Kotak Mahindra Bank: What should investors do?

Kotak Mahindra Bank (KMB) is the fourth largest private bank in India. Over the years, it has been a good all-round performer in all three key aspects – balance sheet growth, asset quality and margins. However, now a host of challenges such as the embargo on the issue of new credit cards and a resultant drop in NIM, dropping CASA ratio and signs of stress in credit card accounts are stacked up for the management to overcome. The management has measures in place, as explained below, to take on these challenges. The efficacy of the same remains to be seen.

Before the pandemic, the stock of KMB used to trade at a premium to its peers such as HDFC Bank, ICICI Bank and Axis Bank. Investors flocked to buy the stock for its relatively higher NIM (net interest margin) and CASA (current account savings account) ratio. Post the recovery from Covid lows, a time wise correction has played out along with a P/B derating driven by the fact that the RoE (return on equity) of KMB is lower than the above peers, among other factors. A sum of the parts valuation some upside left in the stock. While not sufficient to warrant fresh investing, existing investors can continue to hold the stock for the long term.

Credit card embargo

In late April, the RBI ordered the bank to cease issuing new credit cards and onboarding new customers through online channels due to concerns over the bank’s IT infrastructure. Credit card receivables are high yielding and make for about 3.8 per cent of the total loan book as of Q1 FY25. While advances grew at 3.7 per cent quarter on quarter during the quarter, credit card receivables grew a mere 1 per cent due to the RBI’s embargo. NIM for the quarter dropped 26 bps to 5 per cent sequentially, due to the feeble growth in the high yielding credit cards, among other factors such as degrowth in low-cost CASA balances.

Per the management, ever since the order, the bank has demonstrated progress and commitment to set things right and is in constant interaction with the central bank. It appears that the RBI will lift the ban once it is satisfied of the bank’s commitment and not wait until KMB ticks off every single item in the defined scope of work. The management says it is hard to predict at what stage the ban will be lifted.

In December 2020, HDFC Bank received a similar order from the RBI to stop issuing new credit cards. Although the RBI allowed the bank to issue fresh cards after eight months in August 2021, the ban was lifted completely (after five quarters) in March 2022. In this period of five quarters, HDFC Bank managed to grow credit card receivables at a brisk pace of 19 per cent, despite initial hiccups. Quarterly NIMs were also largely stable with fluctuations of about 10 bps. Credit card receivables make around 5.5 per cent of HDFC Bank’s loan book.

KMB’s management is upbeat about achieving growth in mid-teens in the unsecured segment (personal loans and credit cards) this fiscal, having witnessed growth in credit card spends market share in May compared with March.

Watch out for

There are four key things to monitor.

One, credit cost (net provisions divided by advances) for FY25 may be elevated due to stress noticed in low-ticket credit card accounts, especially where customers are over leveraged. Also, recoveries in the corporate banking book are waning in comparison to recovery levels post-Covid, due to little to no recovery expected from newer credit costs.

Two, the increased spending to strengthen the IT infrastructure may take the cost to income ratio of the current and the next fiscal upward. The management has plans for up to 1,500 new branches over five years. This also can impact the cost to income ratio, though the management is sanguine about keeping the ratio low with incremental revenue flowing from the new branches and leveraging technology.

Three, the CASA ratio and deposit growth. The CASA ratio has plummeted from 60.5 per cent in FY21 to 43.4 per cent as of Q1 FY25 (still higher than peers above). In Q1 FY25, the year-on-year growth in advances exceeded that of deposits, pushing the LDR (loan-deposit ratio) up by about 300 bps to 87.2 per cent. The bank has taken two key initiatives to shore up deposits. One, renewed focus on the ActivMoney product (sweep facility) with ad campaigns. Two, offering bundled products, that include investment and lending, targeting the affluent, NRIs and early jobbers, in top cities.

Four, possible pressure on NIM due to rate cuts, as KMB has a large linked exposure on the assets side (Loan book linked to Repo rate was 58 per cent in FY24).

Subsidiaries

Four key subsidiaries constitute about 19 per cent of the group’s net worth and about 30 per cent of the share price – Kotak Securities (share broking), Kotak Mahindra Asset Management Company (mutual funds), Kotak Mahindra Prime (car loans) and Kotak Mahindra Life Insurance. All four are wholly-owned subsidiaries.

The capital market subsidiaries Kotak Securities and Kotak AMC have posted stellar growth in net profit in the latest-concluded quarter, with 83 per cent and 65 per cent year-on-year growth respectively.

Kotak Prime’s customer assets grew 21 per cent year on year and profit grew a mere 6 per cent due to increase in provisions. The company is well capitalised, with a capital adequacy ratio of 25 per cent. Kotak Life’s profitability got impacted on higher distribution cost and ended the quarter with a profit degrowth of 10 per cent. Solvency ratio is at 2.48 times as against the regulatory minimum of 1.5 times.

In mid-June 2024, KMB sold part of its stake in Kotak Mahindra General Insurance (KGI), a wholly-owned subsidiary then, to Zurich Insurance, resulting in a post-tax profit of ₹3,013 crore on a consolidated basis. KMB also infused capital into the divested company after the deal. KMB now holds 30 per cent of KGI.