years to come.
• It is not as operationally or technologically intensive as banking, and doesn't have many of the diversification alternatives available to banks.
• Scale is another matter.  As evidenced by their agency divestitures, some very large banks have concluded they can't achieve scale in the insurance business.  But scale is relative and is achievable in insurance for all but the largest banks.

So where does this leave independent agencies looking to do deals with banks?  Here's what we know:

• Pain is causing banks to take a hard look at their future growth strategies.
• More diversification is needed.
• Fee-based business with low-risk and scalability is the answer.

This sounds like a formula that could lead growing numbers of smaller and midsize banks into the independent insurance agency business over the next few years.

Review of Financial Performance of AccessBank (from CBJ December Issue)

Brien Desilets examines the rise and transformation of one of Azerbaijan’s most successful banks, from its creation in 2002 as the Micro Finance Bank to Azerbaijan through its rebranding as today’s AccessBank. He looks at why this financial institution has attracted such widespread praise, and what challenges the future may bring.

With the full support of multilateral and bilateral agencies, including the bank’s shareholders and lenders, AccessBank of Azerbaijan has been pointed to as a shining example of a successful emerging market financial institution. Its assets have risen from just over $20 million at the end of 2005 to more than $350 million today. The number of client accounts increased from just under 7,000 at the end of 2005 to more than 100,000 today. Fitch has given the bank the highest rating of any private bank in Azerbaijan, indeed the highest possible rating for Azerbaijan, matching the country ceiling of BB+.

The bank completed its debut bond issue in February 2008. This was the first bond issue on international capital markets by an Azerbaijani company, raising $25 million. Since its opening, the bank has expanded its services to include new savings products, loans money transfer services for businesses and individuals, electronic payment cards and an ATM and POS network. It has been viewed as a success story, not only in the microfinance industry, but also in the wider arena of emerging market banking.

This article provides a comprehensive analysis of the bank, from its creation by international financial institutions (IFI) to the equity involvement of AccessHolding Microfinance AG of Germany to its financial performance through the current financial crisis to its challenges ahead.
 

The history of AccessBank

AccessBank was created under a joint initiative by the European Bank for Reconstruction and Development (EBRD), KFW Development Bank, International Finance Corporation (IFC), Black Sea Trade and Development Bank (BSTDB) and LFS Financial Systems (LFS). The creation of the bank can be seen as part of a wider program by these International Financial Institutions (IFI).  EBRD has been involved in 18 microfinance institutions in the region in which it operates. Seventeen of these have been greenfield operations in which a bank was created from the ground up.

When embarking upon such operations, EBRD first assesses the market for suitable partners. If none can be found, it works with other IFIs to establish a bank. Recent projects include the Belarus Small Business Bank which was established in 2008, and has met with success in 2009 in spite of the financial crisis. AccessBank Tajikistan, a sister bank of the Azerbaijan bank, is expected to open its doors in the next few months. The establishment of KMB Bank in Russia in the wake of the 1998 financial crisis set a precedent for similar transactions in the region. KMB Bank was subsequently bought by Italy’s Banca Intesa and now boasts assets of more than $1 billion. Other activities in the sector include 13 banks in the Western Balkans under the ProCredit Holdings Company, as well as ProCredit in Ukraine and Xacbank in Mongolia.

In the case of Azerbaijan, EBRD conducted its feasibility study in 2001 and the Micro Finance Bank of Azerbaijan was established in October 2002. With the IFIs as shareholders, the new bank needed a management team. Through an international competitive procurement, LFS Financial Systems GmbH was chosen. LFS is a German consulting and management company specializing in microfinance. Initially, LFS supplied nearly the entire management team; now only one expatriate remains on the managerial staff. LFS also took an equity stake in the bank.

In 2006, LFS established AccessHolding Microfinance AG along with other international investors. With AccessHolding, LFS is able to expand its role beyond providing consulting services to taking equity stakes in microfinance institutions. In April 2007, AccessHolding took just under a 10% stake in AccessBank of Azerbaijan; this stake increased to a little more than 16.5% in December 2007. AccessHolding’s other investments include microfinance banks in Africa (Liberia, Madagascar, Nigeria and Tanzania) and a new project under development with EBRD – AccessBank of Tajikistan.  The current shareholders of Azerbaijan’s AccessBank are EBRD (20%), IFC (20%), BSTDB (20%), KfW (20%), AccessHolding (16.53%) and LFS Financial Systems GmbH (3.47%).

