Kotak Mahindra Bank’s ‘Industry-Best’ CASA Ratio Tells ‘Half-Truth’, Says Ambit Capital

Kotak Mahindra Bank Ltd.’s “industry-best” current account-savings account ratio and cost of funds have been driven by low loan growth and low leverage, according to Ambit Capital.

“With 61% CASA ratio and 3.2% cost of funds, Kotak Mahindra Bank looks the best bank in terms of liabilities. However, it’s only the half truth,” the brokerage said in a June 15 report titled 'The Emperor’s New Clothes'. “Though its liability side has improved over the years, it is nowhere close to giants ICICI Bank and HDFC Bank.”

Kotak Mahindra Bank’s CASA ratio increased 900 basis points over FY19-22—the sharpest in the industry—against a 600-basis-point rise for HDFC Bank and broadly flat for ICICI Bank, the report said. This was the major reason behind a sharp decrease in cost of funds and improvement in net interest margin for the Uday Kotak-led lender.

But its CASA deposits posted lower annualised growth than HDFC Bank and equal to that of ICICI Bank during FY19-22. That, Ambit said, is because between FY19 and FY22, term deposit CAGR for Kotak Mahindra Bank was much lower than that of larger peers. “This is also visible in overall deposit CAGR for Kotak Mahindra Bank being much lower than HDFC Bank and ICICI Bank.”

“Low growth in term deposits compared to CASA inflated the CASA ratio of Kotak Mahindra Bank between FY19-22. This led to a sharp decrease in its cost of funds,” the brokerage said. The bank also reduced savings account deposit rates, further lowering the cost of savings account deposits and cost of overall deposits.

Also, Kotak Mahindra Bank was “able to manage with such low overall deposit growth” because its loans grew only at 10% CAGR during this period versus 20% for peers. The bank was able to fund this low loan growth with equity capital generated.

“Low deposit requirement helped the bank to cut its deposit rates sharply without worrying about deposit growth. This is how Kotak Mahindra Bank was able to expand its CASA ratio, decrease cost of funds and expand NIMs.”

De-Rating On The Cards

While the Kotak Mahindra Bank stock has de-rated over the last 18 months, Ambit said there’s more on the cards as “it disappoints on NIM and fails to improve return-on-equity despite increase in loan growth and hence leverage”.

For the bank to post more than 20% loan growth as guided by the management, there will be a “significant NIM contraction”, Ambit said. “With growth picking up, Kotak Mahindra Bank would have to raise savings account rates to maintain its CASA ratio or would have to settle for lower CASA. Either way, it would increase cost of funds.”

The bank’s NIM in FY22, according to Ambit, was “inflated” by 75-85 basis points due to “deflated cost of funds”. The brokerage expects the lender’s NIM to contract 50 bps over the next three-four years and a minimum 30 bps between FY22 and FY24.

Ambit has a ‘sell’ rating on the stock with a target price of Rs 1,465 apiece, implying a potential downside of 16% from current levels.

Lagging On All Fronts

Kotak Mahindra Bank has been able to manage its asset quality well over the past decade, but this has come at the cost of low loan growth, the brokerage said. “This cautious approach and flip-flop strategy on growth means that the bank is not dominant in any lending sub segment and is a distant No. 5-6 player in most of the key lending segments.”

According to Ambit, the market share in most payment instruments for the bank is less than 4% and has not shown any marked improvement over the last 4-5 years. “This shows lack of innovation from the bank to dominate anything, be it payments or loans.”

Kotak Mahindra Bank’s market share in Unified Payments Interface transactions at around 2% as beneficiary bank and 3.8% as a remitter bank is also “not great”. “The transaction failure rate in UPI being higher than peers does not give us confidence that it is matching its large private sector banks in digital capabilities.”

Besides, despite low return-on-equity and growth, Kotak Mahindra Bank trades at a premium to HDFC Bank and ICICI Bank by price-to-book value and price-to-equity.

“The market is paying a multiple to excess equity sitting on Kotak Mahindra Bank’s balance sheet despite the bank showing no acumen/intent to intelligently use this capital in the past. In fact, the market has rewarded the bank for sub-optimal capital management to say the least.”

But not all analysts are critical of Kotak Mahindra Bank.

Ambit is one of the only two brokerages out of 42 that have a ‘sell’ rating on the lender. As many as 26 analysts suggest a ‘buy’, while 14 recommend a ‘hold’, according to Bloomberg data. The average of the 12-month consensus price target implies an upside of 20%.

ICICI Securities and Axis Securities maintained their ‘buy’ ratings on the stock, and set a target price higher than Rs 2,000 apiece. According to ICICI Securities, the bank’s recent event showcased its progress with its ‘811’ initiative (zero balance digital savings account) and signaled a shift in strategy toward engagement and cross-sell.

Shares of Kotak Mahindra Bank fell as much as 0.6% before closing 0.2% lower on Wednesday.