Billionaire Kotak’s Expansion Cuts Bank Margins: Corporate India

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

Kotak Mahindra Bank Ltd., the Indian lender with the widest interest margin, said profitability will be pressured by slower growth in lending and the cost of expanding its branch network next year.

The Mumbai-based bank, founded and controlled by billionaire Uday Kotak, plans to add 111 outlets to its existing 389 branches by the end of 2013, Chief Financial Officer Jaimin Mukund Bhatt, 50, said in an interview. The increase comes even as he predicts loan growth of 20 percent for the 12 months ending March 31, compared with an average annual pace of 37 percent since 2003.

“When our expansion is faster than profit growth, there has to be pressure on the margins,” Bhatt said. “We will grow our loan book at a slower pace this year as the bank would rather lose the opportunity of making money than lose the money itself.”

India’s $1.8 trillion economy is set to expand 4.9 percent this year, the least in a decade, according to the International Monetary Fund, while earnings for 12 of the 30 companies that constitute the benchmark Sensitive Index trailed analysts’ estimates for the quarter to September, underscoring slowing demand for loans. Kotak, which has a net interest margin of 4.7 percent, will extend its plan to invest in bad loans to sustain profits, Bhatt said.

Stock Rally

The lender’s net income almost tripled to 18.3 billion rupees ($329 million) in the 12 months ended March 31, from 6.5 billion rupees three years earlier, according to data compiled by Bloomberg. The stock has rallied 48 percent this year, outperforming the 22 percent gain in the Sensex.

The advance compares with the 46 percent increase in the Bankex Index made up of 14 lenders, while lagging behind Yes Bank Ltd.’s 82 percent surge, HDFC Bank Ltd.’s 59 percent and ICICI Bank Ltd.’s 51 percent.

Eleven of the 23 analysts who track Kotak recommend selling the stock, while four rate it a buy and eight a hold, data compiled by Bloomberg show. The shares rose 1.2 percent to 635.05 rupees today in Mumbai, pricing them 32 times estimated earnings, versus 15 for ICICI and 24 for HDFC Bank.

Mining restrictions in the states of Goa, Karnataka and Odisha have crimped sales of commercial vehicles and construction equipment, hurting Kotak, said Hatim Broachwala, a Mumbai-based banking analyst at Karvy Stock Broking Ltd. The loans to the sector account for 13.4 percent of Kotak’s assets, according to the lender.

Mining Probe

“This is one of the expensive stocks in the banking sector now,” said Broachwala. “Their exposure to commercial vehicle and construction equipment is weighing on the mind of investors.”

The western state of Goa, the biggest exporter of iron ore, and Odisha in eastern India have either frozen mining activity or stopped giving new licenses this year, amid an investigation by a government panel into allegations the mining companies flouted environmental laws. The panel, which has submitted its report on Goa, is currently examining Odisha, and will probe five more states.

“Many equipment companies are losing business because of the current slump in mining,” said P.K. Mukherjee, managing director of Sesa Goa Ltd., India’s biggest iron ore exporter that hasn’t seen any production in that state for more than two months.

Sales Slump

Sales of medium and heavy commercial trucks slumped 26 percent in October from a year earlier, the biggest drop since June 2009, according to data from the Society of Indian Automobile Manufacturers.

Kotak plans to buy bad loans from rivals at a discount as returns more than doubled in past investments, Bhatt said. Provisioning mandated by regulators for such purchases won’t deter the bank from expanding the business, he said.

“Short-term accounting pain won’t stop us,” Bhatt said. “If we see value in stressed assets we will buy it at the right price and will make money out of it at the end of the day.”

The lender has a team of lawyers, mergers and acquisition experts, and commercial bankers who specialize in recovering soured loans from debtors, according to Bhatt. The assets are typically bought at a price of 20 percent of the loan amount and at least twice the price is recovered in three years.

Borrowing Costs

“While there is an immediate fall in profits due to provisions, this business adds to their earnings in the long term,” said Vishal Narnolia, a Mumbai-based banking analyst at SMC Global Securities Ltd.

The highest borrowing cost among Asia’s major economies has curbed lending in the region’s third-biggest economy. The Reserve Bank of India’s benchmark overnight lending rate of 8 percent compares with 6 percent in China, 3 percent in Malaysia and 2.75 percent in South Korea.

Loans at banks in India, excluding advances made to state agencies for food procurement, expanded 16.2 percent in the 12 months to Nov. 2, data compiled by the RBI show. The advances grew 18.45 percent in the year before. The central bank trimmed its credit growth projection last month to 16 percent for the year ending March 31, from 17 percent.

Slowing growth also pushed bad loans in the Indian banking system to 3.25 percent of total assets as of June 30, prompting the RBI to say on Oct. 30 that they are “a cause of concern.”

Banking License

Kotak, which got the license to operate as a commercial bank in 2003 from the RBI, had soured debt at 0.61 percent of total loans, compared with 0.66 percent at ICICI Bank, the nation’s second-biggest by assets.

Uday Kotak and his family own about 45 percent of Kotak Mahindra Bank, a stake valued at about $3.8 billion, according to data compiled by Bloomberg. It has 11.4 million customers. The RBI in June ordered the billionaire to cut his stake by more than half to 20 percent in less than six years.

The bank had a Tier 1 capital buffer of 14.9 percent on Sept. 30. The capital adequacy ratio for the lender fell to 16.4 percent as of Sept. 30, from 17.8 percent in the previous year, exchange filings show. Banks in India have to set aside at least 9 percent of the assets as a buffer against bad loans. The lender has no plans to raise capital as of now, Bhatt said.

The shrinking net interest margin may not be a concern because the lender will get business from the new branches, said SMC Global’s Narnolia.

“Softening margin is the price that each lender that aggressively expands has to pay in the short term,” he said. “The margins will widen as the bank reaps dividends from the expansion.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE