DCB Bank Ltd - Stock Valuation and Financial Performance

DCB Bank | Market Cap: 3,550 Cr

CMP 114 | P/B 1x FY21

Results: DCB Bank reported year on year growth of 4% in its Net Interest Income*. CASA** stood at 23% (vs 22.4% in Q1FY21). 

Click here for 10 year X-ray of DCB Bank

Key highlights:

• Overall loan book was flat year on year as the bank has redirected entire focus on collection of existing loans.
• Net Interest Margin was flat and operating expenses declines 6% over previous year.
• Overall deposit growth declined 3% year on year. 
• Operating profit before provisioning grew 46% year on year from high other income and lower operating costs. The provisions stood at 0.6% of overall loan book. 
• Collection for CV is 80% vs 90% in past while for mortgages it is 90-94% versus 98% in past.
• Gross NPA has gone up to 3.7% from 2.2% in previous quarter.

Outlook: As per the management, 3-5% loans would need restructuring. However large majority of loans are secured by physical assets which may ensure less loan given default.

MoneyWorks4me Opinion: We had recommended buy on DCB Bank pre-covid as it was a conservative lender against physical collateral, had ability to earn higher margins and small base for faster growth.  

However, pandemic led slowdown has shifted bank’s focus away from growth and our hypothesis wouldn’t have played out in the medium term. In our previous note we had said, “We will wait for one more quarter to make a decision after seeing NPA and related resolution.”

We have recommended reducing exposure to financials as we find lot of banking stocks are no longer factoring NPA over next 3-4 quarters. Since DCB Bank stock rallied post Nov’20, we found risk reward unattractive to hold on. We recommended SELL.

Post result, we believe it is a right decision to SELL DCB Bank at current price even if it means selling it at a loss. Business circumstances changed for the bank and this would lead to downward revision in MRP of the company. We maintain SELL.

We remain positive on large private sector banks as they have balance sheet strength to absorb any asset quality shocks as well as ability to raise funds at reasonable prices.

DCB Bank | Market Cap: 3,550 Cr

CMP 114 | P/B 1x FY21

Recommendation | SELL

* Net Interest Income- Total interest earned by the bank on lent amount minus Total interest that it expended on its deposits.

**CASA- Current Account Saving Account is essentially the lowest cost funds that are available to the bank to lend. More the CASA, higher the amount of fund the bank can lend and earn interest on it.

We recommend to reduce exposure to banking and financials. There are valid concerns on growth and rise in NPA. At the time of purchase all financials were reporting good loan growth and growth in earnings so we didn't hesitate to add. After correction, they were trading too cheap and factored in most of the negatives. We didn't recommend to Sell.

But now after recent rise in prices, risk-reward is not favorable. We believe that large-cap private sector banks are well placed for long term growth, so these can be held for long term.

Small-sized NBFC & banks may face slowdown in growth during the period of high provisioning. We are recommending Sell on such stocks. We will be selling them at a loss of 10-35%. We recommend to free up cash and we shall recover these losses from other stocks over next few months.

DCB Bank | Market Cap: 2,400 Cr

CMP 77 | P/B 0.7x FY21

Recommendation | HOLD

Results: DCB Bank reported year on year growth of 7% in its Net Interest Income* and Total Income was flat year on year. CASA** stood at 22.4% (vs 21.9% in Q1FY21). 

For financial ratios, click here for 10 year X-ray

Key highlights:

• Overall loan book was flat year on year. Retail loans grew by 60.5% year on year and wholesale loan book was largely flat year on year.
• Overall deposit growth was flat year on year. 
• Operating profit before provisioning grew 21% year on year from lower operating costs. The provisions in relation to Covid-19 stood at 1% of overall loan book. 
• Bank focused on collection versus growth. Collection have improved to 90% in business and housing loans while 77% in commercial vehicles.

Outlook: As per the management, post the easing of lockdown, there has been a substantial increase in collections. The management expects 5% loans to be restructured. However large majority of loans are secured by physical assets.

MoneyWorks4me Opinion: We had recommended buy on DCB Bank as it catered to different segment versus large banks. We believe that DCB Bank’s conservative lending against physical collateral, ability to earn higher margins and small base for faster growth can help us earn good returns. However, pandemic led slowdown has shifted bank’s focus away from growth and our hypothesis will not play out in the medium term. Since the stock trades at very cheap valuation, we are evaluating whether all the negatives are priced in. We will wait for one more quarter to make a decision after seeing NPA and related resolution. 

In past, DCB bank has resolved NPA faster than peers as loans were granular, backed by collateral or loans were sold to other banks as DCB’s has less ability of collection versus peers. We will know more about it in next quarter as NPA will start accruing from next quarter.

* Net Interest Income- Total interest earned by the bank on lent amount minus Total interest that it expended on its deposits.

**CASA- Current Account Saving Account is essentially the lowest cost funds that are available to the bank to lend. More the CASA, higher the amount of fund the bank can lend and earn interest on it.

