The quarterly results season for banks (Q2 FY25) is coming to a close, with almost all major banks having reported figures, barring SBI. So far, it has been a tale of two cities as far as private banks are concerned, with solid numbers being rewarded by the market and weaker ones being punished. Post publication of results, shares of banks such as HDFC Bank and ICICI Bank have gained 3 per cent each. HDFC Bank reported an improved credit-deposit ratio (CDR) of 377 basis points (bps) sequentially to 100.8 per cent, with its unmistakeable best-in-class asset quality, while ICICI Bank reported a healthy set of numbers on all fronts.
On the other hand, shares of banks such as IndusInd Bank and Kotak Mahindra Bank (KMB) have corrected 17 per cent and 7 per cent respectively, since reporting of results. Shares of IndusInd Bank witnessed the worst correction in the last 15 years (excluding the pandemic year) of about 19 per cent intra-day on October 25. A week-performing microfinance (MFI) portfolio is a common feature of both banks’ results.
The gross NPA (GNPA) ratio of IndusInd Bank’s MFI book went up 138 bps quarter on quarter (QoQ) to 6.54 per cent, while the overall GNPA ratio rose marginally by 10 bps. Slippages of KMB were amplified by delinquencies in its MFI portfolio. As both banks scaled back their respective MFI books, their yields were affected, thereby putting the net interest margin (NIM) under pressure. The prevailing embargo on KMB’s credit card business and stress observed in that portfolio on top of that, didn’t help KMB’s margin.
Year to date, the Nifty 50 has returned 12 per cent. Compared to this, the Nifty Private Bank index has yielded just 2 per cent in the same period, while the Nifty Bank index has gained 7 per cent. The Private Bank index trades at a valuation of 2.3 times its book value, which is at a discount to its five-year average price to book (P/B) multiple of 2.8 times. Hence, private banks may be on the radar of many value investors. As multiple private banks including small finance banks (some of which are full-scale commercial banks now) have sizeable exposure to the MFI segment, how should investors play this space safely?
The Genesis
The microfinance segment is a credit-starved space and is underserved. The sheer market size (Estimated overall MFI portfolio of all players as of FY24 was ₹6.9 lakh crore. This is about 4.3 per cent of gross bank credit) and the borrowers’ preference to organised players over unorganised players charging usurious interest rates, are predominantly the drivers behind the stellar growth in the segment’s portfolio assets at a CAGR of 21 per cent between FY18 and FY24. This is expected to grow at a healthy CAGR of between 16 per cent and 18 per cent between FY24 and FY27 (industry data picked from the RHP of Northern Arc Capital).
In October 2022, the RBI lifted the cap on interest rates that MFI lenders can charge the borrowers. The relatively-higher yields and the prospects of higher risk-adjusted returns caused the foray of multiple players into the space. The RBI had lifted the cap in expectation that the increased competition would play out in favour of the borrower in terms of competitive interest rates. Along with this tweak, the RBI had also lifted the cap on how many MFI loans a borrower can sign up for, which was restricted to two per borrower earlier. These factors together have driven the high growth in this segment.
Too many loans
But too much growth meant asking for trouble. Soon, borrowers started overleveraging, meaning they borrowed fresh loans at a time when there were other subsisting loans. The RBI on its part, repeatedly voiced concerns and brought about measures to curb this. Among other things, in mid-August, it ordered at least five private banks to hike risk weights on MFI loans from 75 per cent to 125 per cent.
A report by CRIF Highmark highlights that as of June 2024, out of the total MFI portfolio of all lenders, the sum of outstanding loans that were lent to borrowers who had borrowed from four or more lenders made up 19 per cent..
In the quarter ended September 2024, IndusInd Bank, for instance, reported that 44 per cent of the borrowers were indebted only to the bank, 27 per cent to the bank and one other lender, and about 9 per cent to three or more lenders. In Ujjivan Small Finance Bank, 7 per cent of the MFI borrowers are indebted to four or more lenders and these borrowers account for 10 per cent of the slippages during the quarter. Out of the banks that were analysed by us, RBL Bank had the most overleveraged borrowers with the management reporting that 8 to 10 per cent of the borrowers are indebted to four or more lenders. Banks in their defence, claim that it was only after they had lent first to a borrower, did the borrower get additional loans.
