DCB Bank: Ambitious, But Not Practical!

The Indian banking industry is witnessing a revolutionary change as the Reserve Bank of India (RBI) has approved around 23 banking licenses across various categories in the last one year. Out of these approved bank licenses, two banks started their operations in the recent past. The RBI also granted payment bank licenses to 11 entities in August while permitting 10 small finance banks to focus on small geographies for operations but with a strong capital base. The new banking entities will enter into the Indian banking industry very soon. These finance companies, which are mostly microfinance institutions (MFIs), will provide loans of above Rs 50 lakhs, which is exactly the lending space in which DCB Bank has a presence. As such, the entry of new banking players can pose a threat for banking operations of some small banks, including DCB Bank.

DCB Bank declared its Q2 FY16 results and the share price of the bank collapsed by 19.97 per cent in early trades and touched lower circuits on the stock exchanges. The share price of the bank tanked by more than 32 per cent during one week due to uncertainty over the branch base expansion plan. The bank had earlier announced that it would add 150-plus branches in a one year time period. Later, on October 16, 2015, the bank extended its time horizon of bank expansion to two years. The bank also stated in a press release that the management would work out the financial estimates for a revised branch rollout approach in the next two weeks.

The branch network expansion plan came at a time when the bank’s net profit was seen worsening for the last three quarters. Recent activities in the bank has led to further ambiguity and its growth strategy seems to be unfocused.

Formerly known as Development Credit Bank, DCB Bank is a modern, new-generation private sector bank with 160 branches across 17 states and two union territories. The bank has contemporary technology and infrastructure, including state-of-the-art internet banking for personal as well as business banking customers. The bank’s business segments are retail, micro-SMEs, SMEs, mid-corporate, micro-finance institutions (MFIs), agriculture, commodities, etc. DCB Bank has approximately 5 lakh customers since its inception in the 1930s. The bank’s promoter and promoter group, the Aga Khan Fund for Economic Development (AKFED) and Platinum Jubilee Investments, hold over 16 per cent stake. AKFED is active in 17 countries in the developing world. AKFED had co-promoted HDFC in India in the late 70s.

DCB Bank has a very diversified product portfolio as of September 2015.

DCB Bank is going to double its branch base to 300 branches in the coming two years even though its earlier plan was to grow 25 to 30 branches every year. The banking industry is entering a new phase, prompting DCB Bank to step up its expansion plan. Apart from a rapidly expanding branch network, the bank also plans to invest heavily in customer and frontline-facing technologies to enhance customer experience. The bank also plans to form key alliances in order to improve its product range and distribution. However, the expansion plans for the bank seem to be diverging from its performance over the last few years. When contacted, the bank’s management declined to reply about its expansion plans or provide clarity on other initiatives.

Taking into account the bank’s aggressive branch expansion plan, DCB Bank will need to hire 3,000-plus employees against actually having 1,800 on the ground. Despite this, the bank is going to establish new branches across Tier 2 to Tier 6 cities and though the employee cost will be lower as compared to Tier 1 cities, there will be considerable increase in the bank’s employee cost compared to growth in revenue in the near future.

According to the management, there will be a P&L hit of around Rs 9-15 crore in FY16, Rs 50-65 crore in FY17 and Rs 20-35 crore in FY18 due to additional costs involved in expansion. The cost-to-income ratio may rise by 5 to 11 per cent from its current level of 60.69 per cent and the return on equity may continue to be below 10 per cent even as operating expenses increase.

DCB Bank has NIM of 3.79 per cent as of Q2 FY16. The bank’s management has assured maintaining its minimum NIM of about 350 basis points despite the price war in all products and segments as well as priority sector lending and regressive branch expansion plan. However, its credit losses could be in the range of 50 to 60 basis points on an average for all products except corporate.
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Delayed Break-Even

DCB Bank believes that the initiatives to be taken are likely to have a negative impact on its near-term P&L. However, the bank expects the outcomes to be much better in 5-6 years. The pace of implementing 150+ branches may be adjusted based on their performance, experience, and market conditions. The break-even for new branches will be stretched over a longer period. According to the bank’s estimation, it will be 20-24 months. However, with the entry of new banking institutions, the competition in Tier 2 to Tier 6 cities too expected to intensify and the bank’s branch break-evens seem to be difficult in its estimated timeframe.

