South Indian Bank: Weak quarter with a decent outlook
South Indian Bank reported a decent bottomline performance in the final quarter of FY18 thanks to provision write back and utilisation of Reserve Bank of India’s dispensation in marked-to-market (MTM) on bonds, gratuity limits and National Company Law Tribunal (NCLT) provisions.
Slippages, however, shot up, courtesy the asset recognition norms of RBI as laid down in its February 12 circular. The move to de-risk the book to granular non-corporate lending is underway and the management feels confident about a much lower slippage in FY19. While the liability franchise is much less robust when compared to many private sector peers, growth is contingent upon near-term equity raising (Capital Adequacy Ratio: 12.7 percent). Valuation at 1.1 times FY19e adjusted book limits downside.
Slippages remain elevated
Gross slippage in the quarter gone by, shot up to Rs 614 crore as it recognised certain problematic accounts as non-performing assets (NPA) following RBI’s recent guidelines. Bulk of the slippage (Rs 482 crore) was from the corporate side: two road projects (Rs 190 crore) from standard restructured book, two other road assets worth Rs 163 crore and one jewellery account. The bank also sold three NPA accounts to an asset reconstruction company (ARC) during Q4 FY18.
Is it the end of the trouble?
That is a key question to be answered. In depth analysis of the numbers suggest that the outstanding standard restructured book of Rs 57 crore (one steel, sugar and an engineering, procurement and construction account) is miniscule. Despite the management’s de-risking strategy, close to Rs 4,455 crore (22 percent) of its outstanding corporate exposure is rated below BBB – a pocket bankers usually keep a close eye on.
The bank also has outstanding Security Receipts (SR, against assets sold to ARC) of Rs 1,356 crore and carries a provision of Rs 261 crore (close to 20 percent). Most of the underlying assets are under NCLT resolution. Given that these assets were sold at a discount of 33 percent on an average, the management feels its provision cover is sufficient. It has guided to a much lower slippage of Rs 600 crore in FY19 and a lower credit cost as well. This will remain a key monitorable in the quarters ahead.
Asset book diversification
Focus on de-risking the book with higher exposure to retail, small and medium enterprises (SME) and agriculture is underway. The share of these three categories is close to 60 percent of overall outstanding advances. While overall advances grew 17 percent YoY in FY18, the same in non-corporate was 19 percent YoY. The latter was led by a 21 percent YoY growth in retail, 19 percent YoY in agriculture and 18 percent YoY in SME.
Fee income strong but cost-to-income ratio warrants moderation
While net interest income (the difference between interest income and expenses) saw a muted Q4 performance due to interest reversal (on recognition of higher NPA) of Rs 18 crore, which impacted interest margin, performance on the non-interest front was impressive. While treasury gains were lower, non-treasury income rose 38 percent YoY, with core fees rising by 16 percent YoY. Cost-to-income ratio was higher despite availing of dispensation pertaining to gratuity provision as the bank incurred expenses on centralisation of processes. However, it has guided to operating cost moderation in FY19.
Lot to catch up on liability front
Though we remain comfortable on most other parameters of the bank, the liability side warrants attention. Growth in low-cost deposits, especially savings accounts, wasn’t impressive. Current account-savings account (CASA) ratio at 23.8 percent is much lower compared to its peers. Competitive borrowing cost is key to the success of a bank as every player in the system is chasing high quality credit.
While the management has guided to 30 percent CASA ratio and three percent interest margin by 2020, this area needs a lot of focus, otherwise the bank may end up compromising on quality of the book to ensure higher profitability.
While we are not too concerned about the insignificant divergence observed by RBI, provision cover of 29 percent remains low. The management intends to improve the same in FY19. Capital raising at a decent valuation remains the next trigger along with a marked and consistent reduction in slippages.
We draw comfort from the current valuation, management’s strategic intent and the distinctive change in competitive landscape away from government-owned banks.