Lionheart Holdings Q3 FY2023 Earnings Call

Good day everyone and welcome to the City Union Bank third quarter fiscal year 2023 results conference call hosted by AMBIT Capital. Please be aware that this conference is being recorded.

Thank you, Tanvi. Good evening, everyone. On behalf of AMBIT Capital, I once again welcome you all for the 3Q earnings call of City Union Bank. We have with us Mr. N Kamakodi, MD and CEO; and Mr. V. Ramesh, CFO. And without further ado, I'll hand over the call to Mr. N. Kamakodi for his opening remarks. Post which, we can open the floor for Q&A. Thank you and over to you, sir.

Good evening, everyone. Hearty welcome to all of you for this conference call to discuss unaudited financial results for City Union Bank for the third quarter ended 31st December 2022. The Board approved the results today and I assume you all have received the copies of the results and the presentation. Before going to our business performance, I would like to discuss two things about which we had received multiple calls from the investor and analyst community. First on the recent RBI inspection report and divergence of NPA for the financial year 2021. You may be aware that we had to report similar divergence, which happened in 2016-'17. After that, there was no instance of divergence that needed disclosure till 2021. Even the inspection report of our bank, which was obtained through RTI and made public recently, also revealed the divergence was well below the tolerance level. So we had our last RBI inspection on financial year '19, after which there was no on-site inspection by RBI for financial year '20 and financial year '21. RBI, via their circular dated 14th September 2020, issued notification to the banks to migrate to live marking upgradation of NPA accounts on a daily basis starting from July '21. We have moved to live marking, live upgradation of non-performing assets within the stipulated time period as prescribed by the RBI. Since our NPA marking was automated, we had not expected much divergence. But in the recent inspection conducted by RBI pertaining to financial year 2022, there were few cases of divergence which were identified, and all the cases identified as divergence by RBI were not just because of 90 days overdue, but because of various interpretation issues about which I may be giving you some details. The divergence in additional gross NPA for the said financial year as per the RBI report was INR 259 crore. The gross NPA as on 31st March 2022 as reported by the bank was INR 1,933 crore and as assessed by RBI it was INR 2,192 crore. And the net NPA on 31st March 2022 as assessed by RBI was INR 1,450 crore against INR 1,191 crore as reported by the bank, amounting to an overall divergence of INR 259 crore. The bank has held a specific NPA provision of INR 742 crore as on 31st March 2022, and the provision assessed by RBI for NPA provision requirement was INR 782 crore, with an additional provisional requirement of INR 40 crore for the divergence marked account. The reported net profit for the year 31st March 2022 was INR 760 crore by the bank, and after adjusting the net profit assessed after this divergence was INR 719 crores. As per RBI circular, banks should disclose divergence if either or both of the following conditions are satisfied. The additional provisioning requirement for NPAs assessed by RBI exceeds 10% of the reported profit before provisions and contingencies for the reference period, and the additional gross NPA identified by the RBI exceeds 15% of the published incremental gross NPA for the reference period. As per the above ceiling, 15% of the NPAs worked out to INR 191 crore and since the additional gross NPA divergence assessed by RBI was INR 259 crore, we had to make disclosure on divergence, which we reported to the stock exchange on 20th December 2022. As stated earlier, the divergence was not because of 90-day norms, but due to various reasons including the difference in the interpretation of guidelines and things like that. For example, some of the issues happened in the restructured accounts, particularly on the eligibility for the restructuring. For example, a couple of restructured accounts where the sanction conditions were not fulfilled within stipulated timelines were marked as divergence. But we thought that though the conditions were fulfilled before the audit and so we had taken them as eligible cases for the divergence. Similarly, in a couple of cases where there were accounts that closed their account by transferring funds from their sister concerns, we had given credit subsequently, which was not accepted and hence the divergence was marked. In certain situations, a rule states that any account in SMA 2 cannot be restructured. When we were calculating the number of days during the RBI moratorium and the Supreme Court moratorium, we didn't initially count the days. However, the interpretation was that during the Supreme Court moratorium, the days would continue to accumulate, and the SMA would need to be calculated based on that timeframe. There are several related issues, and these two or three items account for nearly 70% of the reported divergence, which amounts to about 178%. We have already begun taking corrective measures regarding this, and a few jewel loan accounts and other smaller accounts have also been addressed in our analysis. Also, we wish to bring to your attention that out of the divergence of INR 259 crores, 13 borrowers whose balance was more than INR 1 crore amounted to about 89% or INR 230 crores and the balance of INR 29 crore constituted about 218 borrowers where outstanding was less than INR 1 crore. Out of these 