RBL Bank IPO: good bet for long-term investors

In the financial services space, investors are left with just a few choices when it comes to banking stocks. Public sector banks, though available cheap, are riddled with asset quality concerns, while private sector banks, delivering strong earnings growth, are trading at hefty premiums. Against this backdrop, RBL Bank, the first private sector bank to hit the primary market after a long hiatus of over a decade, offers a breath of fresh air.

The bank’s strong loan growth over the last four to five years (albeit on a small base), low delinquency rate, and focussed approach to lending, led by a sound management team, are key positives for investors with a long-term horizon of three to five years.

Valuations too look reasonable when compared to other listed players. RBL Bank (formerly known as Ratnakar Bank), one of the old private sector banks established in 1943, transitioned into a new-age private bank over the last six years, growing aggressively under the aegis of the new management that took over in 2010. RBL Bank’s valuations – 2.1 times its post-IPO book value of FY16 at the upper end of the price band of ₹224-225 a share – lies between the valuations of new (YES Bank and Kotak Bank at around 4 times) and old private banks (Federal Bank at 1.4 times and City Union Bank at 2.6 times).

The only weak link is RBL Bank’s low return ratios when compared to most of its peers. Return on equity of around 11 per cent is much lower than the 15-20 per cent returns sported by many private lenders. Low returns are a result of large investments in branches and manpower over the last couple of years, to drive its aggressive growth in retail and micro-finance segments. As these businesses attain scale and operational efficiency sets in, returns are likely to improve, but only after a couple of years. Hence, investors willing to bet on the long-term prospects of the bank and strong management team can subscribe to the issue.

The new management (incentivised by ESOPs), alongside fresh talent brought in from other private banks, have been instrumental in the strong growth of the bank in the past six years. RBL Bank’s earnings have grown by around 46 per cent annually between FY12 and FY16, driven by strong loan growth of about 50 per cent (annually) during this period.

The bank has been mainly catering to the working capital needs of large corporates and SMEs. While this segment still accounts for 60 per cent of the bank’s loans, its share has been coming down over the past couple of years, as the management has been pursuing growth in segments such as retail (17 per cent of loans), agriculture (8 per cent) and micro-finance (14 per cent).

Going ahead too, the focus will be on retail and micro-finance segments, which, given the low base and relatively higher yields, augur well for earnings.

While the growth in loans has been strong, CASA base of 18.6 per cent of total deposits, is low compared to other banks and needs ramping up. But garnering a pie of the low-cost deposits will be a challenge, at least in the near term.

Aggressive branch expansion to widen the deposit base will mean higher costs and lower profitability.

Kotak Bank (CASA ratio of 37 per cent) and YES Bank (29.6 per cent) have taken more than a decade to ramp up their CASA deposits.

During the last five years, while RBL Bank has nearly doubled its branch network to 197 from 100 and gradually widened its presence across States, it is still mainly concentrated in the western part of India, with half of its branches in Maharashtra.

Despite the aggressive growth in loans over the past couple of years, the bank has been able to keep bad loans under check with gross non-performing assets at 1 per cent of loans. The bank’s restructured loans are also low at 0.09 per cent of loans.

The IPO is a combination of fresh issue of shares worth ₹832 crore and an offer-for-sale for 1.69 crore equity shares. The IPO proceeds will be used to boost the bank’s Tier-1 capital to fund its growth.