Bandhan Bank's Initial Pricey Offer

India’s leading microfinance lender, in terms of size of loan portfolio, Bandhan Bank, is set to go public today. Bandhan Bank has the distinction of being the sole microfinance institution (MFI), which was granted a banking licence by RBI (June 2015), given its stellar track record on financial inclusion and robust operating metrics.

The price band for the share lies between Rs.370-375. The IPO is a combination of a fresh issue worth Rs.3,662 crore and an offer for sale of Rs.811 crore by existing investors — World Bank members, International Finance Corporation (IFC) and IFC FIG Investment Company holding 3.21% and 1.73% respectively. Post the IPO, the stake of the promoter in the firm will reduce from 89.6% to 82.3%.

The firm has consistently delivered high operating performance that manifested in a high CASA ratio at 33%, a NIM of 9.86% and a low NNPA ratio at 0.8% for nine months that ended in December 2017. But from a valuation perspective, the firm which will be valued at 5.1x P/BV, post the IPO, looks expensive compared to its peers. While the bank has no immediate peers given its unique asset base, a comparison with the already entrenched retail-focused banks and some of its MFI peers reveal that the bank is being offered at a significant premium in comparison to its peers. The estimated P/Adj.BV for FY18 for Ratnakar Bank stands at 4.6x, Satin Creditcare at 2.6x, Bharat Financial Inclusion at 2.8x, Kotak Mahindra Bank at 4x, HDFC Bank 4.7x and IndusInd Bank at 4.6x.

The valuation raises questions especially since the firm’s return on equity (ROE), which has been at 28% for the past 18 months, is likely to come down to about 18-19% post the IPO, according to Ravi Singh, vice-president (research), Ambit Capital. “Despite a tier-I ratio of 24.9% already at end H1FY18, against the Basel III mandated 9%, the bank is considering raising estimated fresh capital of Rs.3,662 crore (72% of the net worth). The rationale for raising such a large amount of fresh capital is unclear. Our calculations suggest that the loan book will need to grow at 60-70% CAGR over the next three years to fully utilise the capital raised. This appears unlikely and the ROE may moderate to 18-19%, post the IPO. The lower ROE is one change in expectation that investors will have to adjust to.”

Singh further adds that both geographically concentrated microfinance lenders (Satin) and diversified lenders (Bharat Financials and Janalakshmi) have seen dilution in their ROEs as lenders tend to incur larger losses on expanded balance sheets after a period of rapid growth. Another risk looming large over the firm is the high degree of product and geographical concentration. MFI currently constitutes 87% of the loan book. According to Kajal Gandhi, vice president (research), ICICI Securities, “As they expand more into their new businesses such as SME and retail lending, their return ratios, which are currently among the best in the industry, RoA at 4.07%, might come under some pressure, as margins are relatively lower on these products." With the firm venturing more aggressively into full-fledged banking, its net interest income (NIIs) may come down as well. Right now the new businesses form 13% of the total loan book.

Also, increasing expansion costs, in terms of higher training and recruitment costs, will impact the firm’s capacity to maintain the current cost to income ratio. The firm’s cost to income ratio at 36.3% is among the lowest in comparison to its peers, largely attributable to its lowest employee costs.

A significant portion of its deposits and advances are in east and Northeast India, and in particular the states of West Bengal, Bihar and Assam. As on December 2017, around 81% of loans, 69% of doorstep service centres and 65% of branches are from these regions. According to their draft red herring prospectus (DRHP), due to such concentration, the success and profitability of the overall operations may be disproportionately exposed to increased competition as more players enter these geographies, and there may be other regional developments including political unrest.

Given that the geographical concentration is in a region where levels of income and industrialisation are lower, the ability to scale up across other businesses such as SME lending or even retail lending (like mortgages, vehicle loans) will be a challenge. In order to deliver on its growth expectations, the bank has to look beyond microfinance and expansion into other geographies. Singh perceives, “Given very high concentration, both product and geography wise, one cannot comfortably say that it will continue to grow at a high pace. It is more likely to be disproportionately impacted in case of any external shocks in its core geography/product. The visibility on long-term growth outlook is limited. The reported valuations for the IPO are relatively expensive, justifiable only when high growth can continue for a long time.”