The participation of AccessHolding as an equity investor led the bank to change its name from Micro Finance Bank of Azerbaijan to AccessBank. The rebranding of the bank along with the name change has attracted additional customers. As Chikako Kuno, Director of EBRD’s Small Business Finance team, reports, “Many businesses in Azerbaijan don’t think of themselves as micro or small and are not likely to approach a microfinance bank for lending. The name change helped to attract these customers.”

Technical Assistance from the European Commission and later KfW accompanied the equity investments by the IFIs. AccessBank has had a demonstration effect in Azerbaijan, showing the profitability of lending to small businesses and entrepreneurs. EBRD is now engaged with seven other banks and six nonbank financial institutions (NBFI) in Azerbaijan, providing technical assistance and loans to support microfinance.

AccessBank was ranked 11th out of the country’s 46 banks in terms of assets with two percent of total banking sector assets and was ranked 10th in terms of sector loan portfolio, with 2.3% of the sector loan portfolio at the end of 2008. Today its rank has increased to 6th in terms of both assets and loans. It is one of the few 100% foreign-owned banks in Azerbaijan. Among the leading microfinance institutions (including 12 banks and 20 NBFIs) tracked by the Azerbaijan Micro Finance Association, AccessBank held a 38% market share in 2008, up from 30% in 2007. Finca trails a distant second at 12%.
 

Macroeconomic environment

Azerbaijan is an oil-exporting country, distinguishing it from some of its neighbors in the Caucasus and Central Asia region. The economy received a major boost when the Baku-Tbilisi-Ceyhan pipeline opened in June 2006. GDP growth was higher than 35% in 2006, 24% in 2007 and 11% in 2008. Oil and gas comprised 62% of GDP in 2008, the same year in which Azerbaijan reached a $40 billion trade surplus.

High growth and the trade surplus has led to currency appreciation and inflation. The local currency, the manat, appreciated five percent against the US dollar in 2006, three percent in 2007 and five percent again in 2008. (The Azeri Manat (AZM) was replaced by the Azeri New Manat (AZN) with an exchange of 5,000:1 in 2006.) Official inflation was 16.7% in 2007 and 21% in 2008, slowing toward the end of the year as oil prices dropped.

Azerbaijan Banking Sector

The banking sector in Azerbaijan is dominated by the International Bank of Azerbaijan (IBA) and by Kapital Bank. IBA’s share of total banking assets stood at 47% in 2006 and 39% in 2007, and then rose to 43% at the end of 2008 as a result of the global financial crisis.

At the time of AccessBank’s creation, EBRD’s strategy included increasing diversity in the banking sector to provide alternatives to the state-owned bank. At the time of its intervention, the banking sector was characterized by low capitalization and limited transparency. EBRD’s strategy also included a focus on small business and microfinance. “The loan/GDP ratio is low for the region, never mind comparisons to Western Europe or the US. There is a lot of room for financial intermediation,” says EBRD’s Kuno.

The current financial crisis has led some of Azerbaijan’s banks to halt their lending activities and many, failing to find additional funds for refinancing, have had to repay loans. The Central Bank of Azerbaijan reacted by eliminating the five percent reserve requirement on foreign borrowings, reducing the required deposit reserve from 12 to half a percent and extending loans to certain banks. In general, however, Azerbaijan has fared much better than other countries, particularly emerging markets, in the financial crisis.  The table below shows some key banking sector indicators.

AccessBank’s financial performance

In general, AccessBank’s financial performance has been impressive. With the full support of multilateral and bilateral agencies, including the bank’s shareholders and lenders, AccessBank has grown in the spotlight as a shining example of a successful emerging market financial institution. Total assets grew more than 153% in 2006, 140% in 2007 and 81% in 2008.  In the same years, customer deposits increased by more than 483%, 282% and 90%, respectively. The number of deposit accounts increased from 1,336 in 2005 to 28,158 in 2008. The bank’s operating expenses, however, increased by only 155% in 2006, then less than 90% in both 2007 and 2008. Shareholder equity increased by nearly 140% in 2007 and 154% in 2008.

Portfolio at risk (30 days) peaked at 0.56% in 2008.  This was due to the fact that the bank had not written off any loans since 2006 and that some of its borrowers were facing financial difficulties.  The key results of the bank’s performance are show in the table below.

