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Indian Billionaire Kotak’s Bank Has Margins Goldman Can Envy

Uday Kotak, managing director of Kotak Mahindra Bank Ltd. Photographer: Dhiraj Singh/Bloomberg
Uday Kotak, managing director of Kotak Mahindra Bank Ltd. Photographer: Dhiraj Singh/Bloomberg

Dec. 20 (Bloomberg) -- Billionaire Uday Kotak, not content with 35 percent margins and a No. 1 ranking underwriting Indian IPOs, is aiming to increase profit next year at both his investment bank and commercial-lending businesses.

The performance of his Kotak Mahindra Group could impress Kotak’s former partner, Goldman Sachs Group Inc., which sold its share in their Indian joint venture in 2006, when the New York-based firm began independent operations in the country.

Kotak Mahindra, India’s best-performing bank stock this year, had an average pretax profit margin more than triple that of Goldman Sachs’s 11 percent for the first nine months of 2011.

“Kotak Mahindra today has profit margins that are enviable by domestic and foreign lenders,” said Sampath Kumar, an analyst at India Infoline Ltd., a brokerage in Mumbai.

The reason is the bank’s strategy of pushing growth in corporate and consumer lending at a time when investment-banking revenue has faltered worldwide. The lender’s focus on “middle India” necessities such as farm tractors is proving profitable, Kotak said in a Dec. 12 interview in his second-floor office in the commercial hub of Mumbai’s Nariman Point, overlooking a tiny patch of green.

Kotak’s commercial bank, the most-profitable lending business in India, accounts for 60 percent of earnings of the group, whose subsidiaries include lender Kotak Mahindra Bank Ltd., investment bank Kotak Mahindra Capital Co. and brokerage Kotak Mahindra Securities Ltd. That’s a reversal from 2008, when 60 percent of profit came from investment-banking and brokering activities, said Kotak, the bank’s vice chairman and managing director. Now, with a drop in takeovers, share sales and trading revenue, it accounts for 6 percent, he said.

‘Not Looking Great’

“Right now the outlook is obviously not looking great,” Kotak, 52, said. “We are going to see significant capacity reduction in the sector.”

Kotak, who owns a controlling 41 percent stake in the group, said the money investment banks make no longer justifies the number of people they employ or their salaries. The industry has 20 percent to 40 percent excess capacity, and there is a “correction” under way, he said.

“There are too many firms and too many people per firm,” Kotak said. “Over the last few years, India was the high-fashion country around the world. Every global player wanted to be in India without really analyzing the size of the revenue pool.”

Lower Salaries

India’s top investment banks compensate bankers at about half the rate of foreign counterparts operating in the country, according to Saket Jain, managing partner at recruitment firm Vito India Advisors in Mumbai. A mid-level director at an Indian investment bank makes about 8 million rupees ($152,000) in salary before bonus compared with about 13 million rupees working for a foreign bank, he said.

Lower salaries could catch on as banks realize revenue can’t support such wages, said Kotak, who was paid 17.8 million rupees for the year ended in March, according to the company’s annual report.

“I see combined compensation levels, both fixed and variable, correcting in this segment, in India, as anywhere else in the world,” he said. “Supernormal returns, supernormal compensations, some of it is gone for a long time and probably not coming back.”

Indian companies raised 296 billion rupees from share sales in 2011, almost the same volume as in 2005, even as the number of banks competing to manage those offerings almost doubled to 45, according to data compiled by Bloomberg. Kotak Mahindra Capital is No. 1 in managing initial public offerings in India this year. Goldman Sachs doesn’t appear in the rankings, having arranged only one offering of shares of an already-listed company, the data show.

‘Partnership Culture’

The fee pool in India was about $1 billion last year, compared with almost $5 billion for China, according to Freeman & Co. LLC, a New York-based research firm. This year’s fees may be lower because share offerings are down almost 75 percent and there were about 40 percent fewer mergers, according to data compiled by Bloomberg.

Kotak, whose stake in the company is worth $2.8 billion, is ranked No. 15 on Forbes magazine’s 2011 India billionaires list. He said his approach to leadership was learned growing up in an extended family of “60 members, under the same roof, with a single kitchen” in Mumbai.

