Bandhan Bank - in a sweet spot?


(Kanwal Sudan) #1

Bandhan Bank IPO is out. Issue details along with business summary and investment rationale is given blow. Most of this data is from the Red Herring Prospectus along with my notes in investment rationale and risk sections.

Issue details:
Public issue of 11.93 crores shares including
9.77 crores fresh issue; and
2.16 crores offers for sale by IFC and IFC FIG
Dates: March 15 – 19, 2018
Price band: 370 – 375
Total issue capital (higher end): 4473 crores
Objects of issue: Augment Tier – 1 capital
Post-issue market cap: 44700 crores
Promoter holding for BFSL: From 89.6% to 82.3%
Anchor Investors: Amansa Holdings, ICICI Prudential, Neuberger Berman, Nomura Fund, HDFC Standard Life, Birla Sun Life, Citigroup, Aberdeen, SBI Life and Kotak Mahindra.

Business Summary:

History:
• 2001 – Bandhan Konnager formed as NGO providing microfinance services
• 2006 – BFSL started
• 2009 – NGO transferred microfinance business to BFSL
• 2015 – BFSL was largest microfinance company by number of customers and size of loan portfolio when it transferred assets to Bandhan Bank

Management:
 CEO/MD – Chandra Sekhar Ghosh (only person with equity holdings)
 CFO – Sunil Samdani
 CS – Indranil Banerjee

Shareholding (prior to issue):

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Overview:
• Commercial bank focused on serving under-banked and under-penetrated markets in India
• Incorporated in Dec 2014 and began operations in Aug 2015 when BFSL transferred entire microfinance business
• Network growth –
o 2022 doorstep service centres (DSCs), 501 branches and 6.77 mn customers In 2015 to
2633 DSCs, 877 branches and 9.86 mn customers by Dec 2017
o 2.13 mn general banking customers added since 2015
o Despite extension, 56.37% of branches in East and Northeast India
• Assets/Liabilities
o Deposits and advances stood at 25293.96 crores and 24364.39 crores
o Advances to deposits ratio at 91.46%
o Retail to total deposits at 85.07%
o NIM of 10.34% in 2017
o Assets
 96.49% gross advances are priority sector lending (PSL) compliant
 Interest earned is 90.48% of total income.
 6.78 % income from Priority Sector Lending Certificates (PSLCs) as of nine months Dec 2017
o Liabilities
 Current accounts, savings accounts (CASA) make up 33.22% of total liabilities and can be withdrawn any time.
 70.62% of term deposits of tenure less than 12 months
• Profitability and return ratios
o RoE of 25.55% in Dec 2017
o RoA of 4.07% in Dec 2017
o Revenue of 4320 crores and PAT of 1111.95 crores in FY 2017 => PAT margin of 25.7%
• Credit ratings
o NCDs: AA –
o Term loans: AA-
o Certificates of deposits: A1+

Strengths:

  1. Operating model focused on serving underbanked and underpenetrated markets
     17 years history in microfinance - was largest MFI by asset size when it became bank.
     Enjoys brand recognition, network and low cost of funding due to banking deposits
     Loans given to women (considered more risk averse than mean) who form self help groups of 30+ members
     Incremental higher loans given to individuals with good repayment history
     Reach customers through cost effective DSCs which are low overhead banking outlets
     29% branches in unbanked areas against RBI requirement of 25%
     96.49% of gross advances are microloans, considered PSL against RBI requirement of 40%

  2. Consistent track record
     Since March 2016, gross advances grew from 15578.44 crores to 24364.39 crores and number of customers grew from 6.77 mn to 11.99 mn
     Deposits grew from zero in Aug 2015 to 25293.96 crores by Dec 2017
     Weathered trouble in 2010 to microfinance industry and rose from 4th largest to largest position in microfinance industry.
     Despite demonetization, GNPAs in March 2017 stood at 0.51%. In Dec 2017, GNPAs at 1.67%

  3. Extensive low cost distribution network
     Hub and spoke model whereby 3-4 DSCs are connected to single bank branch.
     Ability to increase penetration to unbanked regions using DSCs
     DSCs have lower overheads as employees use handheld devices connected to Internet to process loan applications instead of fully fledged systems at bank branches
     Cost to income ratio at 35.38% as of Dec 2017, among lowest in industry