AccessBank also provided some loan data as of end-October 2009:

• The overall average loan size is $3.600
• 95% of loans are less than $10,000 and of those, the average is less than $3,000
• 3.4% are small loans of $20,000-100,000 with an average of $40,000
• Some loans are medium-sized, but these are very few and limited.

AccessBank was rated at BB+ by Fitch Ratings. This is the highest rating for a private bank in Azerbaijan[2] and indeed the highest possible rating since it matches the country ceiling. Very few banks in Azerbaijan have ratings and, of those, most are rated B-. “This provides a lot of confidence to investors,” notes Walid Fayad, a banker with EBRD who works directly with AccessBank.

The bank completed its debut bond issue in February 2008. This was the first bond issue on international capital markets by an Azerbaijani company, raising $25 million through a Luxembourg-based Special Purpose Vehicle. In November 2008, the EBRD arranged the bank’s first syndicated loan, raising another $28 million. Since its opening, the bank has expanded its services to include new savings products, loans money transfer services for businesses and individuals, electronic payment cards and an ATM and POS network. In general, it has been viewed as a success story not only in the microfinance industry but also in the wider arena of emerging market banking.

While the bank’s performance has been impressive, there are some areas of concern. One of them is the bank’s source of funds for lending. Traditional banks receive deposits and then on-lend them to other customers, channeling money from savers to investors. AccessBank’s model is to borrow money internationally, combine it with equity from international investors (many of them lenders as well – approximately 17% of borrowings come from shareholders) then to on-lend it domestically. This is clear from the graph below. The bank’s total loan portfolio as a percentage of international borrowing plus equity increased from 81.6% in 2005 to 98.3% in 2008. Meanwhile, the ratio of lending to customer deposits has decreased from more than 26 in 2005 to 7.6 in 2008.

From a long-term sustainability perspective, it would be desirable for this last figure to continue to fall so AccessBank could become a true bank, independent of international financing and serving the fundamental banking role of channeling domestic savings into investments. “The bank currently has a deposit to loan ratio of twenty-seven percent,” notes Oksana Pak, Senior Banker with EBRD, “its sustainability requires a higher level.”

The bank has benefited from some unique events and conditions over the past few years, most importantly the opening of the Baku-Tbilisi-Ceyhan pipeline and the depreciation of the US dollar. The pipeline provided a one off (although certainly significant) boost to Azerbaijan’s GDP.

This growth has already cooled from 35% in 2006 to 11% in 2008 and is expected to cool further this year and next, to around 7.5%. The pipeline was opened at a good time for oil prices but those prices may not stay high forever and Azerbaijan’s economy is highly dependent on those prices. While the Azerbaijan manat has indeed appreciated against the US dollar, much of that can be attributed to the dollar’s decline rather than to the manat’s climb. This has provided extra comfort for AccessBank since a major share of its international borrowing is in US dollars. A falling dollar makes for easy repayment of dollar loans. A rising dollar would do just the opposite. This is again one reason for the bank to focus on increasing deposits, so it can source its liabilities in the same currency as its assets. The bank has moved to hedge its currency risk in its borrowing by sourcing two loans in the local currency – in November 2007 and August 2008. Still, it would seem that if the Azerbaijan economy were performing as well as the figures indicate, there should be sufficient depositors and savers interested in financial intermediation. The bank has also developed new products, namely term deposits, that should help to address this issue as well.

Another area for concern is the significant increase in impaired loans. These rose from approximately AZN 3.5 million in 2007 to AZN 12.0 million in 2008, or from 3.1 to 5.8% of the total loan portfolio. The bank reports that this change has come solely from accounting policy changes imposed by external auditors in response to the global crisis and is not a reflection of a deteriorating portfolio. The indication in the financial statements that these loans are fully collateralized by marketable real estate or 100% guarantees by AA rated banks does not provide much comfort with the effects of the US subprime crisis fresh in the minds of most analysts and investors. The bank should adjust its estimates of collateral coverage as real estate prices change. The financial statements indicate that these loans are not overdue or in arrears, but still this increase is significant especially considering the slowing growth of the overall economy, and given that the bank’s major increases in lending has been fueled by foreign borrowing over the past few years.