“Being in the same house, the whole philosophy of getting along with people, carrying them as teams, was deeply ingrained,” he said. “I think about leadership as a partnership culture.”

Mahindra Investment

In 1985, Kotak, then 26, set up Kotak Capital Management Finance using 3 million rupees he borrowed from friends and family members who ran a cotton-trading business, he said. The following year he recruited as an investor the industrialist Anand Mahindra, who said in a Dec. 16 telephone interview that the two met when he became Kotak’s client and admired his “very mature approach.”

“I told him if he ever thought of going public, I would support him,” said Mahindra, now vice chairman and managing director of Mahindra & Mahindra Ltd., India’s largest tractor and sport-utility-vehicle maker. “During his wedding reception, he came and told me he would take me up on that offer.”

The name was changed to Kotak Mahindra Finance. Mahindra still owns about 3 percent of the company.

On his first visit to New York, in 1992, Kotak said he saw that “some of the biggest names in the business were family names, and they were standing strong 150 years later. We named our company what we did, saying you should be ready to put your name on the line in a financial-services business.”

Goldman Venture

Kotak formed a partnership with Goldman Sachs in 1995. In 2006, he paid 3.3 billion rupees to buy out the 25 percent stakes that the New York-based firm held in the investment banking and securities businesses.

“Two people can’t own 51 percent each in a company,” Kotak said. “That was the bottom line. Goldman believed India was very important. We felt it was equally important for us. We parted as friends.”

Edward Naylor, a spokesman for Goldman Sachs in Hong Kong, declined to comment.

Kotak said that dealing with Goldman Sachs taught him things were changing quickly in India and that he had to professionalize his capital-markets business.

“Discipline, culture, we learned a hell of a lot from them,” Kotak said.

‘Aligned With Investors’

After obtaining a banking license in 2003, he now has India’s fourth-largest private bank by assets, according to Bloomberg data. Shares of Kotak Mahindra Bank, with about 330 branches and more than 9 million customers, have gained 0.2 percent in 2011, compared with a 32 percent decline in India’s 14-company Bankex Index. The MSCI World Index has lost 11 percent this year, heading for its worst annual performance in three years.

The shares fell 3.1 percent at 12:03 p.m. in Mumbai, compared with a 0.3 percent drop in the benchmark Sensex index.

“From an investor perspective, it’s great to have Kotak at the helm,” said Brian Hunsaker, an analyst in Hong Kong at Keefe, Bruyette & Woods Inc. “He’s built the business, his interests are aligned with investors, and he will presumably be running it for many years to come.”

Kotak Mahindra’s investment bank posted a loss of 40 million rupees for the quarter ended Sept. 30 compared with a 70 million-rupee profit a year earlier. Profit at the commercial-banking unit increased 34 percent to 2.6 billion rupees.

‘Consistent’ Growth Story

Overall, group profit for the period was 4.3 billion rupees on revenue of 16.7 billion rupees. In the fiscal year ended March 31, the group reported net income of 16.7 billion rupees on 84 billion rupees in revenue.

“Investors always look for consistent and strong growth stories and Kotak Mahindra today has that,” said India Infoline’s Kumar.

Foreign banks have cut jobs in commercial and investment banking in India amid global firings this year. Barclays Plc, based in London, will eliminate 200 retail-banking positions in India as it winds down consumer lending, a person with knowledge of the matter said on Dec. 8. Three of Tokyo-based Nomura Holdings Inc.’s most senior executives in India left amid job reductions in Asia and Europe, three people familiar with the matter said Nov. 16.

Competitors Scale Down

Kotak Mahindra won’t follow suit, its founder said. The lender expects to get a “larger share of this pie in due course” as competitors scale down and the banking industry improves over the next 12 to 18 months, Kotak said. He estimates that his investment bank, which employs 82 people working on mergers and selling shares, will revive next year if India starts lowering interest rates, as analysts have forecast.