  4. Customer-centric approach
     Offer range on microloans including educational and health. Deposits such as daily and recurring.
     All micro loan customers are insured so if they pass away family does not have to take burden.
     Pass on benefits of low cost of funds. Reduced interest rates on micro loans from 22% in August 2015 to 18.5% in Dec 2017

  5. Consistent performance and robust capital base
     NIM at 9.86 %, RoA at 4.07%, RoE at 25.55% as of Dec 2017
     Increase in non-interest income due to treasury and PSLC contributions
     Share of retail deposits increased from 37.95% in March 2016 to 85.07% in Dec 2017.
     CASA ratio and large percentage of retail deposits provide low cost funding
     SLR, CRR and CAR at 24.9%, 4.12% and 24.85% as against requirements of 19.5%, 4% and 13% respectively.

  6. Experienced and professional team
     MD/CEO Chandra Shekhar Ghosh has 37 years of experience in microfinance
     Members of senior management have 23.9 years of experience in financial services industry
     Hire employees from villages to better relate with customer base
     Eight training centres in India

Strategy:

  1. Maintain focus on micro lending while expanding to retail and SME lending
     Develop pan India network in both microfinance and retail lending
     Reduce dependence on East and Northeast India
     Open branches in affluent areas and urban areas to improve deposit base while increasing opportunities to cross sell products

  2. Continue to strengthen liability franchise
     Focus on source of low cost funding by seeking retail deposits as opposed to wholesale deposits as bank believes retail customers are more loyal.
     Selectively open branches in urban areas where potential of deposit collection is higher

  3. Boost share of non-interest income
     Leverage strong PSL compliant portfolio by selling PSL certificates to non-PSL compliant banks
     Distribute third party insurance and mutual fund products
     Inward and outward remittances services

  4. Enhance digital platform to improve customer acquisition and retention and reduce costs

  5. Enhance retail banking systems and procedures by training staff initially developed for microfinance to carry out duties in retail banking

Financial statements:
Balance sheet:

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Profit and Loss

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Valuation with industry comparison:

*Figures in red are values estimated/calculated by me

Industry comparison:

Investment rationale:

  1. Access to low cost of funding from retail deposits likely to ensure superior NIM against peers in private banking. Also poised in industry better than NBFCs that do not have access to deposits.
  2. Majority of client base is currently in Eastern and Northeastern India where access to retail credit is poor compared to other parts of the country such as Western and Southern India so long runway ahead.
  3. Management has a proven track record in microfinance and should be able to leverage its hub and spoke model, especially in Central and Northern India where access to microloans is low.
  4. Capital adequacy ratio already very good. Net proceeds will improve this further. Any hit from increasing NPAs to ballooning loan book in the last two years should be contained without threat to operations overall.
  5. Ability to gain non-interest income from selling PSLCs and third party distribution of mutual funds and insurance products is added positive.

Risk factors:

  1. Since its operations as fully fledged bank began in Aug 2015, it has limited experience in general banking
  2. Substantial portion of operations in East and Northeast India - any regional problem will destabilise operations
  • 65% branches in East and North-east India
  • Region contributes to 81% of total advances
  1. Competition from players in both traditional banking and microfinance
  2. Asset liability mismatch
  • May rely on funding options with short term maturity for extending long term loans which may lead to negative asset liability gap
  1. Majority of net advances (87.56%) are unsecured microloans extended to customers with little credit history and greater propensity to default.
  2. Inability to preserve asset quality as geographical presence increases and customer profile changes.
  3. Exact usage of net proceeds has not been outlined – may be used for organic/inorganic growth and/or improving capital adequacy
  4. Seasonality in loan disbursements in third and fourth quarter of year due to agricultural conditions
  5. Cases of embezzlement, fraud and theft in microfinance network
  6. Key man risk of CEO/MD who has almost single-handedly grown the business
  7. Too many changes in key management personnel in the last 2 years

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Disc: Investing in IPO to maximum extent in retail section


How to find a Compounding Machine
(Yogesh Sane) #2

I am listing out some of the additional risks:

True benefit of banking licence

Bandhan Bank is the only MFI that received a universal banking licence. The idea was that with access to low cost deposits with a banking licence it will be able to lower interest rates on its MFI loans thereby improving credit access to weaker sections of the society.

