Why you should buy CSB Bank shares now

A bank promoted by a noteworthy investor, which is gradually course correcting and now embarked on a new growth trajectory, trading at 0.9 times FY23 estimated book isn’t something that investors would stumble upon often in the financial services space. The case in point is CSB Bank, formerly Catholic Syrian Bank.

CSB had made the mistake which most small private banks had in its earlier avatar, that is, taking huge exposure in corporate loans. With the bricks crumbling post 2015’s asset quality review, CSB wasn’t spared.

Fairfax came in as the knight in shining armour, and now holding 49.7 per cent stake in the bank, it has undertaken a deep clean up of the bank’s balance sheet, process, systems and operations. While the first part – book cleaning – is almost done with, the other transformation steps, including building a strong leadership team are underway.

However, CSB stock has corrected 37 per cent from its listing price due to slower than expected course correction. Inexpensive valuations coupled with the transformation process underway positions it attractively for investors having a three to five years timeframe.

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CSB 2.0

Usually when a new management steps in there is a massive churn in a bank’s style of operations and its focus areas. Many a time, these changes are welcomed by investors and industry. In fact, in anticipation of these happening at a fast pace, CSB’s initial public offering in December 2019 was a runaway hit. The stock returned 55 per cent gains on listing day.

But the reality ended up being somewhat bit different. Hit by the pandemic in four months post listing, the bank decided to stick to its core and play on its strengths, which essentially is its focus on gold loans and geographic dominance in the Southern market especially Kerala.

Despite being backed by Canadian billionaire Prem Watsa (through his investment firm Fairfax India Holdings) CSB remains a Kerala-dependent outfit. While the dependence on the state has reduced from over 60 per cent in December quarter (Q3) of FY20 to 44 per cent in FY22, it remains a chunky market in terms of balance sheet and may remain so till the bank makes reasonable headway in markets outside the state.

What’s also interesting is that the share of gold loans to the total book has risen from 32 per cent in Q3 FY20 to 39 per cent in FY22, reiterating the relevance of sticking to its DNA especially during testing times like the pandemic.

This strategy seems to have paid off, given that CSB is the only bank which has seen provision write-backs in FY22. The bank wrote back provisioning costs totalling to ₹34 crore in FY22 on the back of healthy asset quality supported by its gold loan book. In fact, CSB is the only bank to have a negative credit cost of 0.07 per cent. This is despite maintaining an additional Covid related provisioning of 106 per cent. The provision write back helped the bank post record net profit of ₹458 crore in FY22, up 110 per cent year-on-year.

Asset quality improvement

One of the telling aspects about the bank is its massive loan book clean-up exercise. Gross non-performing assets (NPA) has sharply fallen from 4.87 per cent in FY19 to 1.81 per cent in FY22. NPA levels in FY22 is the best the bank has seen in over a decade.

The good part about its balance sheet cleansing is that it hasn’t happened at the cost of growth or capital. For instance, in FY21, despite provisioning cost increasing by 52 per cent year-on-year, the bank earned net profit of ₹218 crore, a massive jump from a year-ago level of ₹12.7 crore. This performance was helped by net interest income (NII) growth of 59 per cent year-on-year in FY21.

With the past mistakes with respect to quality of the book almost on the mend, the stage is now set for growth and diversification.

Way ahead

While the balance sheet cleansing happened at a fast pace, the bank’s course correction otherwise has been quite slow and calibrated. At 7.5 per cent CAGR increase in deposits from FY19 to FY22 (₹20,188 crore) and loan book (₹16,742 crore) expanding by 10 per cent CAGR during this period, CSB has lagged large banks on both fronts and explains why the stock is undervalued at 0.9 times FY23 estimated book.

CSB’s focus has largely been on retail loans, which accounted for 48.7 per cent of total book in FY22 (see chart). While the gold loan (which is its mainstay retail product) market is densely populated by non-banks, CSB’s access to low-cost funds gives it an edge over competition.

A fourth of the bank’s book is spread across corporate loans with 64 per cent of borrowers having A and above ratings. With much of the legacy loans in this segment taken care of, the current book offers some comfort. However, given that the top private banks and CSB’s immediate peers such as Federal Bank have over 70 per cent exposure to A and above rated corporate loans, there is scope for betterment.

Manpower revamping

This may be the only patchy aspect at the bank. In May 2020, CSB roped in Pralay Mondal from Axis Bank to head its retail, SME, operations and IT. He has now been elevated as the bank’s interim MD & CEO. Considering that Mondal’s entry was seen strategically very important from a growth and diversification perspective, further re-rating of CSB Bank stock will depend on whether the RBI permits him to assume a full-time role.

Why

Improvement in asset quality is positive

Gradual diversification of loan book and geographies

Stronghold in gold loan business augurs well

The senior management team of the bank has witnessed overhaul since Fairfax came on board and the team is more or less stable now. The issues are largely with entry to middle level positions, primarily due to disagreements on wage board matters.

In 2021 and earlier this year, the friction between the management and employee led to certain sections of staff going on strike. How fast and effectively the bank rehauls its compensation practices is important given that the success of geographic expansions currently underway will hinge on this aspect.

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