DCB Bank’s (DCB) Q2FY17 PAT at R485 million (up >30% y-o-y) came in line with our estimate. Key highlights: (i) NII momentum sustained (up 27% y-o-y) on above-industry loan growth (up ~29% y-o-y) and superior NIMs (around 4%); (ii) given higher opex (up >25% y-o-y), cost/income continued to be high at 60%; and (iii) asset quality was stable with slippages reined in at 1.5% (>2.0% run rate over past 6 quarters); however, recovery trend continues to be soft. DCB’s strategy of upfronting branch expansion will keep cost high, impacting return ratios (RoEs modest at 10–11%), especially in the backdrop of modest revenue profile.
Revenue momentum on track; sustainability is key
NII momentum sustained (up ~27% y-o-y) on above-industry loan growth (up ~29% y-o-y) and superior NIMs (3.96%). While pressure was visible on yields, it remains elevated (at 12%). Henceforth, yields run risk of decline as MCLR rate is lower than the base rate by >15bps and further cut in base rate (6 bps in Q1FY17). Consequently, we perceive risks to sustenance of revenue momentum. Though other income has shown encouraging signs (up >26% y-o-y), its sustainability needs to be monitored. Fee-to-assets continues to be lower than peers, restricting RoA improvement.
Strategy revamp to impact on near-term cost ratios
A major factor that has hampered DCB from delivering higher return ratios has been its high-cost structure. The bank’s strategy is to build a strong franchise and ramp up branch network to >300 (228 currently) over the next year.
While this is a long-term positive, in the near term it will push up cost ratios and hit profitability, unless revenue momentum scales up.
Outlook and valuations: Execution key; maintain Reduce
DCB has posted remarkable turnaround, but upfronting of cost will strain return ratios. While we are confident about the strong management, execution risks remain elevated owing to many variables. The stock trades at 1.7x FY18E P/ABV for RoE in the 10-11% range, rendering risk-reward unfavourable. The capital consumption has been on higher side (tier-1 at 10.8% excluding H1FY17 profitability), which warrants monitoring.
Consequently bank will likely have to raise capital by FY18, which will further suppress already modest RoEs. We maintain ‘REDUCE/SU’ with TP of R109 (1.5x FY18 P/ABV).
Loan growth up ~29%, driven by mortgage and agri book
DCB continued to post higher-than-industry loan growth, with advances coming in at R144 billion (up >29% y-o-y, 8% q-o-q). The robust growth was retail-driven, aided by spurt in CV loans (up >69% y-o-y on low base, up >8% q-o-q), healthy growth in agri loans (up >50% y-o-y on low base, up >8% q-o-q), and continued build-up in mortgage (up ~24% y-o-y, 6% q-o-q) and SME+MSME (up ~18% y-o-y, 8% q-o-q) segments. ~65–70% of the bank’s mortgage book consists of small-ticket LAP loans, with majority loans having a ticket size of Rs 30 million. In line with its retail-focused strategy, corporate banking loans posted modest growth (up ~5% y-o-y), with the book now constituting ~16% of overall portfolio (~20% a year ago). DCB has also been building granularity in loan book by focusing on secured lending, including mortgages and reducing lumpy exposures. The bank is aiming to double its loan book over the next 3 years.
Slippages curtailed; recoveries still softer
Slippages came in lower at Rs 501 million (1.5% versus run rate of >2.0% over past 6 quarters). However, the general recovery trend continued to be softer (Rs 139 million versus run rate of Rs 270 million over past 4 quarters) which along with nil write offs resulted in GNPLs inching up to Rs 2.6 billion (up >10% q-o-q). Segment-wise analysis indicates that slippages were driven by mortgage (1 account), with no slippages in corporate accounts.
Profitability during the quarter was supported by higher non-interest income, which came in at Rs 616 million (up >26% y-o-y, 2% q-o-q). This was on account of strong treasury income (Rs 116 million versus run rate of Rs 78 million over past 4 quarters) and healthy core fee income (up >20% y-o-y). However, its sustainability needs to be monitored. Fee-to-assets continues to be lower than peers, restricting RoA improvement. While SA has maintained traction, jumping 22% y-o-y, CASA ratio has dipped (to 21.9% versus 23.1% in previous quarter) because of higher deposit growth (up > 30% y-o-y). Capital consumption was higher due to: (i) higher back-end loan growth (8% q-o-q) and (ii) better liquidity. DCB invested in some PTCs which attract higher risk weights and thus consume higher capital. The bank’s board has approval to raise tier-II capital of Rs 3 billion (of which Rs 840 million is being raised and balance ~Rs 2.2 billion will be raised in a couple of months). Post that, the bank may evaluate to raise tier-1 capital by September 2017.
Earnings call highlights
With respect to growth:· Advance growth (ex-corporate) registered > 36% (supported by branch additions and headcount increase). Bank is aiming to double the loan book over next 3 years with similar loan composition. Will continue to remain cautious on corporate loan book (at best this corporate book will grow by 15–20%). The focus continues to be focussing on SME segment.
With respect to LAP portfolio: (i) Two concerns are emerging in LAP segment (a) Aggressive pricing (not enough assets so players are chasing LAP) and (b) Over-valuation of properties. However bank had made all the checks on their portfolio and is comfortable with quality of book. (ii) Time for resolution is higher for larger ticket size (sometimes as high as 2 years) and lower for low ticket size loans. Further in process of resolutions the hair cut taken on higher ticket size LAP is higher (sometimes closer to 20–25%) while on other hand hair cut is very small/negligible for low ticket size self employed segment. (iii) Balance transfer is a problem as aggressive pricing and top-up is being offered by the competition. However the problem is more acute in big-ticket loans and that’s why bank has been cautious in big ticket lending. (iv) For the bank 65-70% of the mortgage loans is LAP (small ticket LAP). Max ticket size in LAP is R30 million.
In larger cities 50-60% originations happen through aggregator and in the smaller locations 70-75% of originations happen through aggregators.
Plans to do personal loans to the existing customer and will keep the personal loan portfolio < 5% of the loan portfolio.
Bank does MFI to the extent it needs to meet PSL targets (the exposure to MFI segment is not that large). Approach will be to have MFI to meet PSL target; bank doesn’t foresee growing this portfolio heavily or acquiring any portfolio.
Tractor demand will likely pick up in some time. Some positivity has started flowing due to better monsoon.
Capital consumption was higher due to higher backend loan growth (8% q-o-q) and further due to better liquidity, bank invested in some PTCs ( which are of higher risk weight).