^LCR- Liquidity Coverage Ratio is bank's high-quality liquid assets by its total net cash flows

Results: DCB Bank reported year on year growth of 8% in its Net Interest Income* and 30% delince in net profit. 

• Overall GNPA increased as the management took upfront NPA classification for certain loan type. 
• Loan mix broadly remained unchanged during the quarter, with mortgage continuing to contribute highest share at 42% to total loan portfolio.
• Within mortgage, average ticket size for home loans is Rs 17 Lakhs while that for business loans is Rs 20 Lakhs with 87% is self-occupied property.
• Loan to value ratio is around 40-50%, making is less dependent on real estate prices. 
• Half of the loan book is outside Metro and large cities. ~60% of the loan book is under moratorium as the bank gave moratorium option to all but opt out facility. Other banks gave opt in facility. 

Outlook: DCB Bank made provisions worth Rs. 63 Cr out of which Rs. 9 Cr was as per regulatory requirement and balance towards contingency buffer considering the Covid-19 issue. As per the management, the near term aim is to preserve capital, manage portfolio stress, reduce costs and maintain adequate liquidity. While asset quality held up well until now, its high exposure to self-employed segment possess risk of higher slippages going forward.

We had recommended DCB Bank as it had very unique loan portfolio with secured, granular loans and different segment versus larger private sector banks. However, the lockdown and related business impact has led to sharp correction in stock price. We believe that the bank is well equipped to handle the stress, and make provisioning and recovery. At current price, it already factors more than 5% NPA, if we do not see such a level of NPA, the stock would bounce back. We will add to our position once we are certain that the bank’s valuation hasn’t materially changed after adjusting for NPAs in next 2-3 quarters.

* Net Interest Income- Total interest earned by the bank on lent amount minus Total interest that it expended on its deposits.

Steep cut in stock price

DCB Bank’s stock has fallen >50% since our call. While it has fallen alongwith other financials, the fall is steeper as it is a small cap stock.

DCB Bank is into Mortgages, agri and SME/MSME loans. Break up of the loans are as below: 

We find DCB Bank attractive for conservative process to lend into pockets where they face less competition from large banks. Since some of the top banks had run up in price (eg. ICICI Bank) we thought of adding to financial exposure through DCB Bank as it offers faster growth potential due to small size.

Strengths of DCB Bank

Firstly, DCB Bank gives out only secured loans, meaning they are backed by collateral. These loans are serviced by the business income. The bank has low to nil exposure to unsecured loans like Personal Loans or credit card or Microfinance, more vulnerable sectors. This gives us comfort that the NPAs won’t eat into networth. The bank will be able to make provision and sail through.

Secondly, DCB Bank has relatively more exposure in non-metro areas i.e. less exposure in Red Zones. With slow opening up of economy, many of its clients will be back in business and take advantage of moratorium till they stand on their feet. This will lead to lower stress for DCB. Granular nature of loans and self-occupied property as mortgage makes these loans relatively less risky. In our note we had written, “No loan exceeds 3 Crore. Median ticket size is around 35-40 Lakhs. Over the years, the bank has created niche in meeting credit requirement of self-employed people through mortgage in Tier 2 to Tier 6 locations with tremendous efforts on enhancing the products, improving processes and controlling portfolio quality.”

We find that currently the expectation of rising NPAs had led to many banking stocks to come down. The fall in stock prices indicate a lot of pain as these are leveraged businesses. Small dent in loan book can cause rapid erosion of equity value. However, it depends on how prudent a bank has been to take such hits from time to time. Secured nature of loans, lending only to viable business models and diversified portfolio reduce some of these risks. We believe DCB Bank has all these qualities.

DCB Bank had worries pertaining to liquidity but since it has secured portfolio, it can sell its portfolio to large banks to generate liquidity. Its Fixed Deposit base has been stable after Yes Bank fiasco as highlighted by the management in their recent concall.

About DCB Bank

DCB Bank (erstwhile Development Credit Bank) started in 1995; is one of the emerging private sector banks in India, predominantly based in Maharashtra and Gujarat.

DCB has deep roots in India since its inception in the 1930s. Earlier it was called Development Credit Bank which was formed after merging a group of co-operative banks. In 1995, it got scheduled bank license from RBI. The bank network is now spread across Andhra Pradesh, Karnataka, New Delhi, Goa, Tamil Nadu, Haryana, West Bengal, Rajasthan, Union Territories of Daman and Diu and Dadra and Nagar Haveli.

Its promoter is the Aga Khan Fund for Economic Development (AKFED) which holds over 14% stake. AKFED had also co-promoted HDFC in India in the late seventies. AKFED operates as a network of affiliates comprising 90 separate project companies

In 2010, the new management set out a strategy to focus on niche segments and get NPA under control. Over time, DCB bank has created mortgage financing (currently accounts for 41% of total advances) with emphasis on small ticket loans (ticket size below Rs. 3 Cr) to self-employed in Tier II-VI cities. It has one of the best diversified loan portfolios with greater reliance on secured lending. It offers comprehensive range of products and services, contemporary technology and infrastructure including state of the art internet and mobile banking.