13 borrower accounts above INR 1 crore, 4 accounts amounting to INR 60 crore were classified as NPA by us in the first half, and 2 accounts amounting to INR 4 crore were closed as of date. Hence, the balance of divergence in the above INR 1 crore category is INR 160 crore from 7 accounts, which were now recognized during this quarter as NPAs. For borrowers less than INR 1 crore, 218 accounts had 1 account marked NPA during H1 financial year '23, and 55 accounts were closed till date amounting to about INR 9 crore. Hence, the balance divergence in this category of INR 20 crore is now also recognized as NPA in this quarter. So the net effect on the NPA to be marked by the bank comes to INR 186 crore as said above, and out of INR 186 crore, accounts worth INR 47 crore got upgraded as standard during Q3 FY '23. Thus, out of INR 439 crore slippage for Q3 financial year '23, INR 140 crore is basically because of the divergence. The second item for which we were getting repeated calls was for the recent RBI discussion paper on the expected loss method approach for loan provisioning by the bank. As you all know, all banks are already submitting pro forma Ind AS financials starting from financial year 2019 as advised by the regulator, and these financials were based on IFRS regime. Each bank has its own method to calculate ECL based on historical loss data. We have also done our calculations using our past historical data and probability of default and loss expected on default. We have also made our own calculations. As per our past collection pattern, we have seen the NPA collection from the recovery from the NPA accounts typically face a haircut of maybe between 25% to 35% at an aggregated level overall. And the difference between the existing NPA norms and ECL-based approach in the past 4 years on a cumulative level is less than INR 100 crore. In our experience, the provisions held by the bank and PCR are going to decide the impact on what final guidelines need to be made on the ECL method. As you all know, we have about 60% to 70% of provision coverage ratio after taking into account keeping the technical return of provision also. And one good thing is that incrementally we think it's in our interest to slowly and steadily increase the PCR coverage. We have also increased the PCR coverage by 3% to 4% in this quarter. The exact impact of the ECL will only be known after the final guidelines are issued. By our back of the envelope calculation based on the available data, we foresee that after moving to the ECL regime, we may require around INR 200 crores or so maximum, which will be adjusted against CET1 capital, stretched over a period of 5 years as per the transitional arrangement given by the RBI. So year-over-year, the impact could be approximately INR 40 crore to INR 50 crore, or maybe about INR 10 crore or so during the quarter or something like that. Based on our overall profitability, the total impact should not be significantly large. It should be manageable on an overall basis. Now let us move to our financial performance. We shared with you all the following expectations for financial year '23 during earlier calls and all. In earlier calls, we said on the growth parameter, we will push the growth pedal and achieve 15% to 18% credit growth for the financial year '23 and projected that the investment cycle would start from Q3 financial year 2023. However, you might have heard that even during the last week's RBI policy, the capacity utilization is still around 75%, and the investment cycle is getting delayed. There could be a few months of delay in seeing the results, so whatever we projected 15% to 18% could be a shade lower. Overall, things are slowly progressing, but not to the expected level. However, improvements are definitely on the horizon. There have been questions about why some banks show 18% to 20% growth rates in various segments, especially on the consumption side, and even higher growth rates in the SME front. As stated in the past, we need to have a comfort on everything, with all ecosystem aspects favorable for growth. Systemic deposit growth is not very high, so it is not right to push for a growth rate, particularly when deposit growth is lower. We are monitoring the situation, and when we feel the time is right, we will push hard. Currently, expected overall slippages are expected to be in the range of around 2.5% for the current year. Because of the divergence, the slippage has slightly increased; we expect the overall slippage for the current year should be between 2.5% to 2.8%. The current year should bring everything back to 2% to 2.5%. Hence, we are preparing for a return to pre-COVID levels by financial year '23-'24 and believe it should moderate below pre-COVID levels by financial year '24-'25. Net interest margin currently is staying around 3.85% to 4%. While discussing this, a situation arises where some amount of interest income particularly from the gold loan interest of close to INR 32 crores have not been recognized this year. Interest income on advances for Q3 was lower by INR 32 crore mainly because of nonrecognition of interest subvention of KCC agri loans. These loans were given to borrowers in agricultural and allied activities in rural and semi-urban areas, collateralized by gold. Although the prescribed LTV was maintained, the subsidy was given upfront when the accounts were closed within a one-year period. During the current inspection, it was opined that the end use of this gold loan had been proper. However, they observed deficiencies in linking the scale of finance to these gold loans. Scale of finance is determined by district-level consultative