This overleveraging menace has been exacerbated by factors such as elections, heat waves, diminishing rural income in certain pockets and political expectations such as loan waivers. This has led to serious asset-quality issues for lenders. Consequently, the sequential slippages ballooned this quarter. For IDFC First Bank, out of the net slippage addition of ₹260 crore for Q2 FY25, which is a 23 per cent increase QoQ, 40 per cent came from the MFI book.
Credit costs up
This prompted banks to ramp up provisions. IDFC First Bank, for instance, has made additional provisions of ₹315 crore specifically for the MFI book. It has also tweaked its provisioning policy such that 80 per cent of delinquent accounts are provided for on a 90-DPD (days past due) basis and the management reported that 99 per cent of SMA 1 (30 DPD) and SMA 2 (60 DPD) accounts have been provided for already. This has pushed up the credit cost attributable to the MFI book from about 4.5 per cent in Q1 to 7.5 per cent in Q2. Including the provisions for one Maharashtra toll road account of ₹253 crore (due to the state government waiving payment of toll), IDFC First Bank has guided for a credit cost of around 2.3 per cent (on the overall loan book) for the fiscal.
RBL bank has guided for a credit cost of 2.5 to 3 per cent, and Ujjivan SFB has guided for up to 2.5 per cent, with an indication that the credit cost during the second half of FY25 will be higher than the first. IndusInd Bank has increased its contingency provisions by over ₹500 crore. Though this is not directly attributable to the MFI book, the fact that the timing of these provisions coincides with a weak quarter in which GNPA ratio in the MFI book has gone up, raises eyebrows.
The increased stress in the segment has forced banks to scale back on disbursements in the segment (see infographic). A lower share of high-yielding MFI book, means lower yields for the lenders. This comes at a time when yields are anyway set to trend down when rate cuts come (since most private banks having higher share of floating rate loans). Additionally, if repricing of deposits take longer than that of loans, it could result in a double whammy for NIMs.
Outlook for MFI loans
The outlook for the MFI segment remains bleak with managements uncertain about when things will start looking up for the sector and most reckon that the stress will sustain for the next two-three quarters.
Lenders have adopted various measures to tackle the strained segment. RBL Bank is focusing on renewals to the existing borrowers, while also limiting exposure to one loan per borrower. IDFC First Bank is expecting to insure incremental advances with the CGFMU (Credit Guarantee Fund for Micro Units) up to 75 per cent of the portfolio by FY25-end. It has 50 per cent of the MFI book insured as of Q2 FY25 end. Ujjivan SFB has the following measures in place – restricting advances to NTC (new to credit) borrowers, serving only those customers who have a good track record with the bank and limiting exposure to problematic clusters of some States. Almost all banks have ramped up resource allocation in the collection department. This can mean that the operating expenses in the coming quarters can inch upward.
Clearly, there are near-term ramifications due to the MFI slip-up and though many banks have put checks in place for the future, one needs to wait and watch as to how banks navigate through this challenge. Risk-averse investors can be better off keeping away from banks that have a sizeable exposure to the MFI segment. At bl.portfolio, we have a ‘hold’ call on Kotak Mahindra Bank. Post this development, investors can continue to hold the stock, as the MFI portfolio is only a small part of the bank’s loan book (see infographic). We also have an ’accumulate’ call on HDFC Bank. Investors can continue to accumulate the stock in dips. First, the bank does not have exposure to the risky MFI segment. Second, the bank continues to display progress in its plan to bring down the CDR.
Key metrics
While risks from MFI exposure and its ramifications on financials of affected banks have hogged the limelight, how have players fared on other key metrics in Q2? Here’s a look.
Higher levels of CDR, driven by deposit growth rates trailing loan growth rates, were the overarching theme of the first quarter of FY25. The RBI Governor, too, repeatedly insisted that banks focus on deposit mobilisation, lest they face liquidity risks.
There is good news on this front this quarter (Q2). The deposit growth rate at the system level (all scheduled commercial banks combined) this quarter has been 11.8 per cent year on year, which is not far from the advances growth rate of 12.8 per cent. Last quarter, the rates were 11.1 per cent and 17.4 per cent respectively. As a result, the system CDR also has eased from 79.3 per cent to 78.9 per cent.
However, the low-cost CASA (current account savings account) balances haven’t picked up and the growth in deposits is primarily fuelled by good growth in term deposits, possibly due to investors wanting to lock-in deposits for longer tenures at prevailing higher interest rates. CASA balances declined 0.4 per cent sequentially, while term deposits grew 3.5 per cent. Consequently, cost of deposits/ funds of most banks saw an uptick.