DCB Bank: Credit & Credibility

DCB Bank is a small player in the private banking sector that has shown a fair performance in recent times and potential for future growth. Vidrum Mehta tells you whether the bank is worth investing in.

Introduction

If you are bullish on a sector, it makes senses to not only invest in the best or the topmost of the companies but also to consider the smallest ones. This is because companies at the top provide stability, while the smallest ones have significant potential for growth.

We, at Dalal Street Investment Journal, were the first to call a bottom on the woes of the banking sector. We completely stand by that judgment of ours even now, and the superlative returns of more than 40 per cent provided by the BSE Bankex on a YTD basis confirms our belief. For those in doubt, we suggest you look at how the Sensex has performed over the same period – it has moved up by almost half (up 21 per cent on a YTD basis).

Within the banking sector, the private banking space is looking much better than the public sector banks. Let’s take a look at one such private sector banking company which we think is poised for big growth going forward – DCB Bank.

A small bank faces stiff competition from its peers and has to strive really hard to survive in the economic environment. Will DCB be able to emerge as a strong bank going ahead? Moreover, is the bank a good bet that can yield give multi-fold returns going forward? Here, we present a detailed analysis of various factors to help you take an appropriate decision.

About DCB Bank

In the wake of economic liberalization, DCB was converted from a co-operative bank to a scheduled commercial bank in 1995. It was started way back in 1930 by the Aga Khan Fund for Economic Development (AKFED) and Platinum Jubilee Investments.

The bank had tapped the market with an Initial Public Offering (IPO) in October 2006, which was subscribed around 35x. The price was fixed at Rs 26 per share, and on its first day, it surged by more than 80 per cent, closing at around Rs 47 per share. It is rather surprising that the bank received such a good response from investors, considering that in FY2006, it had reported a loss of around Rs. 85 crore. But those who have tracked the stock following the favourable response to the IPO will vouch for the fact that it was the last positive to have happened to it. Thereafter, the stock has actually gone nowhere. The listing price and the current market price are almost at the same level.

Key Points

• The management is focussing on the headwinds and is trying to put the bank back on the growth path, with good profits of Rs  21 and Rs  55 crore seen in FY11 and FY12 respectively.
• Mortgage loans and lending to the SME and MSME segments constitute around 30 and 27 per cent of the total loans respectively. Even in this volatile environment, the management does not see any major concerns in these two segments.
• The bank has seen some strength on the asset quality front with improved gross and net NPAs, and no significant exposure to risky areas like aviation, state electricity board (SEBs) and textiles. The Provision Coverage Ratio also is at sub-90 levels, which reduces the risk of the asset quality worsening.
• Its high Cost to Income ratio stood at 71.95 per cent as of September 2012, which indicates that the bank is not really operating efficiently. The branch expansion planned by the management would take this ratio to a still higher level, which would not be good for the bank.
• The stake of its promoters and promoter group is constantly decreasing, which would adversely impact the shareholders, reducing the EPS and infusing excess capital in the business.
• The management’s guidance of doubling the balance sheet in the next three years and bringing down the Cost to Income ratio now looks achievable, unlike earlier, when the bank was facing headwinds.

Most Indian banks usually declare high dividends, but DCB did not do so as it has incurred losses in the past. In six out of the past 10 years, the bank has posted significant losses. According to the management, it cannot declare dividends till it recovers from most of its losses. We believe that the bank would, in all probability, not declare dividends for at least the next couple of years.

However, if we look at its financial performance in the past two years, it seems that the management is focussing on the headwinds and is trying to put the bank back on the growth path. It has made an attempt to recover, posting good profits of Rs  21 and Rs  55 crore in FY11 and FY12 respectively.

So, is there any kind of a turnaround to be seen in DCB, and more so, do its prospects look promising from here on from a long term point of view? Here are some answers.

Business

Of the total deposits with the bank, around 84 per cent come from the retail segment while the remaining is the bank’s borrowings. Around 54 per cent of the total deposits are in the nature of term (fixed) deposits as the bank is offering an attractive interest rate. The CASA (Current and Savings Account) ratio stands at around 32 per cent. The bank has not deregulated its savings bank interest rate, as a majority of its deposits come from the retail segment and any hike in interest rates could have an adverse impact on its margins.

