Southern discomfort

It is banker to over 2,000 religious institutions across Kerala, including the Guruvayoor temple, all the temples under the Travancore Devaswom Board and Kottayam’s Juma Masjid. Male volunteers from branches across the country head to Sabarimala every year to manage the temple’s collections from devotees during the pilgrimage season — they count millions of coins, sort them according to denomination and even organise tractors to cart sacks of change to branches across the state. “We are god’s own bank in god’s own country,” says PG Jayakumar, the new managing director and CEO of Dhanlaxmi Bank. “We have the Lord’s blessings.”

Those blessings are desperately needed right now. The past year has been one of turmoil and trouble for the 85-year-old Thrissur-headquartered bank, culminating in the unceremonious exit of MD and CEO Amitabh Chaturvedi in February this year. The unrest in the labour unions, which had voiced their displeasure with Chaturvedi’s strategies and alleged accounting irregularities, as well as Chaturvedi’s own differences with the board over the high-cost growth model, are not only showing up in the bank’s P&L, they’ve also impacted the stock. 

Analysts believe Dhanlaxmi’s ₹36.87 crore loss in the December quarter of FY12 is the first of what is likely to be several quarters of loss for the bank and that it will close FY12 in the red. Meanwhile, over the past year, not only have credit rating agencies Fitch and Icra downgraded the bank, the stock has also underperformed the Sensex, falling 42% compared with a 9.74% fall in the benchmark; in the same period, its peers Federal Bank and South Indian Bank have seen a 7% and 15% rise in stock prices. All of which is fuelling speculation that Dhanlaxmi is ripe for takeover. However, the bank management denies rumours of a sell-out. “There is no question of a takeover or merger,” says Jayakumar. But Dhanlaxmi needs capital and if it fails to raise it, it will have to explore other options. 

The Chaturvedi effect

Rumours of a takeover at Dhanlaxmi aren’t new. They were last heard in October 2008 when Chaturvedi, who had left Reliance Capital, took charge of the southern bank. Speculation was rife at the time: was the Anil Ambani confidante ‘on deputation’ to set the bank up as a suitable target for acquisition as and when the Reliance Group got its banking licence? After all, Ambani’s ambitions in the financial space were well documented and Chaturvedi’s move didn’t seem to fit into his career plan — he had been with large corporates like ICICI Bank and Reliance Capital until the move to Dhanlaxmi. 

Chaturvedi, though, dismissed the rumours and embarked on an aggressive expansion plan, winning over the bank’s four unions by hiking salaries and promising jobs to employees’ children. The transformation of a regional bank to one with a pan-India presence started swiftly: from 66 branches in March 2008, Dhanlaxmi grew to 275 in three years (see: Expansion overdrive). In the past three years, the bank has also increased its headcount by 3,000 (see: Growth pangs). 

There was nothing wrong with the strategy and even the sharp spike in operating expenses was understandable. In a media interaction in September 2010, Chaturvedi was blasé. “I don’t think we should be worried about profitability,” he said. “Last year was the investment phase…This year is my optimisation period.”

Trouble is, income didn’t keep pace with this scorching expansion. Against a 328% increase in staff costs between FY08 and FY11, income rose only 197%. The result: the cost-to-income ratio became uncomfortably high, climbing from 68.4% to 83.6% over the same period. “The bank could have rationalised high costs by higher growth but now it seems like the biggest growth in business is not enough to compensate for these costs,” says Prakash Agarwal, an analyst with Fitch.

Other growth parameters, too, suffered. Between March 2009 and September 2011, Dhanlaxmi’s return on assets fell to 0.23% from 1.21%, while the capital adequacy ratio dropped to 10.81% from 14.44% between March 2009 and March 2011. The CASA ratio (deposits in current and savings accounts as a percentage of total deposits) declined to 20.3% in Q3FY12 from 29.2% in FY08. A report by Quantum Securities says this is because a majority of the bank’s growth in advances was funded by high-cost certificates of deposit/ bulk deposits (which constituted 43.7% of total deposits in Q3FY12). 

