For City Union Bank Ltd., the end of financial year 2023 was little to write home about.
The bank primarily caters to small companies and the agricultural sector. Its presence is concentrated in Tamil Nadu and with a loan book of Rs 43,791 crore, City Union Bank is among India’s smaller, and older, private banks. But its performance is lagging that of its peers.
City Union Bank’s net interest margin or NIM—the gap between interest income earned and interest paid by a bank, relative to its assets—in the final quarter of FY23 stood at 3.65%. Others lenders such as Tamilnad Mercantile Bank Ltd., Karur Vyasa Bank Ltd., and RBL Bank Ltd. reported NIMs of 4.7%, 4.46%, and 5.1%, respectively.
“Overall, the result has been satisfying and yes, there are few disappointments in terms of the growth,” N Kamakodi, managing director and chief executive officer of City Union Bank, told BQ Prime. The bank’s annual performance is strong and it’s hopeful about covering ground in FY24, he said.
But analysts monitoring the company aren’t quite as bullish.
Macquarie Research on June 1, for instance, reduced City Union Bank’s stock price target from Rs 175 to Rs 140, a 20% cut, and downgraded the bank’s rating from ‘buy’ to ‘neutral’.
ICICI Securities, Axis Securities, and Prabhudas Lilladher, too, lowered their target price estimates on the lender after the Q4 FY23 results.
The bank's stock has tumbled 30.3% so far this year compared to a nearly 1.9% rise in the benchmark Nifty 50. Shares of the private lender closed at Rs 123.50 apiece on Friday.
City Union Bank’s performance in the third quarter of FY23 also marred by a divergence of Rs 259 crore in the bank’s reported gross non-performing assets for FY22, following an inspection by the Reserve Bank of India. Such divergences occur when the bank’s reported bad loans are smaller than the actual size of bad loans, according to the RBI’s assessment.
The divergence was reported in December and the disclosure also led to a 9% single-day drop in the bank's stock price.
“The interpretation of the restructured loans, which were done during the Covid period, was the main issue where the divergences basically came,” Kamakodi said. The bank has since taken steps to ensure that such elements are properly in alignment with the expectations of the regulator, he said.
“There are a few learnings which we have to take particularly in the risk measurement and in the digital environment under which we are in the process of upgrading our systems,” Kamakodi said.
City Union Bank is also in the process of finalising an arrangement with Boston Consulting Group to help upgrade the bank’s digital lending and risk measurement processes, Kamakodi said.
"The outlook for FY24 appears soft with guidance of back-ended credit growth and continued pressure on NIM," analysts at ICICI Securities wrote in a May 28 note, regarding City Union Bank's fourth-quarter performance.
While banks across the board have seen a rise in their cost of deposits as a consequence of rising interest rates, for City Union Bank, that was accompanied by a dip in its returns on the loans it makes as well.
The small and medium enterprises credit model of City Union Bank is facing a challenge due to competitive intensity, as the bank's yields on loans fell by 13 basis points year-on-year in FY23, as compared with a 100-basis-points rise for private banks overall, analysts at Prabhudas Lilladher wrote in a May 27 report.
Changes in the bank's credit-deposit ratio—particularly after the reduction of excess liquidity in the system—and the inability of City Union Bank to get interest subvention on Kisaan Credit Card agricultural loans were the main reasons behind the dip in the bank's margins, Kamakodi said.
"There were certain things we had to improve in compliance in terms of KCC agricultural loan to get the interest subvention from the government," Kamakodi said, regarding the bank's inability to accrue the subvention.
While one cannot completely rule out competitive pressure, the margin compression for City Union Bank was largely a supply-side issue, Suresh Ganpathy, managing director at Macquarie Capital, told BQ Prime. The management's focus was clearly on putting the house in order following the divergence in NPAs which emerged last quarter, he said.
City Union Bank's overall asset quality position improved in the final quarter of FY23, with its gross NPA ratio falling by 25 basis points sequentially to 4.37%. Similarly, the bank's net NPA ratio also improved from 2.67% in Q3 FY23 to 2.36% in Q4 FY23.
The improvement was accompanied by a write-off of loans worth Rs 136 crore. Over the four quarters in FY23, City Union Bank wrote off a combined total of Rs 529 crore worth of loans—denoting a 1.2% share of its overall loan book in FY23.
The lender's long-term track has been that on an overall slippage of Rs 100, the bank is able to recover about Rs 70, with the remaining Rs 30—or 30%—being written off, Kamamkodi said. The bank expects slippages to drop and recoveries to improve in FY24, he said.
An improvement in recoveries would aid City Union Bank's profitability but another factor that will put pressure over the next two quarters is the repricing of deposits. Although interest rates on about 90% of the bank's loans have already moved upwards in line with the interest rate cycle, only half of its deposits have repriced.
"To have your term deposits replaced fully, it normally takes four quarters and we probably have another two quarters to go on that front," Kamakodi said. This would keep the bank's cost of deposits on an upward trajectory and also compress NIMs further.
Exit return-on-assets for FY24E are highly contingent upon recoveries and lower credit costs amid declining margins (on rising deposit costs) and a relative increase in cost ratios (on lower treasury income and higher compensation benefits) will act as inhibitors.Macquarie Research, May 31 On City Union Bank
With 519 of its 752 branches in Tamil Nadu, City Union Bank is a lender that is staying focused on its core base.
Over 60% of its loans typically flow to medium, small, and micro enterprises or the agricultural sector and the bank has no immediate plans to jump into retail lending. But as a back-up in case MSME loans continue to see pressure, City Union Bank has been building up its gold loan business.
The bank's gold loan book grew 22.4% year-on-year in Q4 FY23 to Rs 11,027 crore. Over half these loans at City Union Bank fall under the agricultural gold loan bucket. The overlap "between the MSME and the gold loan is virtually very minimal, not even 5% or so. But overlap with agriculture is very significant ... not less than 70-80%," Kamakodi said.
Tacking on a layer of gold loans to agriculture can help the bank expand its loan book while backing it with a safe and liquid asset but the overlap can also raise its level of reliance on the same set of borrowers.
Overall, as City Union Bank moves through FY24, the bank's task is cut out. It is eyeing a recovery in credit growth and margin while keeping its asset quality on track and changing internal systems that have led to divergences in the past.
The bank's ability to restore growth in its core segments while keeping asset quality slippages in check might very well determine how well one of India's oldest private banks gets off the mat.
“BQ Prime Exclusive Users”
this article for
FREE stories limit