In general, term risk is not a major area for concern since most of the bank’s loans (71%) carry terms of less than one year while most of its borrowings are in the range of three to six years. Interest rate risk is also not a major issue since the bank is borrowing at rates around 10% and lending at rates around 30%. However, looking forward to 2010 AccessBank has at least $43 million in principal due on its borrowings. An additional $128 million in principal is due in subsequent years with interest payments of $20 million per year. When added to the $43 million in principal payments over the coming year, it means that total debt service in 2010 is approximately $63 million. Should the bank’s impaired loans deteriorate into portfolio at risk or worse, the bank may face cash flow challenges in 2010.

In response to this observation, AccessBank General Manager Andrew Pospielovsky noted: “We follow a very conservative liquidity and refinancing policy to ensure that we never have cash flow challenges.  Today, we have over $60 million in liquid assets — fully covering all our principal and interest repayments over the next 12 months. We also have very good relations with our refinancing partners and have over $70 million in refinancing loans either signed or in process. Lastly, we now receive around $25 million in loan repayments every month – ensuring very strong cash flow. We take pride in the fact that throughout the crisis we have never stopped lending and our portfolio has grown every single month.”

“The bank needs to follow a safe trajectory and make sure internal infrastructure keeps pace with the growth of its business,” notes EBRD’s Kuno. She says that the bank has been able to maintain portfolio quality in the past, even through the financial crisis, and it needs to ensure its ability to maintain that quality moving forward.

The EBRD’s Fayad also notes the availability of qualified personnel as a challenge moving forward:  “The best and brightest have been selected and put in senior management positions.  As the bank grows, it needs to fill new positions in its ranks. Due to the rather limited availability of highly experienced bankers in Azerbaijan, the bank has focused on training and promoting from within.”

As far as an exit strategy for the IFIs, EBRD says is interested in exiting its investment once the bank has matured to a suitable level.  An example is KMB Bank in Russia which was sold to Italy’s Banco Intesa, now has assets of more than $1 billion and continues to focus on small business lending.

Financial Performance of Halyk Bank in first six months of 2006

Almaty, August 1, 2006 – Mr. Grigoriy Marchenko, Chairman of Management Board of JSC Halyk Bank, announced results of the Bank’s performance in H1 2006.

Halyk Group Financial Group, led by Halyk Bank, is reaching new heights in its performance. Halyk Bank once again confirms its status of a successful bank, being a stable and reliable financial instution of the country.

On 18 July 2006, Standard & Poor’s upgraded Halyk Bank’s long-term rating from “ВВ” to “BВ+”, affirming at the same time the bank’s short-term rating at “В”, outlook stable. On 1 June 2006, S&P’s issued a report on achievements and performance of biggest banks in Kazakhstan, Russia and Ukraine. Halyk Bank was named best in terms of ROA (Return on Average Assets) and net interest margin.

Euromoney rated Halyk Bank as “The best bank in Kazakhstan in 2006”. The Banker included Halyk Bank into the list of 1,000 biggest banks of the world, where the Bank occupies 658th place in terms of first level capital. Russian “Commersant-Bank” published a ranking by Interfax Center for Economic Analysis (CEA Interfax) of 1,000 biggest banks in CIA on the results of 2005, where Halyk Bank takes 12th place in terms of assets.

In May 2006 Halyk Bank successfully allocated 300 million US dollar 7-year eurobonds. Taking into account 5-year securities issued in 2004, the Bank established yield curve which is stably traded with discount in relation to liabilities of its main competitors: JSC Kazkommertsbank, JSC Bank TuranAlem, JSC ATF Bank and JSC Alliance Bank. Results testify that investors consider both positive financial results and quality of loans, as well as conservative approach of Halyk Bank to external borrowing.

The bank retains leading positions in the domestic market of retail bank services to be confirmed by the following facts.
Profit of Halyk Bank in H1 of the current year made more than 7.5 billion KZT, with a growth of 62.8% as compared to H1 2005. Assets reached 762.7 billion KZT, having increased from the beginning of the year by 36.5 % or by 204.1 billion KZT. The Bank’s Own (balance) capital increased by 12.1% and reached 67.5 billion KZT.
Loans to customers (loan portfolio (gross)) increased by 9% to reach 466.9 billion KZT. Out of which retail customer loans increased by 14.7% to make 184.6 billion KZT.
Deposit base makes 485.4 billion KZT, out of which retail deposits made 171.6 billion KZT, with a gain of 31.1% in January–June 2006. On H1 2006 results, the increase in the volume of Halyk Bank’s deposits was practically equal to aggregate increase of those of Kazkommertsbank and TuranAlem Bank.