As of December 2018, DCB Bank had 334 branches and 501 ATMs. The branches are almost equal between metro, urban and rural areas. Other than that the network of the bank is spread at 35000+ points via direct selling agents.

Which segments does the bank operate in?

Over past seven years, the management team led by Mr. Murali Natrajan (Ex-Standard Chartered, Ex-CitiBank), steered the bank during challenging environment and reinvented business model with greater emphasis on Retail Banking i.e. on asset side focused on secure lending via products like Loan Against Property (LAP) (primarily for self-owned businesses), Gold loan, CV, Home loan etc. and on liability side greater reliance on Retail deposit (~81%). DCB Bank had inherited concentrated loan and deposit portfolio but now it has just 6% loans to top 20 borrowers and less than 12% of deposits from Top 20 depositors. It has completely revamped old business processes/technology and made it more customer and employee friendly to improve productivity and turnaround time which is critical in retail banking.

To pursue this mission, DCB has expanded its branches from 130 in FY14 to 331 at present. Due to lower ticket size of loans, the bank has to hire more employees per branch taking its cost higher. This led to drop in ROE from 14% in FY14 to mere 12% in FY19.

Who does it lend to?

From FY14 to FY19, DCB Bank has grown its loan book at 23% CAGR and currently stands at ~ 25,000 Cr. In the same period, Profit before tax went up by 27% CAGR.

As evident from the above chart, mortgage is the leading product of the bank. Mortgage loan book consists of Loans against Property (forming 70-75%) and Home loans (forming 30-25%). No loan exceeds 3 Crore. Median ticket size is around 35-40 Lakhs. Over the years, the bank has created niche in meeting credit requirement of self-employed people through mortgage in Tier 2 to Tier 6 locations with tremendous efforts on enhancing the products, improving processes and controlling portfolio quality.

DCB bank has tough competition from large banks in salaried and corporate segment. Due to this, it has limited product portfolio versus others. It doesn’t have Credit Card, Personal loans, etc. However, it has managed to find its feet in Agri and Mortgage loans. It also sells Agri loans to other banks to help them fulfil their Priority Sector lending thereby making fee income.

How does it source funds?

On the liabilities side, the bank is aiming to attract granular deposits from retail segment to reduce concentration of large value and NRI deposits. This would help the bank gain new customers in exchange of high interest outgo. Later DCB aims to cross-sell them other products or savings bank account shoring up its CASA. As on today, DCB’s CASA stands at just 23%. Its cost of funds is higher than average bank but at the same time, it has granular risky exposure helps it earn better yield. Despite this, its net interest margin is 3.7%.

Do all loans get repaid?

Asset quality has showed steady improvement post restructuring of balance sheet in FY10.

Gross NPAs have inched up lately due to weak economic environment. Hence, DCB bank has decided i) to trim corporate exposure, ii) reduced average ticket size in SME/MSME loan to achieve granularity, iii) focus on secured products with liquid collateral and iv) lowered Loan to Value for loans.

DCB’s recovery mechanism is relatively weak versus larger peers due to small scale, hence it transfers the bad loans to reconstruction company.

DCB has also shown good track record in recovery/upgrade of loans which has helped it reduce provisioning requirement. For example: In Q3FY20, it recovered/upgraded 130 Cr loans versus 200 Cr slippage. Likewise in previous quarter, it had 160 Cr in slippage but recovery/upgrade of 80 Cr. This gives us confidence that NPAs won’t be eating into profitability much.

What are the Risks?

• Exposure to high risk loan against portfolio, better loan to value and granularity of portfolio makes us less worried.
• High cost to income ratio (C/I) as it hires more employees versus average bank but increase in loan book may bring down C/I ratio.
• Being a small sized bank, DCB may find it tough to raise equity in bad times for provisioning/growth.
• Higher vulnerability versus larger bank due to economic slowdown as small businessmen get more affected in slow economy.

Is it a good price to buy?

Since DCB Bank has expanded its branch network recently, its ROA & ROE are subdued. As branches mature, ROE will come back to reasonable level over next 2 years. In recent quarters, despite lower profit margin, ROAs are maintained at 1%. The management is expecting to double its loan book by FY23-24. This growth would lead to favourable operating leverage and enhance return ratios.

With above industry growth rate in past 5 years including recent quarter (Q3FY20 DCB 11% vs Industry 7%), we expect DCB to clock loan book growth of 15-18% CAGR from FY20-FY24. We also expect ROE to improve to 14% by FY23-24. This makes us believe that DCB can be a good compounder over next 2-3 years.

DCB Bank trades at a very favourable valuation of P/E of 13x FY21 and P/B of 1.5x FY21.

Since this is a very small bank with market capitalization of just 5,300 Cr and loan book of mere 25,000 Cr, we recommend only aggressive investors (or only risk portion of portfolio for others) to invest in DCB Bank.

Note: Those who hold LIC Housing Finance can consider DCB Bank in place of LIC HF and reduce LIC HF as you get better selling price.