On the lending front, mortgage loans and lending to the SME and MSME segments constitute around 30 and 27 per cent of the total loans respectively. Corporate banking contributes around 23 per cent and agriculture (including the priority sector) contributes around 15 per cent. Even in this volatile environment, the management does not see any major concerns in their SME and MSME segments and has been focusing on them.

As at the end of FY2012, its total deposits stood at Rs 6335 crore against Rs 4787 crore in FY2010, registering a two-year CAGR of 15 per cent. On the other hand, its advances stood at Rs 5284 crore against Rs 3460 crore during the same period, registering a CAGR of 23.4 per cent. The RBI had slashed the repo rate in April 2012 and other banks have also started reducing their rates. However, DCB is holding on to its rates at present and would bring them down gradually going ahead.

On the asset quality front, the bank has seen some strength. It had faced serious headwinds a couple of yea Rs ago on account of its exposure to some big ticket accounts, which led to the deterioration of its asset quality. For FY2010, the gross and net NPAs of the bank stood at 8.7 and 3.1 per cent which, after improving over the years , stood at 4.4 and 0.57 per cent respectively as at the end of FY12. Further, it does not have significant exposure to risky areas like aviation, state electricity board (SEBs), textiles etc. The Provision Coverage Ratio (PCR) also is at sub- 90 levels, which is good and reduces the risk of the asset quality worsening further.

Current Financial Health

The bank recently came out with its September 2012 quarter numbers, which were pretty good. As on 30th September, 2012, its net NPAs stood at 0.68 per cent, down by seven basis points on a sequential quarterly basis. The management is very confident of keeping the net NPAs level below the one per cent mark.

The Net Interest Margin (NIM) for the bank was up six basis points to 3.24 per cent on a sequential basis after its cost of funds decreased by six basis points to 7.74 per cent. The yield on investments contracted marginally by two basis points to 12.69 per cent. The bank has not passed on the rates to the consumers, and there might be some pressure on its margins front going ahead. However, the management has guided that they would keep the NIM above the three per cent level.

In the March 2012 quarter, the bank had raised around Rs 193 crore, which helped its Capital Adequacy Ratio (CAR) move higher. As of September 2012, the CAR of the bank stood at 13.97 per cent, with its Tier 1 CARat around 12.71 per cent, which we believe is at a very good level.

One problem that we foresee with its financials is its high Cost to Income ratio. As of September 2012, this ratio stood at 71.95 per cent, which indicates that the bank is not really operating in an efficient manner. Currently, it has a network of 87 branches and 331 ATMs. DCB added a significant number of around 182 ATMs in FY12 alone, and it has now paused to see how the fee structure works out. The management expects the number of branches to go up to around 130 by the end of March 2015. We believe that this kind of branch expansion would further take the Cost to Income ratio to a still higher level, which would not be good for the bank.

Promoters Diluting Equity

One significant point worth noting about DCB is that the stake of the promoters  and promoter group is constantly decreasing, coming down from 31.29 per cent in FY07 to 19.2 per cent as of 30th September, 2012. The management said that this is as per the regulatory norms, and the bank would be required to bring it down to the levels of 10 per cent approximately till March 2014. This would adversely impact the shareholders, as the equity base would increase, thus reducing the EPS. Secondly, this would infuse excess capital in the business, which the bank does not require at present, thereby not allowing it to operate at an optimum level.

Another significant thing which could happen is that some big bank may acquire a stake in it. As of September 2012, South Indian Bank is a leading stakeholder in DCB (with around a 3.82 per cent stake).

Will DCB Bank Meet Its Guidance?

In FY2009, the bank had provided a guidance of doubling its balance sheet size in three years, bringing down its Cost to Income ratio to around 55 per cent in two years and also achieving a Return on Equity of more than 15 per cent. However, looking at the current financial numbers it seems that none of these targets were achieved.

Now, the management has announced its intention of doubling its balance sheet in the next three years and bringing down the Cost to Income ratio below 60 per cent by FY2015. We believe that unlike earlier, when the bank was facing headwinds, it now looks to be in a decent shape and thus, may be able to achieve these goals.

Conclusion

DCB is currently available at a Price to Earnings multiple of around 17x and a Price to Book Value of around 1.3x. Overall, we believe that the bank is showing some strength as compared to how it was faring in the past. However, being a small bank, it has to weather competition and also emerge from its internal issues that are affecting growth.

We believe that one could grab the stock at the current levels but should watch out for the management ability to achieve it’s spelled out targets. The bank still needs to post a strong performance going ahead to become an investor favorite.