Reality is that its interest rates on MFI loans have come down by just 2% from 20% to 18% after becoming a bank 2 years ago. Other MFIs have also seen a similar trend in their interest rates over the same period. This indicates that benefit of access to low cost of deposits is almost fully offset by cost of running the branch network and maintaining SLR, CRR ratios etc. Bandhan isn’t really helping weaker sections of the society but its shareholders.

Bank licence isn’t really that much valuable anymore. No wonder no one is applying for a bank licence even when it is available on tap. Large NBFCs like HDFC and Bajaj Finance are able to fund their operations without a banking licence and still earn a good margin.

A bank is suppose to convert small deposits into wholesale industry loans to help the country industrialize. Here Bandhan is breaking small deposits into even smaller microloans and earning a spread from both ends of the inter-mediation.

Deposit growth

Bandhan was funded by borrowings prior to becoming a bank. Since starting banking operations it is funded by deposits. Its deposit base has grown rapidly, in fact too rapidly. This is how its deposit base grew
First 8 months - 12,000 Cr
Next 12 Months - 11,000 Cr
Next 9 Months - 2,500 Cr
Such a rapid deposit growth is surprising to say the least. Moreover, while its branch network grew over last 2.5 years, incremental deposits dropped which is even more surprising. It is possible that it offered high rates initially to attract deposits and now it is offering rates in-line with peers as it has built a large enough deposit base. but still, if the bank expects to grow in future I would rather see incremental deposits grow and not shrink.

Promoter holding

Banks are required to follow RBIs promoter holding rules. Bandhan Financial Holdings will own 82% of Bandhan Bank post issue which is higher than 40% prescribed by RBI. BFHL is also not a selling shareholder even when they will be required to sell part of their stake. RBI rules say that promoter holding has to come down to 40% within 3 years of starting banking operations (which is Aug 2015) so this limit expires in 5 months. SEBI rules will not allow BFHL to sell stake in Bandhan Bank for up to a year post listing. This means BFHL will violate RBI rules and will need some kind of exemption.
BFHL is owned by Bandhan Financial Services Ltd which in turn is promoted by two trusts which together effectively own just over 40% of Bandhan Bank so that might meet RBI rules. But this is something we should keep in mind.

Valuation

Bandhan is asking for a premium valuation on a post-issue book value, 40% of which will be cash raised from IPO. It reminds me of Reliance Power IPO 10 years ago.

Rationale for a premium valuation is that it earns a high return on equity. True. It earns a high return of equity of 25% which will be sufficient for a growth rate of 25%. Essentially it is self-funded up to 25% growth rate. It will need additional capital only if it expects to grow in excess of 25%. Do we really believe that Bandhan can grow in excess of 25%? that’s a little too optimistic.

On a post issue basis ROE will drop to 15%. Hardly exciting. For every capital raising ROE drops and P/B drops too but in this case, Bandhan is asking for a high P/B (4.93) on the higher book value. It is valuing itself at 7.2 times pre-issue book value. that is what investors are paying and it doesn’t deserve that.

If you value the company at 4.93 times the pre-issue book value and value fresh capital at book value, fair value works out to be 254 /share. (4.93 * 5404 + 3664)/119.3. Essentially, bank is asking investors to treat every rupee of fresh capital as 4.93 rupees as if all this capital will be instantly deployed and start earnings high returns. That is a case of putting the wagon in front of the horse.


(atul1082) #3

Thanks Yogesh for a very informative post.A normal investor like me also goes by anchor demand and the type of funds.your views whether this approach has some merit and your comments, if any, on the anchor list of bandhan bank.


(Rohit) #4

Hi ,
May be am asking a v basic question here. How the ROE and P/B drops if company raises new capital. Would appreciate if you can answer this.


(Varun) #5

its basic mathematics…

P/B

Old no of shares = 100, Price 200, BV = 50
New Shares = 10, Price 200

New BV = (50 * 100 + 200 * 10)/110 = 63.63

New PB = 3.14 (compared to old 4.00)


(Varun) #6

ROE

Profits = Rs 200
Face Value = Rs 10
Old Issued Capital = 100 shares

ROE = 20% (200 / (100*10)) ***Assuming no reserves

Now, after issue
Profits = Rs 360 (Rs 200 old profit + Rs 120 assuming 6% interest can be earned net of tax on ipo amount)

Total Capital = Rs 3000 i.e 110 * 10 + (190 * 10) *** Securities premium reserves

ROE = 360/3000 = 12%

since all the new funds cannot be applied on issue date immediately, there is always a time lag.