committees, which specify how much loan can be given for specific agricultural needs. All these loans are between INR 1.6 lakhs and INR 2 lakhs. We have to work out and demonstrate that although borrowers are within the scale of finance, proper recording and documentation were missing as required by the regulator. We have partnered with the borrowers, and this particular amount of INR 32 crores is pending for recognition. Once we complete the required paperwork to the satisfaction of the regulator, we should receive this amount as soon as possible. Without taking that amount into account, the net interest margin has come in the range given to you previously. The ROA, as we said, is expected to reach 1.5%. Even though the quarterly ROA is lower, the nine-month ROA is 1.5%, as declared in the past. The cost-to-income ratio has also come below the numbers shared earlier. As the interest rate increases, the actuarial calculation showed that the provisions made for leave encashment during the first two quarters are sufficient for the third quarter as well. Hence, we did not make a provision for leave encashment this quarter, which has helped in showing lower employee costs for this time. Overall, deposits are just below the INR 50,000 crore mark. Credit grew by 12% to INR 43,000 crore, with an overall business growth of 9%. CASA recorded 5% growth, and we observed migration from CASA to term deposits as deposit rates began to increase. Gross profit for the Q3 to Q3 showed a growth rate of 3%, with net profit increasing to 21% from INR 196 crore to INR 218 crores. ROA for nine months stands at 1.51% against 1.32% for the same period last year. Gross NPA stands at 4.62%, and net NPA at 2.69%. Regarding SpiceJet, they are paying as per the schedule. They have repaid so far INR 34.4 crore, and the current outstanding is INR 65.6 crore. The final installment is scheduled to be received by June 2023. We reversed a surplus provision of INR 25 crore earmarked for this. The slippage during Q3 financial year '23 is INR 439 crore, which, as explained earlier, comes from both our usual slippages plus those added because of the divergence. Total recovery and upgradation during Q3 were INR 257 crore, comprising INR 173 crore from live accounts and INR 84 crore from technically written-off accounts. The current SMA 2 number stands at 2.19%, which includes accounts from ECLGS, restructured and other regular accounts. The cost-to-income ratio for nine months is at 38% against 41.41% for the corresponding year. The capital adequacy ratio for the bank stood at 20.47% as on 31st December 2022 vis-a-vis 19.39% for the corresponding period last year. We have not diluted any capital in the last eight years, and the last time we raised funds was during July financial year 2014. As explained earlier, ROA stands at 1.51%. The operating profit for the third quarter was at INR 497 crore against INR 370 crores for the same period, showing a 35% growth rate. The total provision made during Q3 financial year '23 was INR 279 crore against INR 173 crore for the corresponding period last year. The net profit for Q3 financial year '23 was at INR 218 crores vis-a-vis INR 196 crore during Q3 financial year '22 with a growth of 11%. Starting from the Q4 of financial year '22, we have been achieving quarterly PAT of INR 200-plus crore on a continuous basis. The nine-month profit crossed INR 700-plus crore. We opened 25 branches during Q3, with the total number of branches currently at 752. We opened our 500th branch in Tamil Nadu during this quarter. On SR front, the outstanding is only INR 1.2 crore, since we have written off INR 79 crores of SR, for which provisions had already been made. I'm also glad to share with you that we received 6 awards in the past 3 months, 2 from BFSI and 4 from IBA, most of which are for technology-related initiatives. We have completed the technical integration with the brand new e-filing portal. Now our customers, both individual and corporate, can pay their direct taxes by selecting CUB in their existing accounts. This enables a simple, instant, and convenient tax payment process. Indirect taxes, including GST payments, were enabled for CUB customers earlier. With these facilities, a long-standing requirement of our customers is accomplished by enabling tax payments through branches, net banking, and mobile banking. To sum up for the financial year '22-'23, things are improving, but the investment cycle is getting delayed by maybe a few months; capacity utilization still reported at 75%. There is some delay in our comfort to push the growth pedal fully. Our slippage ratio was around 2% till financial year '19, increasing to 3.2% during financial year '20 and is around 3% until last year. We expect overall slippages for the current year to be around 2.5% to 2.8%. For next year, it should be below 2.5% and probably moving towards pre-COVID levels in stages. Provision coverage ratio improved to 67%, and we aim to take it to 70% plus as quickly as possible over the next couple of quarters. The net interest margin will stay around the current levels. Additionally, the ROA is expected to remain around the current level of 1.5% for the financial year. The cost-to-income ratio should also stay around 40%, as seen in the past; possibly 40% to 42% in the absence of higher treasury income. Despite this minor setback, we feel we should be able to cross this period almost inline with what we have shared with you all during previous quarters. Overall, we hope the general economy will take a turn for the better going forward and we anticipate improved results as we move forward. With this overview, I open myself for questions.

