In our bl.portfolio edition dated October 13, 2024, we had given a ‘hold’ rating on the stock of CSB Bank, citing margin compression and elevated slippages in the corporate and SME segments of the loan book as key drivers justifying a valuation of 1.4 times book value (Q1 FY25). Now, as we stand at the end of Q3 FY25, the bank has delivered a strong set of numbers over Q2 and Q3 of FY25. The advances and deposits growth (year on year) has been upwards of 20 per cent in each of these quarters. Asset quality also has improved.

The book value in due course has increased, bringing the price to book value (P/B) multiple to 1.24 times. This is at a considerable discount to the P/B multiple of 2 times, at the stock’s all-time-high price of ₹422.25 on December 29, 2023, and the average P/B ratio since listing of about 1.7 times. Given the factors listed below, it calls for a relook at the rating and we recommend investors with a long-term perspective can accumulate the stock.

Strong couple of quarters

The bank has been in the process of rejigging the balance sheet for a while now. The balance sheet has been derisked of segments such as microfinance and personal loans, which are high yielding too. The corporate book also has seen a makeover.

During Q2 and Q3 of FY25, the bank posted healthy growth in advances, close to twice the banking system growth rate, driven by gold loans (45 per cent of the bank’s loan book), SME and other segments of retail loans such as loan against property (LAP) and commercial vehicle loans. Corporate loans, which saw marginal degrowth (year on year) in Q1 and Q2, saw growth in Q3 to the tune of 5.3 per cent. Excluding liquidation in the DA (direct assignment) portfolio, corporate loan growth works out to a higher 30 per cent year on year.

Asset quality, as measured by gross NPA ratio, credit cost and quarterly additions to gross NPAs (see infographic), has improved in the last two quarters. The bank continues to hold contingency provisions of over ₹180 crore.

Margin impact

A healthy growth in deposits has fuelled the growth in loans. However, growth in the low-cost CASA (current account savings account) balances have not been great, forcing the bank to support loan growth with term deposits and more importantly, with a higher share of bulk deposits. Bulk deposits account for 39 per cent of term deposits as of Q3 FY25, up substantially from 27 per cent as of Q3 FY24. The problem with higher term deposits and bulk deposits is that they cost more than CASA balances and bulk deposits are not granular. This has a bearing on the net interest margin (NIM).

Also, since the bank has derisked the portfolio of high-yielding microfinance and personal loans, yield would naturally trend downward, bringing NIM down along. Also, with corporate loans and secured retail loans being the focus areas of the bank now, the incremental yield is going to be lower, as these loans carry relatively lower yield. However, the full-year NIM guidance for FY25 still stands at 4 per cent plus. The shorter-tenor nature of the bank’s loans (45 per cent of the loan book is gold loans) enables quicker repricing.

Transition phase

For want of sustainable growth in the long term, the management has outlined a transition plan leading to FY30, with a shift from largely a product (gold loan) company towards a comprehensive franchise (serving all segments from salary accounts to large corporate accounts to wealth management), with a tech transformation (for scale) to enable this, expected to be live latest by FY29. The management wants to shift focus from product-level profitability to customer-level profitability. For instance, leveraging the improved tech stack to offer corporate salary accounts (which the bank doesn’t have now) and cross-sell products such as credit cards and personal loans (the risk is lower when lent to customers having salary account with the bank).

By FY30, the gold loan portfolio is expected to be just 20 per cent of the overall loan book, as the other segments grow faster. The management notes that when this happens, the bank will have to sacrifice the minimal credit cost that gold loans have, as riskier products are scaled up. But there is a trade-off here. As gold loan share comes down, so does the high operating cost associated with it, thereby allowing maintenance of return on assets (RoA). Higher fee income from corporate accounts, for instance (example forex transactions), will also aid RoA. The management does acknowledge that in the process, NIM would be sacrificed to some degree in favour of sustainable growth of the franchise while maintaining an RoA of 1.5-1.8 per cent.

RoA for Q3 FY25 (annualised) stands at 1.5 per cent. The management expects it to be rangebound between 1.5 per cent and 1.6 per cent until FY27. From FY28, it is expected to inch upward towards 1.8 per cent. In the meantime, the bank wants to build a wholesale portfolio (with expected RoA of 2 per cent), even if funded by bulk deposits, as opportunities are ripe to be grabbed now.

That said, FY28 is still some time away, making the stock susceptible to the cyclical nature of the financial sector. There is also execution risk. In our view, the stock’s current valuation adequately factors in the said risks, providing long-term investors an opportunity to profit when accumulated.

Published on February 8, 2025