The depressed ratios were only half the story. In October last year, the Dhanlaxmi Bank Officers Organisation alleged that the bank was ‘window-dressing’ its balance sheet to show inflated profits. The charges were that the bank had booked income upfront that was to be booked over a period of time and had staggered expenses that should have been shown upfront. Protests from the unions followed, prompting the Reserve Bank of India to examine the banks’ books in November 2011. It then issued a 15-point ‘monitorable action plan’ to the bank, asking it to, among other things, improve its cost-income ratio to 70% by March 2012.  

Desperate measures

That’s exactly what Jayakumar, a 30-year veteran of the bank who was previously executive director, is now attempting. The Quantum report says Dhanlaxmi is seeking a cut of ₹60-65 crore in its operating expenses in FY13, of which a saving of ₹50-55 crore is expected to come from salary cuts and “the rest from savings in ATM-related and other administrative costs”. Other reports talk of retrenching 1,000-1,500 employees, wage cuts of 5-40% and closing 50 ATMs. 

Jayakumar declined to share details of the restructuring, citing an upcoming board meeting, but confirmed that as a first step the bank will reduce operating costs through wage cuts. “Our wage costs have increased phenomenally. There is scope for reduction in it,” he says, adding that no branches would be closed. “We will absorb all the good changes that have happened, like expansion in branches, centralised customer operations, KYC and customer service.”

Capital raising and improving the CASA ratio will also be priority. While Jayakumar estimates that increasing the focus on branches should take care of the deposits ratio, there’s a plan currently to raise capital in Q1 or Q2 of FY13. Analysts are sceptical whether the bank will succeed in doing that. “It will be difficult for the bank to raise capital until it comes back to profit and improves its operating parameters substantially,” says Rati Pandit, an analyst with Quantum Securities, in her report.

Will Dhanlaxmi succeed in making itself over? That depends as much on the bank’s ability to manage costs as on its ability to leverage the capabilities it has built. What is still not visible, and probably vital to the bank’s health in the future, is the quality of its loan book. For now, its credit risk does not look bad. The loan book is around ₹9,500 crore, in which the maximum ticket size is around ₹50-60 crore. “The bank does not have any concentration risk, because the loan book is diversified and it does not have exposure to high risk industries such as aviation or power,” says Sri Karthik Velamakanni, an analyst with Espirito Santo. But the real risks may not have shown up yet. “We are concerned about the high loan growth of Dhanlaxmi Bank, which has resulted in the majority of its loans, comprising unseasoned loans, resulting in elevated credit risk,” says Fitch’s Agarwal. 

Notwithstanding its current woes, what makes Dhanlaxmi Bank an attractive stock to buy is that it is a potential candidate for acquisition. “Anybody could be a buyer, from Kotak and Yes Bank to IDFC. For instance, Kotak does not have much presence in South India and Dhanlaxmi’s 275 branches would help in its expansion. But there is a higher possibility of a non-banking entity taking over,” says Darpin Shah, deputy head of research at Almondz Global Securities. 

Analyst opinion is divided over the stock. Quantum has a ‘buy’ call with a target price of ₹82. But ICICI Securities suspended coverage on the bank in February, citing that a revival in the bank’s prospects will take time. Velamakanni thinks given its negative return on equity, a price of ₹70 — implying a price/ book of 0.85 times — is fair value. He has a higher target of ₹90 if the bank can raise capital. This compares with South Indian Bank, which trades at a price to book of 1.3 times with 22% return on equity or Federal Bank that trades at 1.1 times price to book with 14% return on equity.

If a takeover does not materialise soon, the stock could stagnate or even correct some more from the current price of ₹65. Jayakumar admits that a full revival will take time. “It will take us two or three years to see return on our investment,” he says. Investors buying the stock now should be prepared for the long wait ahead.