The first question is from Prakhar Agarwal from Elara Capital.

I have three questions. First, regarding the 12% to 15% growth target and the potential for 15% to 18% growth that you mentioned, which you are not expecting to meet this year, what do you think the target should be for next year? Additionally, what would the ideal industry growth rate need to be for you to reach that target?

Please repeat the question and ask one by one. First question, please.

So I'm saying, sir, when you talked about falling short of the 15% to 18% growth target that you set for this year, what is ideally our growth target for next year, and to achieve that growth target, what is essentially the industry growth that you're probably foreseeing for next financial year FY '24?

I will be able to answer this question more clearly along with my next quarter results. There are a few assumptions that need to get firmed up. For instance, the overall system growth rate and capacity utilization needs to touch 85%. Therefore, predicting growth at this point is challenging as it requires firm answers. Let us wait for the fourth quarter to make that number. My expectation is that the growth rate will definitely be in double digits and should not be lower than the current growth rate.

Sure, sir. Sir, the second question in terms of the lending yields and probably interest rate movement. If I were to exclude the current rate hike taken in terms of repo, before that there were around 225 basis points rise in the systemic rates. What sort of lending rate hike have you seen in your customer base? Against this 225 basis points, how much have you been able to pass through to your customers?

Overall, apart from the gold loan side, we were able to share about 1% to 1.5% and we are planning to go for another 25 basis point hike after the current RBI hike. The 0.25%, 25 basis points, may transfer into around 15 basis points, 20 basis points ultimately. Thus, the overall transmission could be around 50% to 60% of the increased rates.

Got it. Lastly, sir, on asset quality and some clarification on what you said about INR 32 crores. So even if I were to knock off the INR 146 crores net impact you mentioned because of divergence, we are running on the higher end in terms of our guidance, plus the fact that we have also stated that in FY '24 as well, we will probably move towards our pre-COVID run rate of around 2%. Why is that conservatism? Is it anticipated from the restructured pool? Is that why you're assuming a cautious stance?

How it works is for the first three quarters, excluding the incremental slippages, the slippage for the financial year was INR 270 crore, INR 261 crore for the second quarter; excluding the RBI divergence mark, it's around INR 280 crores to 290 crores for the current quarter. We are expecting around 2.5% for the current year. Apart from the divergence, overall numbers are coming as expected. So we believe the trend is that incrementally, numbers are moderating.

If I'm allowed, can I ask one last question if possible or shall I come back?

Go ahead.

One last thing, sir, on this INR 32 crores you spoke about and lack of paperwork. Is there any lapse in process regarding this INR 32 crores? Ideally, we are handling a larger portfolio, but then of this INR 32 crores alone, why has this paperwork and all occurred? Just wanted to get your sense.

Let me clarify that. There are two issues. One, accepting that as the agricultural loan with proper end use, and the second is the scale of finance. It has been confirmed that they are all agricultural loans, and there have been no questions about end use itself, which is significant for us. The issue lies in the calculations of some of these loans not being recorded properly. For small-ticket loans of INR 1.5 lakhs to INR 2 lakhs, ensuring the end use was taken as proof was not recorded in the systems. Although we satisfied ourselves on whether we had funded anything beyond the scale of finance, capturing this in the proper documentation in the system did not happen. We have already started taking steps to remedy this process.

The next question is from Renish Bhuva at ICICI Securities.

Sir, just 2 questions. One is on the steady-state ROI metric. We have always maintained a 1.5% ROA this year. But now if we assume the ECL framework will be the new guidelines, would that impact our steady-state ROA assumption or will we compensate with any other line item in the P&L?

