Question

Using a particular industry as a focus, find an industry report that covers several ventures having various levels of maturity and/or performance. Compare their performances in recent years. Develop a model of how you would conduct a multiple-scenario valuation for a newcomer in that industry. What type of discount rate would be appropriate for your approach?

Answer 1

Industry - Banking

TheIndian banking system consists of 20 public sector banks, 22 private sector banks, 44 foreign banks, 44 regional rural banks, 1,542 urban cooperative banks and 94,384 rural cooperative banks in addition to cooperative credit institutions.

Comparison of top 5 Indian private banks :

1.Net NPA

The trend of Net NPAs of these banks is almost similar to that of Gross NPAs. Net NPA numbers are calculated by deducting provisioning towards the bad loans from Gross NPA.

On account of the increased provisioning towards the bad loans, the Net NPA numbers of all the banks have declined QoQ as well as YoY. It is a very positive sign. As a result of which the bank’s asset quality is improving consistently.

Among all major private banks, HDFC Bank is having the least Net NPA numbers at 0.36% in Q4 FY20. It indicates the thorough risk assessment of the wholesale book performed by the bank internally which has served well the bank over the years.

While, the Net NPA of Kotak Mahindra Bank is comparatively higher than that of HDFC Bank due to lower provisioning made against bad loans. Bank’s Net NPA is at 0.71% in Q4 FY20, which indicates Asset quality is improved QoQ (0.89%) as well as YoY (0.75%).

On the other hand, in case of Corporate Banks, like ICICI Bank and Axis Bank, Net NPA % are in much higher range like Gross NPA trend.

in Q4 FY20, the Net NPA of both ICICI Bank and Axis Bank has declined considerably QoQ as well as YoY on account of declining Gross NPAs and rising support from provisions made against bad loans. In Q4 FY20, the decline is more significant for Axis Bank than ICICI bank.

2. Provision Coverage Ratio (PCR)

Provision Coverage Ratio Comparison of Major Private Banks

Provision Coverage Ratio Comparison of Major Private Banks (Q4 FY20)

The Provision Coverage Ratio (PCR) is the ratio of provisioning to gross non-performing assets.

The provision coverage ratio gives an indication of the provision made against bad loans from the profit generated. It indicates the extent of funds a bank has kept aside to cover loan losses.

Higher the PCR, lower is the unexposed part of the bad debts. A higher ratio means the bank can withstand future losses better, including unexpected losses beyond the loan loss provision.

HDFC bank, Kotak Mahindra bank, Axis bank has shown a decent growth QoQ as well as YoY in their Provision coverage ratio in Q4 FY20. It is a positive sign.

In case of ICICI Bank, though the provision coverage ratio % is higher than the rest 3 bank, its QoQ growth is flat. It may add more concerns towards its Corporate loan book amid current COVID-related slowdown.

3. COVID-Related Provisions

Comparative Analysis - Loans under Moratorium % by Value

COVID-Related Provisions of Major Private Banks (Q4 FY20)

Comparison of COVID Provisions as a % of Operating Profit of Major Private Banks

Comparison of COVID Provisions as a % of Operating Profit of Major Private Banks (Q4 FY20)

For Q4 FY20 performance analysis of these major private banks, the parameter – COVID-Related provisions has played a significant role in the overall profitability of the banks.

On March 27, 2020, RBI has announced a 3-months Loan Moratorium up to May 31, 2020. And this Moratorium period is further extended 3 months up to August 31, 2020 in RBI’s recent press conference on May 20.

Thus, all the banks made COVID-Related provisions, in addition to the RBI mandated provisions, based on their assessment of the potential impact of COVID-19. However, the relative quantum these COVID provisions made by different banks varied vastly.

The amount of COVID-Related provisioning made by the banks from their Pre-provisioning Operating Profits (PPOP)

In spite of having the highest Operating Profit of Rs.12,959 Cr amongst major private banks, HDFC bank has made relatively lower COVID provisions. This is mainly due to its Retail Loan Book.

COVID Provisions as a % of Operating Profit

If we refer the second graph, we get a clear idea of the COVID provisions made by these banks as a % their respective operating profits.

Thus, HDFC Bank is having the lowest COVID provision % of its operating profit (12%) due to lower COVID provisions on account of its Retail loan book (in Rs. Cr) and higher Operating profit.

Whereas, Axis Bank has the highest COVID Provisions as a % of its Operating profit. It is mainly on account of its Corporate Loan book, due to which bank has made COVID-related provisions almost 51% of its Operating profit.

The COVID Provisions as a % of Operating Profit for Kotak Mahindra Bank and ICICI Bank are 24% and 37% respectively.

4. Loans under Moratorium % by Value

Comparative Analysis - Loans under Moratorium % by Value

Comparative Analysis – Loans under Moratorium % by Value of Major Private Banks

The Loans under Moratorium % by value of these banks are shown in above table.

HDFC Bank

Moratorium usage in standard retail assets has been surprisingly low in single-digits.

Kotak Mahindra Bank

Moratorium in the retail segment is much higher (in value terms) than wholesale segment.

ICICI Bank

Retail segments saw a higher proportion of customers availing of the moratorium.

A higher proportion of Rural, Commercial Vehicle and 2-wheeler customers opted for the moratorium.

Axis Bank

In case of retail customers, individuals across income bands and geographies having sufficient a/c balances (equivalent to 2-3 times EMI) opted for the moratorium to maintain sufficient liquidity amidst uncertainty.

Bank has granted moratoriums to wholesale customers on a case by case basis.

For Wholesale and SME customers : Moratorium was on an opt-in basis and

For Retail customers : Moratorium was on opt-out basis

For any newcomer entering Indian banking sector would be very challenging especially because of tedious regulatory concerns and the competitiveness. If a bank is innovative and efficient in every possible way and adapts to technological changes going around , it can give a run for the money to the top private banks and value more in coming years

The discount rate approach I would suggest would be APV (Adjusted Present Value) as APV analysis tends to be preferred in highly leveraged transactions; unlike a straightforward NPV valuation.