Investors likely to be tight-fisted as private banks look to raise capital

As a clutch of private banks set out to raise capital, the quality of assets and governance will hold the key more than ever before as to how the sector is seen from hereon

Last week, Murli Natrajan was in Geneva to meet Aga Khan, founder-chairman of the Aga Khan Development Network, to brief him on DCB Bank’s plans. “We are comfortable on the capital front as on date, but a year down the line, equity capital will have to be raised,” says the managing director (MD) and chief executive officer (CEO) of the bank. The Aga Khan Fund for Economic Development holds 15 per cent stake in the bank, but however blue-blooded your promoter-lineage is, investors will be much more tight-fisted in handing over money to private banks, going ahead.

Then, you have YES Bank and RBL Bank — the former has got its board’s nod to raise equity capital up to $1 billion (about Rs 7,000 crore); the latter is in the hunt for up to Rs 3,500 crore. It can be argued that YES Bank, RBL Bank and DCB Bank are relatively small compared to the big boys among private banks to be seen as benchmarks, but that’s missing the plot. When Mint Road cracked the whip on banks, private banks as a class lost their halo as being superior when compared to state-run banks.

Be it the variance in the declared dud-loans, which cropped up during central bank inspections when it conducted its asset quality review (AQR) or governance issues, something was more than amiss. The PJ Nayak Committee’s (May 2014) observation proved to be spot on: “Either they are better bankers or are able to successfully sell their assets or else they successfully evergreen their assets.” Nayak’s comment had to come three years before the AQR when private banks reported gross non-performing assets of 2.06 per cent with total stressed assets at 4.13 per cent; the same was higher at 5.07 per cent and 12.6 per cent, respectively, for state-run banks.

A new life

In the case of YES Bank, its senior management led by Ravneet Gill — the new MD and CEO — has not specified the timeline for raising capital, but in a call with analysts, said the bank needs time to communicate the renewed strategies to the market. He’s spoken of repositioning as a corporate bank, but it’s a business model that’s not been seen among private banks though several of them rolled out on that platform before becoming full-service banks. Gill’s course correction is a first-of-its-kind on our turf, and will be closely watched, given the stress in India Inc and overhang of the twin-balance sheet problem. It is anybody’s guess as to what the narrative will be when the bank embarks on its investor roadshows led by Gill — again a first for the bank as a non-promoter head will do the honours; the former Deutsche Bank India CEO has his task cut out to get a buy-in from investors.

“We have enough capital to take us through this year and half of next year. The capital will be required across-the-board and we will accelerate investment in our physical networks,” says Vishwavir Ahuja, MD and CEO at RBL Bank. It’s unlikely Ahuja will go public on it, but the bank is looking out to buy a mutual fund company to widen its bouquet of offerings.

According to rating agency ICRA, the tier-I capital adequacy of private banks as a class was at 14-14.5 per cent levels in Q3 FY19, of which common equity tier-I stood at 13 per cent with the balance being in additional tier-I capital.

“While calculating capital requirements for the three years (till FY22), we have assumed that banks will keep a cushion and not allow CET 1 to fall below 12-13 per cent. They will need at least Rs 10,000 crore every year to maintain that level. So, a total of Rs 30,000 crore will be the capital requirement for three years,” says Karthik Srinivasan, group-head (financial ratings) at ICRA Ratings. Among large private banks, HDFC Bank and ICICI Bank may not need to visit the market to raise fresh capital – the former raised Rs 15,000 crore as equity in FY19 and its profitability is better while the latter has room to monetise its stake in some subsidiaries to raise funds; Federal Bank (though not a new private bank) may well be in the queue.

It can’t be more of the same

The call before investors is straightforward. The window for getting a significant foothold in the country’s financial sector has so far been largely through private banks. With nearly 70 per cent of the sector being in the hands of state-run banks, the scope for play in this space is limited, given governance and related issues. In the case of private banks, significant investor interest in the past was driven by the fact that state-run banks’ growth trajectory had held flat and their incremental share of assets had headed southwards.

“Investors will look at specific banks, the quality of the book and governance; not bet on the sector as a whole. Price-to-book multiples of four-five will have to be scaled down; and I don’t see issues commanding the premiums you saw in the past,” says Romesh Sobti, MD and CEO, IndusInd Bank. IndusInd is well placed when it comes to capital; its buyout of the well-capitalised Bharat Financial Inclusion did not eat up capital. He adds that the choice is among three types of private banks – one with a growth story; one which largely has to provide for bad assets narrative, or a combination of both.

You also have the emerging regulatory topography to deal with. The Reserve Bank of India is to look closer into banks’ exposure to sensitive sectors which it defines as that to commodity, realty and capital markets; a new set of guidelines for bank subsidiaries is in the works. The central bank is to engage with bank auditors in a much closer manner, virtually making them an extension of its inspection department. 

“Select large private banks also saw significant private equity (PE) capital flowing in and attracted good premiums to the book value. Small private banks struggle as well; though, we have now seen the first controlled majority equity position offered in Catholic Syrian Bank to Prem Vatsa’s fund, Fairfax,” says Vivek Soni, partner, EY India. The central bank’s policy of diversified bank ownership is also a limiting factor for investments. Will the fact that a large number of non-bank finance companies (NBFCs) are in disarray make private banks a more attractive bet? “It depends on what kind of NBFCs we are talking about; you may see more of portfolio buyouts by banks and NBFCs from their distressed peers,” says a person, who wished to remain anonymous.

As for PE firms, their interest in local banks led to 15 deals in calendar 2017 and three in the first half of 2018, six deals in 2016 and four in 2015. The total investment between January 2015 and June 2018 was $2.9 billion (excluding deals for which the deal value was not disclosed) with $1.9 billion coming in 2017 which was when banks began to show signs of recovery, especially the private banks. Will PEs have the stomach for more of private bank stock, going ahead? 

Whichever way you look at it, tougher questions are set to be asked – the upcoming roadshows will tell you just how; and you have to say yes to that.