(Kanwal Sudan) #7

Hi @Yogesh_s, I was looking at your comments and decided to dig deeper into RHP - may be we can re-evaluate Bandhan on basis of this new information. :slight_smile:

Disagree. As per RHP and comunication given by MD after March 2017 results, the drop in interest rates is 400 bps from 22.4% to 18.52%. Also in another video, MD said they offer same loans at 16% also if the customer comes to the bank branch. Some customers are doing so, esp. those that have graduated from taking micro credit loans (<1 lakh) to small enterprise loans (SEL) (1 lakh - 10 lakh). It’s the doorstep delivery of loan procedures for which they charge 2.5% extra. I think that is fair.

(see 11:45 in above video)

MD also highlighted that his rates have to be competitive given credit worthiness of customers and because microloans are unsecured. There are some cases where the borrower might further lend out to other people at even higher rates. They have to assess that the borrower will use loan for productive purpose and not start lending activity on their own.

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This has to been seen in light of decreasing wholesale deposits (see figure below). The mix of retail and wholesale deposits has changed significantly from Dec 2016 to Dec 2017. On the whole, the growth rate in total deposits might seem small, but growth in retail deposits is very strong. And this has reduced cost of funds from 8.09% in Dec 2016 to 7.21% in Dec 2017. As retail portfolio increases further, there may be additional decrease in cost of funds.

image

This I agree with you. Don’t know why promoter did not go for stake sale? In the same video above at 10:55, MD said CAR is very comfortable and no need to raise capital at this juncture. Promoter could have sold stake and abided by the RBI rules. Are they hoping to sell stake after public market has fully discovered their price - do they hope to get even better valuation??

According to presentation given after March 2017 results, MD said they hope to grow by 30% in deposits and advances in the coming year. IMHO, even if their growth slows down, this should be achievable. Also consider the fact that RHP says there is seasonlity in advances and Q3/Q4 are stronger quarters due to agricultural and other reasons.


(Kanwal Sudan) #8

Some additional points to note from presentation to media in Jun 2017 (link given in post above):

  • Plan to increase branches from 840 to 1000 in coming year. Employee base to increase from 24k to 30k

  • 30% deposit/credit growth expected in next year

  • Large part of income (up to 7000 crores) in FY 2017 came from IBPCs. This is included in the interest bearing income.

Note: RHP states that they want to move to PSLCs instead of IBPCs and going forward this income will form part of non-interest bearing income. In light of this, results may have to be restated to compare.

  • Microcredit loans are of value < 1 lakh according to them. Average ticket size is 30k.

  • On question of why such high NIM of 10%, MD said 91% book is from microcredit, so there is significant cost of doorstep delivery that needs to be taken into account. There has been drop of 400 bps from 22.4% to 18.52% and bank will pass on lower rate as cost of funds decrease.

Note: Also IBPC income is included in FY17 results, so this will move to non-interest income going forward with use of PSLCs. Need to more clarity how this affects results. If someone can shed light here, it will be good.

  • While microcredit remains focus, bank wants to focus on small enterprise loans (SEL) of value 1 - 10 lakh because this is seeing good traction. Increase from appro 100 crores to 1000 crores in this category in FY17.

  • Current cost to income ratio at 36%, and this should be norm except some fluctuations due to investments in infrastructure, etc.

  • Did not face any pressure in operations due to demonetisation because clients had to come and put old currency in bank anyway.

  • Milestones expected in next 2 years
    1. Improve general banking and become like other private banks
    2. Retain focus on microcredit at same time.
    3. Increase MSME lending as only 5% penetration by bank credit at this level.

  • Interest for non-microcredit loan as 11 - 16% based on risk profile. MCLR for Bandhan is higher because it’s a new bank and lends to less credit worthy customers. Hope to reduce rates in the future.

  • No plans as such for capital raising as CAR is healthy. Will tap markets if required.

Note: In this regard, fresh issue of shares for Tier-1 capital raising is a strange development.