See, the INR 10 crore difference, our calculation shows should not impact our ROA metrics because of the ECL.

Okay, sir. Sir, and secondly, this is just a clarification. Our staff cost is lower this quarter because we have not provided for leave encashment. So any particular reason why we have not provided this quarter?

Due to the overall rate increase, the actuarial calculations showed that provisions made during the first and second quarters are sufficient for the third quarter as well.

The next question is from the line of V.P. Rajesh from Banyan Capital Advisors.

My question is regarding the gold loan book that we have. What kind of growth are you expecting in that book in fiscal year '24?

The gold loan growth between December '21 to December '22 is about 25%. Currently, 25% of our total loan portfolio is gold loan, which was 21% during the same period last year. Honestly speaking, it seems the pattern indicates that we should have similar growth or even slightly more during the next financial year. Our preference is to issue gold loans where we do not have other options.

Are you gaining market share from some of the NBFCs or is it just that there is a lot of stress in the system, that's why people are coming to get loans against gold?

The trend suggests that these loans are being issued where we lack capacity for other lending. Also, gold loans provide an advantage for capital adequacy. If we can grow our regular advances, then the growth rate of gold loans will be less emphasized. If we're not comfortable growing the SME segment, we focus on the gold loan portfolio.

Understood. That's very helpful. And my second question is related to the same topic. What do you think your typical gold loan size and tenure are for customers?

The segment for agricultural loans ranges from INR 1.6 lakhs to INR 2 lakhs, while non-agricultural personal gold loans are around INR 1 lakhs to INR 1.5 lakhs. We do not focus heavily on market share but prioritize our comfort level regarding growth. We aim for prudent growth, even if slightly conservative compared to larger banks that can adopt a more aggressive stance.

The next question is from Rohan Mandora from Equirus Securities.

Sir, in the comments you mentioned we have translated around 100 basis points to 150 basis points on advances. But year-on-year, there's a decline. Just wanted to understand if renegotiations are happening on the spreads.

The gold loan segment is around 9%, which is pulling down the average. Overall in the non-gold loan portion, we are able to take that to levels we want. For the first quarter, our overall yield was only 9.04%. We observed about 35 basis points incremental growth for the second quarter.

But on a year-on-year basis, if there was 100 basis point increase, then there should have been some rise. However, there's a sequential uptick seen in the second quarter?

Yes, while the conditions of the gold loan segment are separate from non-gold loans, we are passing on increments to non-gold borrowers.

Understood, sir. In terms of deposits, this quarter has been broadly flat. Are there challenges in raising deposits or is there a strategy to be slower about it?

Yes, the growth started only towards the quarter's end. We see good growth after the first quarter, particularly migration occurring due to term deposit rate hikes. We expect clarity on deposit growth to take care of our advance growth rate to be double digits.

Regarding the maturity of deposits, what proportion of deposits would reprice over the next year?

Typically, around 70% to 75% of term deposits will be repricing within 1 year.

Also, just to clarify on CapEx, the commentary suggests you're missing out on significant investment links. Would that be accurate?

Yes, financial institutions face different opportunities based on their networks. Although markets are improving, we cannot recklessly expand without proper assurance of deposit growth.

The next question is from Gaurav Jani from Prabhudas Lilladher.

Regarding the restructured portfolio, the peak size was around INR 2,280 crores, which has reduced by about INR 545 crore or INR 550 crore. Can you split that between slippages and recoveries, please?

In the beginning of restructuring, I mentioned 15% to 20% would go bad. Currently, our expectation is that about 7% became NPA from that estimated 15% to 20%.

Thank you. As there are no further questions, I now hand the conference over to management for closing comments.

Once again thank you all for attending this. The Q3 focus was mainly on compliance and other issues, and there were concerns that investment cycles did not pick up as expected. But overall, everything shared regarding growth and net interest margin should remain on track. Although we may marginally fall short for the 15% to 18% growth rate, I believe we will be able to take it forward once we receive positive signals. Overall, things are improving even if not at the expected pace. If you have any more questions, please reach out to Mr. Jayaraman whose details are provided in the presentation. Thank you for participating, and let us hope for the best going forward.

Thank you very much. On behalf of AMBIT Capital, that concludes this conference. Thank you for joining us and you may now disconnect your lines.