Reference Information

During first six months of 2006 all three international rating agencies upgraded Halyk Bank’s ratings:
In 2006 Standard & Poor’s raised twice long-term rating from “ВВ-” to “ВВ+”: on 10th February and on 18th July 2006. In S&P’s opinion “…Halyk Bank’s ratings have been increased taking into consideration that the Bank has a clear strategy aimed at building a group for rendering financial services on the domestic market. Despite the growing competition, Halyk Bank is continuously increasing its profitability and capitalization, which are today the highest among big and medium Kazakhstan banks. Halyk Bank has such advantages before competitors as availability of “cheaper” funding sources in the form of attracted deposits (available through extensive Halyk Bank’s branch network) and the opportunity to work with a higher margin”. On 30 May 2006, Moody’s upgraded the Bank’s Eurobonds rating from “Baa2” to “Baa1”. Earlier this year, on 23 February 2006, Fitch increased long-term foreign currency rating from “BB” to “BB+”. Both agencies note the extensive branch network, improvement of financial results, as well as possibility of state support in case of need due to strategic importance of the Bank to the country.

Since the beginning of the year Halyk Bank has retained leadership on the deposit market, both in terms of volume of the portfolio and absolute gain. During first six months of the year, the deposit portfolio increased by 40.7 billion KZT to make 171.6 billion KZT. The Bank’s share of retail deposits has increased from the beginning of the year from 21.93% to 22.91%. Moreover, Halyk Bank retains leading positions in mortgage lending among second tier banks, owning more than 29% of market share. Currently, the mortgage portfolio of the bank makes approximately 79 billion KZT. Customer loans have increased from the beginning of the year by 19 billion KZT (with balance of principal receivables) to make 70 billion KZT. Loans to companies have increased by 5.6% to make 282.4 billion KZT.

The number of Halyk Bank’s effective charge cards makes 2.5 million. Let us remind that the Bank is the undisputed leader on the domestic market of charge cards.
Charge card service network comprises of more than 800 Automatic Teller Machines and about 3,500 POS-terminals and imprinters.

Halyk Bank’s branch nework includes 549 subdivisions, out of which 19 are oblast and regional branches, 126 district branches and 404 cash settlement divisions.

The number of clients of Internet-banking reached 8,896. During H1 2006, the web-site of the “Internet-Banking” system, www.mybank.kz, was visited 40,981 times. This is 34% more than results of the similar period of 2005. Besides Kazakhstanis (20% of all visitors), the highest percentage of users are from European Union, United States, Russia and other countries. Internet accounts of our clients in H1 2006 were directly accessed from the territory of 11 countries (Kazakhstan, Europian Union, United States, Russia etc.).

As of 1 July 2006 (after 14 months of operation), the Mobile banking system has been used by more than 82,000 clients (growth in H1 2006 made 47,000). In terms of growth rate Halyk Bank is absolutely the best bank among five CIS countries where VISA has launched this project. Moreover, in March, “Mobile banking” became the most popular remote bank service in the Republic of Kazakstan.

Syndicate Bank profits fall 18.5% on higher provisions

Our Bureau

Bangalore, May 4

Despite a 57 per cent increase in net interest income, Syndicate Bank's net profits fell 18.5 per cent during the fourth quarter of financial year 2009-10.

A bank release said that net profits were lower “mainly due to higher provisions towards wage arrears, taxes, etc”.

The provision made towards taxes during the quarter at Rs 121.07 crore (Rs 26.56 crore), up almost 4.6 times. The bank has also made provision of Rs 34 crore (Rs 15 crore) towards arrears of wages during the quarter.

The board of directors has recommended a 30 per cent dividend for the year. On Tuesday, the bank's shares ended down 2.48 per cent at Rs 90.35 on the BSE.

The bank's NPA coverage ratio is 73.3 per cent.

For the fiscal ended March 31, 2010, the bank's net profit was down 11 per cent at Rs 813.32 crore (Rs 912.82 crore), mainly due to higher provisions towards taxes at Rs 360.71 crore (Rs 111.92 crore) and wage arrears at Rs 220 crore (Rs 75 crore).

Bank of India net slips 67 pc

Mumbai , Jan. 22 

LED by a significant decline in its profit on sale of securities, Bank of India has recorded a 67 per cent drop in net profit at Rs 75.03 crore for the third quarter ended December 31, 2004, against Rs 228.54 crore in the corresponding period the previous year.