“As the interest-rate cycle turns downward in India, which I think happens sometime post-April 2012, we would love to see both the engines fire -- the banking engine and the capital-markets engine -- sometime in the second half of next year,” Kotak said.

Credit will expand about 17 percent this fiscal year, which ends in March 2012, Kotak said. India’s economy will return to long-term economic growth of 9 percent, from 7.5 percent for the year ended March 31, Prime Minister Manmohan Singh said in a Dec. 14 interview in New Delhi with Bloomberg News.

Farms, Home Loans

Kotak Mahindra’s commercial-banking business has been helped by an avoidance of loans to airlines and infrastructure projects and a concentration on expanding collateral-backed loans for farms, home mortgages and vehicles, Kotak said.

“We’ve stepped on the gas in terms of agricultural lending against agricultural commodities, against tractors, against commercial vehicles,” he said. “The real backbone to the Indian economy is middle India.”

Kotak said that because of the bank’s loan mix, it can expand at 1.5 to 2 times India’s 15 percent nominal growth rate, which is the GDP growth rate plus the rate of inflation.

The group’s net interest margin, a measure of its lending profitability, shrank to 4.8 percent for the quarter that ended in September, from 5.2 percent a year earlier. Kotak Mahindra still has the highest net interest margin among Indian lenders compared with 4.1 percent for HDFC Bank Ltd., 3.7 percent for the nation’s largest lender, State Bank of India, and 2.6 percent for ICICI Bank Ltd.

The bank has a relatively small savings deposit base compared with its rivals, according to KBW’s Hunsaker.

“They are certainly disadvantaged on the funding side,” Hunsaker said. “That is something they could improve upon longer term.”

Cricket Accident

Kotak, who has a master’s degree in business administration from Jamnalal Bajaj Institute of Management Studies in Mumbai, played cricket in his youth before he got hit in the head with a ball in 1979 and almost died, saved only by emergency surgery, he said.

“It got me a perspective on life,” he said. “I learned to do what you think is right, and be bold about it.”

Unlike many family-owned enterprises in India, Kotak Mahindra has avoided employing family members.

“My view is you need to think professionally,” said Kotak, who has two sons of university age.

Professional Management

Mahindra, for his part, lauds his partner for his professional management practices.

“He definitely knows how to build consensus,” Mahindra said. “People see Kotak Mahindra as a one-man show. It’s anything but. His core senior team has all stuck around because of the climate of challenge and empowerment.”

Kotak is unlike many billionaires in Asia “who would never stoop so low as to take an analyst’s call,” said Hunsaker. “He’s out there meeting with analysts, investors, policy makers, making himself accessible.”

Kotak criticizes the practice of offering loans to fund acquisitions to win investment-banking business.

“There’s a fundamental conflict between good advice and writing a check,” he said. “An advisory league table is about what value has been added by a banker, and you don’t mix it with finance.”

Rivals including London-based Standard Chartered Plc say they plan to increase takeover financing in India as they seek to gain ground in mergers advisory.

“We run advisory as an integrated piece,” Neeraj Swaroop, Standard Chartered’s outgoing chief executive officer for India and South Asia, said in an interview Dec. 13. “If we have to give balance sheet and we are comfortable with the client, we will put out our balance sheet.”

Looking to Expand

In mergers-and-acquisitions advisory, Kotak Mahindra is ranked No. 21 this year, while Standard Chartered, which funded deals including Aditya Birla Group’s $875 million purchase of Columbian Chemicals Co. in January, is No. 3, according to Bloomberg data. Morgan Stanley is No. 1.

As investment-banking revenue slows amid the European sovereign-debt crisis and banks face tougher capital requirements from regulators, financial companies have announced 230,000 job cuts globally this year, eclipsing 174,000 in 2009, data compiled by Bloomberg show.

Still, Kotak Mahindra is looking to expand in Sri Lanka, Indonesia, Bangladesh and Malaysia, Kotak said.

“There are a lot of countries in Asia that are not necessarily the most fashionable but make the most business sense,” he said.

To contact the reporter on this story: Ruth David in Mumbai at

To contact the editor responsible for this story: Chitra Somayaji at

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