Impact of Base Rate Calculation Methodology

The RBI has proposed new methodology to calculate the base rate for lending to bring in uniformity among banks and for effective transmission of policy rates. The RBI has suggested considering marginal cost of funds to calculate individual lending rates, and has stated it would implement these proposals with effect from April 1, 2016. The components of base rate will include cost of funds, negative carry on CRR/SLR, unallocable overhead costs, and average return on net worth. The new methodology will undergo monetary transmission where the lending rates have to be sensitive to the policy rate. DCB Bank estimates that the base rate may be impacted by 50 to 75 basis points. The change in base rate will add more pressure to the bank in order to maintain minimum net interest margin (NIM).

Growing NPAs

The environment has not improved much in the last many months. It is taking a longer time to recover overdues from customers due to cash flow challenges faced by them. For the DCB Bank, both GNPAs (gross non-performing assets) and NNPAs (net non-performing assets) have increased steadily. The reason for increase in NPAs may be the seasoning of mortgages, MSMEs, SMEs and AIBs. Though DCB Bank has intensified its recovery efforts, legal cases are taking a long time to achieve closure. Even customers who are willing to sell their businesses and settle the bank’s dues are not finding buyers at appropriate valuations.

In the recent few years, two or three accounts have already started to show a lot of stress across DCB Bank’s corporate portfolio. Despite the bank’s assurance that the NPAs for mortgage, MSME, SME and AIB portfolios should remain within acceptable range, by and large the bank has failed to manage the risk of increasing NPAs.

Financials

As economic recovery is taking its own good time to revive, the financials of a few financial institutions are taking toll and showing weaker and weaker performance every quarter. DCB Bank is no exception. The third consecutive quarter reported continuous de-growth in the bank’s profit.  Though the bank reported a marginal increase of 2.39 per cent on a sequential basis in its total interest earned at Rs 416 crore in Q2 FY16, the bank’s total expenditure rose by 5.9 per cent on a sequential basis to Rs 121 crore in Q2 FY16.

On a negative note, the bank’s PAT decreased by 21.21 per cent to Rs 37 crore in Q2 FY16 on a quarterly basis as other income reduced by 22.85 per cent to Rs 49 crore during the quarter. The net interest margin of the bank stood at 3.79 per cent during Q2 FY16 as against 3.81 per cent in the previous quarter. The asset quality of DCB Bank declined and gross NPAs stood at 1.99 per cent to Rs 224 crore in Q2 FY16 as against 1.96 per cent to Rs 206 crore in Q1 FY16. Its net NPAs contracted by 6 basis points to 1.16 per cent, amounting to Rs 130 crore in Q2 FY16 on a quarterly basis.

Considering the segment results, DCB Bank’s treasury segment revenue reduced by 12.55 per cent to reach Rs 162 crore in Q2 FY16 on a quarter-on-quarter basis. The bank’s revenue from wholesale/corporate banking segment declined by 6.65 per cent to Rs 91 crore in Q2 FY16 on a quarterly basis. However, its revenue from the retail banking segment increased by 5.79 per cent to Rs 379 crore in Q2 FY16 on a quarterly basis. On a yearly basis too, DCB Bank’s PAT decreased by 10.12 per cent to Rs 36.93 crore in Q2 FY16 due to higher operating expenses and higher credit cost. Its provisions and contingencies increased by 57.6 per cent to Rs 21.67 crore in Q2 FY16 on a yearly basis.

Conclusion

DCB Bank has announced a aggressive expansion plan to counter competition from MFIs, which are expected to commence banking operations very soon. Further, the expected banking branch network will definitely increase the head count to almost double, escalating its personnel expenses. The expansion will put considerable pressure on its finances in days to come and is expected to delay the break-even of its new branches. Hence, the cost to income ratio for the bank is expected to considerably increase to more than 70 per cent for the next couple of years at least. This very fact will further pressurize the bank’s profitability in the coming days. Any further delay in branch break-even and worsening of asset quality due to seasoning of mortgages will lead to further slide in the bank’s stock price. Until the bank completes its branch expansion and attains break-even, the stock price of the bank would remain at the same level or is not expected to show considerable appreciation. Hence, we advise our readers to stay away from this banking stock.