During this period, profit on sale of securities declined by Rs 154.12 crore, a release said.

Total deposits of the bank grew to Rs 7,7029 crore (Rs 6,9291 crore), while total advances increased to Rs 5,42,18 crore (Rs 4,54,22 crore).

Retail credit grew to Rs 9,540 crore (Rs 6,965 crore). Housing loans at Rs 2,332 crore constituted 5.92 per cent of non-food credit.

Priority sector advances grew by 16.50 per cent to Rs 16,147 crore, while agriculture advances increased by 15.59 per cent to Rs 5,835 crore.

Capital adequacy ratio of the bank stood at 11.9 per cent after allocating increased risk weights on housing loan and consumer credit including personal loans and credit cards portfolio of the bank.

Gross NPAs declined to Rs 3,649 crore (Rs 3,975 crore), while net NPAs declined to Rs 2,028 crore (Rs 2,177 crore).

Yes Bank is amongst the youngest prominent Private Sector Banks in India and many of you might have noticed its recent Television Ads being shown on several channels including Business News channels. Started by a group of extremely experienced Bankers led by Mr. Rana Kapoor, Yes Bank always aimed at becoming one of the best Private Sector Banks backed by a very strong Technology Platform. Its journey over the last 5-6 years has been exactly as per what Mr. Rana Kapoor had projected it to be. Yes Bank has now grown at a rapid pace to become one of the most respected Banks in the country.

In the initial formative years, Yes Bank focused on corporate and institutional Banking business. It launched new Branches at a measured pace just to have a presence in all the important cities where small to medium sized organisations were present. Yes Bank provided innovative services to help small & medium sized organisations grow their business. Yes Bank virtually partnered them by offering Banking services as well as Financial Advisory services. As the organisations grew, so did their relationship with Yes Bank. Yes Bank’s strong Advisory-based Banking services has helped the bank maintain healthy levels of fee-income over the years. Yes Bank took more than 3 years to reach the figure of 25 operational Branches. The Branch Network increased at a faster pace over the next 3 years to reach a figure of 150 operational branches as of now. And now the Bank is aggressively getting into the retail Banking business and increase its Branch Network by nearly 100 new branches in just 1 year.

Yes Bank’s Financial Performance has been proof of its calculated yet superior growth performance over the years. Yes Bank’s Total Income has multiplied over 10 times from a level of Rs. 290 crores in FY’2005-06 to a figure of Rs. 2945 crores in FY’2009-10. During the same period, its Net Profit has multiplied almost 9 times to reach a figure of Rs. 478 crores last fiscal. Thanks to its strategy advantage, Yes Bank has managed to post vastly superior growth rates even during the last 12-18 months, when the global economy has seen several challenges. Its superior performance has been reasonably well rewarded by Global investors with handsome recovery in valuations after the huge crackdown it saw during the October’08 collapse. Have a look at the following charts:

As you can see from the above charts, Yes Bank’s Financial Performance has been strong and the progress has been steady. Yes Bank has continued to post robust growth rates even after the Economic crises situation between October’08 to March’09. Yes Bank has posted a strong growth of 21% in its Total Income and a much stronger growth of over 57% in its Net Profit over the last 12 months on a Y-o-Y basis. Yes Bank’s share price and hence its Market Cap and Valuation had taken a very bad beating during the crises period. But thanks to its continued growth in Business performance, its Market Cap recovered smartly post March’09 and is now above what it was before the crises period. Look at its P/E Ratio. The Ratio had fallen to about 5 at the end of March’09, but has risen to about 19 by June’10.

In my previous report I had compared HDFC Bank and Axis Bank. Both of them are more than 5 times larger than Yes Bank. Being smaller in size Yes Bank has the potential to grow at a faster pace than both HDFC and Axis Bank for many more years. In terms of quality of growth as well as assets Yes Bank is in no way inferior to the two larger Banks. Hence Yes Bank deserves a valuation on par with the best in the industry. HDFC Bank is currently commanding the highest P/E Ratio of over 30 and I feel Yes Bank too deserves a P/E Ratio of between 25 to 30 levels. Now lets try to estimate its 12-months Fair Value Price Target. Yes Bank posted a Net Profit of Rs. 477 crores in April’09 to March’10 period. We can safely expect it to grow by about 40% over the next 12 months to reach a figure of Rs. 665 crores. At a P/E Ratio of 25 to 30, its Market Cap should rise to be in the region of Rs. 16,000 to 20,000 crores over the next 12 months. This should translate into a share price of around Rs. 475-500/-. That means a potential appreciation of upto 80-85% over the next 12 months.