  • Roadmap to listing - for IPO, MD said not in position to comment but in process.

Note: In this regard also, bank has moved very quickly (8 months) to comply with regulatory requirement to list. Maybe they wanted to tap the market while it was in bull market phase.


#9

Well, IPO has been re-defined.



(jayantmum) #10

A potential strategy with such a large amount of money raised could be to acquire another player to quickly grow in adjacent areas [a huge caveat here that I have not yet studied them in detail and so, this is just an initial thought basis my reading of ideas on this thread :slight_smile: ]. So, a takeway for me is probably to look for candidates which Bandhan may look to target with this money.

Nevertheless, I would have to agree with certain observations made in the Ambit report regarding the implications on growth pressure and returns when Bandhan raises such a large sum of money. Somehow, the valuations being demanded don’t seem to justify over the next 2-3 year period post IPO.


(Gary) #11

This actually reminds me of Avenue Supermart where the float remained low and has created an artificially high valuation irrespective of the good business they have. Providing window for promoters to exit at even higher levels …


(Kanwal Sudan) #12

Since I started the forum and disclosed that I plan to invest in the IPO, I think it’s fair on my part to also disclose if I change my mind.

I’ve now decided to not apply. My reasons are as follows:

  1. No clear visibility for use of issue proceeds as the capital adequacy is quite good and I see no reason for Bandhan to raise capital now and dilute RoE.

  2. A number of changes in top management in the last 2 years. It does not inspire confidence in their ability to build their general banking business. I feel key man risk in terms of MD is very high and I’m not willing to bet on his ability to single handedly run the show. While I may be wrong in assuming that Bandhan does not have good management depth, I will wait to see how things pan out. A two year operating history is too short to make a decision, especially when the rapidly increasing deposit base is likely to come from existing client base. Moreover I fear the NPA numbers may be misleading as the loan book is growing very fast.

  3. Valuations are high - while they seem to be in line with other private banks, I think this is because of general frothiness in financials. So on a relative basis things may look fine, but otherwise I find no comfort.

I have immense respect for Bandhan otherwise and I would urge everyone with interest in this space to read Tamal Bandhopadhay’s book on Bandhan (he is also strategic advisor to them). I will track Bandhan closely and evaluate entry at a later time.


(reacher) #13

they plan to add 160 branches.this will distort their current rosy nos like cost to income,roe,roa.we saw the same pain of expansion in equitas and ujjivan.Equitas i rate higher on governance and on risk mgmt.over reliance on mfi is a worry (just like ujjivan)


#14


(Vivek Gautam) #15

Good report.Got listed at good premium.Nomura buys 83 lacs shares at 478 today.

Whats your take on it at cmp?


(Vivek Gautam) #16

Good report.Got listed at good premium.Nomura buys 83 lacs shares at 478 today.

Whats your take on it at cmp? did u applied in IPO or thinking of buying more now that it has listed?


(Vivek Gautam) #17

(Mayank Narula) #19

MFIs are truly a contrarian bet. I am invested in Ujjivan, Satin and Arman at post-demo lows and keenly follow the sector for last 8-10 months. Somehow I always feel that most of the senior investors have a negetive bias against the sector. But for me, key factor is that they have been able to mobilize funds in the form of equity, debt and deposits even during their darkest hour.

I was hoping and was assured of bumper listing of Bandhan and strongly believe that it will get reflected in other scripts as well.


(Jaclyn) #20

While I am no expert or can say have great knowledge about MFI, I was positive at least in the contribution it makes to the society at large which needs a helping hand. But listening to the con calls of IndusInd Bank/BFIL on their merger, I could get a fair sense or lurking dangers considering the BFIL’s past experience in its earlier avatar as SKS Mircofinance and the whirlwind which could have wiped it out if not for the luck.

But just because MFI’s could lend through JLG’s does not mean they have the capability or knowledge to lend to other segments. Until that capability is proven it is not safe to invest in Bandhan Bank. It would be better to wait for some more time to see how they mature into and have a track record to show. After all we see the mature ICICI Bank & Axis Bank falter repeatedly.


(Mayank Narula) #21

Please don’t think of it as a charity. This is a business with comparable margins with other lenders. Only factor is that they are catering to huge untapped market covering almost 80% of the country.