Five attractive small private banks

City Union, Federal, RBL, DCB and Karur Vysya have been able to grow consistently

Exceeding Street expectations after demonetisation, five small private banks have again become market favourites.

While these stocks tend to react to any news on consolidation in the sector (they’re viewed as acquisition targets), investors should consider them for the strong franchise built over years. In a sector where even large banks struggle to maintain the net interest margin (NIMs) at over three per cent, ensuring this has not proved difficult for these lenders. Here are the five names, which investors could sample in their portfolios.

City Union Bank

This is among the oldest private sector banks, with a strong grip on market dynamics in the south, particularly Tamil Nadu. This is why despite over half of its loans being to small and medium enterprises (SMEs), it has handled asset quality issues better than others while lending to similar customers. A 63 per cent bias to working capital loans has helped it weather several downturns.

Its deposits are retail-oriented (meaning, small depositors), with high maturity terms. The two factors have helped the bank manage its NIMs comfortably at over three per cent. While some short-term pressure on NIMs is not ruled out, as deposits are locked at earlier high rates, retail deposits also lend stability. Some of the margin pressure will also ease due to a decline in cost of deposits from other sources. Analysts at Elara Capital recently upgraded City Union from a rating of ‘sell’ to ‘accumulate’. They feel the bank is well poised to generate a return on equity of over 16 per cent over FY18-19.

DCB Bank

Over a year earlier, when it declared an ambitious expansion target, this didn’t go well with the Street. The pessimism is fading, after seeing DCB consistently add branches. The bank is largely focused on commercial lending, with 44 per cent of its book from mortgage loans. Its underwriting skills have helped the bank stay ahead of peers in this segment. A low delinquency rate (1.9 per cent) and net non-performing assets ratio (1.1 per cent) are noteworthy.

Analysts at HDFC Securities recommend a ‘buy’ on DCB for its healthy business growth, diversified loan book, tight leash on asset quality and conservative management. With the stock near its target price, investors may want to buy on correction.

Illustration: Ajay Mohanty

Federal Bank

A diverse loan book is an advantage. With a fair share of lending to corporate and retail (individual) accounts, loan growth has not been a problem in recent times. Even in the December quarter (hit by demonetisation), the loan book grew 32 per cent. Its SME and corporate loan book remain stable and the management doesn’t expect any stress in these portfolios in the near term.

The strong asset quality makes Federal attractive, while good loan growth should enable fast growth in earnings. Analysts at Prabhudas Lilladher expect earnings per share to increase by 28-35 per cent in FY18-19.

Karur Vysya Bank

With strong presence in semi-urban and rural regions, where cash assumes importance, its financials took a knock in the December quarter. Despite 15 per cent net interest income growth, a steep fall in non-interest income due to flat loan growth dented its net profits in that quarter. Despite this, analysts remain confident on KVB, primarily for its abilities to sustain NIM at over 3.5 per cent. With a large part of asset quality issues factored in, investors are unlikely to see surprises on this front. For this reason, the stock trades at 1.8 times the FY18 price-to-book ratio, lower as compared to peers.

Analysts at Antique Stock Broking recommend a ‘buy’ on KVB for its focus on expanding the retail (individual depositors and borrowers) business, decision to stay away from large consortium loans and attractive risk-reward.

RBL Bank

Despite 62 per cent of its loan book contributed by commercial loans, RBL’s ability to keep a lid on its asset quality is the scoring factor, thanks to its focus on working capital loans. This helped improve its NIM to 3.4 per cent in the December quarter. Expansion on the retail loan book is underway and the bank is strengthening its branch network.

Therefore, as RBL is in a penetration phase, analysts believe the loan growth could be strong at 30-35 per cent annually in the two to three years. Those at Motilal Oswal Securities believe RBL could generate a 1.3 per cent return on assets by FY19 which would best in the sector. While all these should help sustain the stock’s higher valuation, investors could look at buying on dips.