 

HDFC Bank and Axis Bank are No. 2 & No. 3 Banks in the Private sector. In terms of Stock Market performance, HDFC Bank has always been valued at nearly twice that of Axis Bank. The same holds true even today. But the Question is: Is HDFC Bank doing business that is double that of Axis Bank ? Both these banks started operations in the year 1994, after the Government of India allowed new private banks to be established. Both of them have been backed by large Financial Institutions. As the name suggests, HDFC Bank’s promoter is HDFC, which is India’s largest Housing Finance Company. Axis Bank was formerly known as UTI Bank, because it was once majorly promoted by Unit Trust of India. Even today, the Specified Undertaking of the UTI, i.e. SUUTI is still amongst the largest shareholders of the Axis Bank. Both the Banks are run by independent professional & aggressive managements.

To compare the operational size of the two Banks, HDFC Bank has spread its Branch Network to over 1700 branches and 4300 ATMs. HDFC Bank has done 2 acquisitions in the last few years which has helped it reach this figure. On the other hand Axis Bank has done pure organic expansion to reach a figure of over 1000 Branches and over 4400 ATMs. Both the banks have growing their business at a rate higher than industry average and the growing Indian economy has helped several Banks in their growth plans. Over the last 5 years, both the banks have seen their Total Income and Net Profit multiply between 6-7 times. But it is interesting to see the gap between the two Banks. Five years ago, i.e. in FY’2004-05 HDFC Bank’s Total Income was 60% higher than Axis Bank, while its Net Profit was almost 100% higher. But in FY’2009-10, the gap in Total Income is just 28% and the same in Net Profit is just 17%. Over the years the gap is narrowing because of Axis Bank’s superior growth performance.

Now it is interesting to study their recent performance and their corresponding valuations. I have summarized the same in the following charts:

1) HDFC Bank Progress Analysis :

 

 

HDFC Bank’s 12-months Total Income & EBITDA flattened and has seen a gradual decline over the last few quarters mainly because of changes in interest rates over the last 12-18 months. The business volume has registered healthy double digit growth. It is reflected in the strong growth in its Net Profit. HDFC Bank’s 12-months Net Profit has risen by over 40% over the last 5 quarters. But the even more interesting factor to watch is the valuation HDFC Bank enjoys from the market. Before the October’2008 collapse, HDFC Bank always enjoyed a P/E ratio of somewhere around 30. Now look at the P/E Ratios graph. Over the last 5 quarters, the P/E ratio has been steadily climbing and has now reached over 30. What does this mean? An expansion in P/E ratio in subsequent quarters means the share price has been rising faster than the Bank’s Profit growth. After looking at HDFC Bank’s charts, it will be interesting to compare it with Axis Bank’s charts.

2) Axis Bank’s Progress Analysis :

Axis Bank’s growth story has been better than HDFC Bank’s growth for the past 5-6 years. And it has not changed over the last 5-6 quarters as well. Axis Bank’s Net Profit has jumped over 50% in the last 5 quarters, substantially better than HDFC Bank’s performance. Even the Total Income & EBITDA performance has been marginally superior. But inspite of superior Financial Performance, Axis Bank has always traded at a discount to HDFC Bank’s valuation. Look at the P/E Ratios graph. Eventhough Axis Bank’s P/E Ratio has improved substantially over the last 5 quarters, at 20 it is still way below the P/E Ratio enjoyed by HDFC Bank. Does this make sense? Axis Bank’s Financial Performance is superior. Axis Bank is not far from overtaking HDFC Bank to become India’s No. 2 Private Sector Bank, either in terms of Total Income or Net Profit. So, there is no major size advantage with HDFC Bank. Considering all this, I think it is time the valuation ratios also change in Axis Bank’s favour. Either the P/E ratio enjoyed by Axis Bank should rise or HDFC Bank’s P/E ratio should come down. The latter is unlikely to happen, hence in all probability, it will be Axis Bank’s P/E ratio that will rise faster in the coming quarters. That means Axis Bank’s stock should substantially outperform HDFC Bank’s stock in the coming few quarters.