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Hope for turnaround with private banker at the helm but need long-term capital support

Private banker to head the bank for the first time, raising hope for the much-needed turnaround: South Indian Bank (SIB) has long been plagued with asset-quality issues given its legacy corporate-heavy asset book built largely by PSU bankers heading the bank in the past, making it difficult for the bank to raise survival/growth capital. To avoid the fate of other weak small banks such as LVB and BOR calling for RBI intervention, the board has rightfully appointed a credible private banker (Mr. Murali Ramakrishnan, ex-ICICI) to head the bank with strong expertise in the retail business and most importantly in risk management, which we believe is a typical problem with small-size banks and more so for SIB. He was one of the key trouble shooters in ICICI Bank, particularly in tackling asset-quality issues in the SME/retail business and build risk management/analytical models. At SIB, he has charted a three-year turnaround plan (till 2024) based on 6C strategy (similar to ICICI’s 4C strategy), encompassing Capital, CASA, Cost-income, Competency, Customer Centricity and Compliance. As a part of turnaround strategy, the bank has successfully raised the first tranche of capital (Rs2.4bn) via pref-placement and is hiring experienced senior professionals from ICICI/HDFCB to plug management gaps. To offset higher costs, the bank would focus on gradually building a strong retail portfolio, initially around traditional gold/housing loans and strengthen the SME book with robust risk management in place to drive quality growth and sustainable profitability. It has guided for RoA/RoE of 1%/13% by FY24 from <0.5%/10% since the past five years.

* Near-term asset quality risk inevitable but needs to bite the bullet and move on: The new management has indicated about strengthening underwriting practices and risk management architecture by supplementing internal talent with external consultants/agencies; however, legacy asset-quality issues are likely to hound for some time. The bank has reported pro forma GNPA of 7.3% with some resolution (Rs4bn) in the near term, while the new management has strategized to restrict restructuring (Rs9-10bn; 1.6% of loans) to cut down tail-end risk. Traditionally, the bank has been operating at lower PCR (<40%), while pro forma PCR, including Covid-19-related contingent provisions, too remain low at 45%. The bank has indicated about improving specific PCR to 65% from current 58% in the next three years, which we believe is a relatively moderate target. In our view, the bank needs to seriously lift its provisioning buffers and w-off legacy sticky NPAs, even if that means incurring losses initially, instead of carrying the burden of NPAs for a prolonged period.

* Constant flow of capital must for sustained turnaround which will be challenging without a strategic investor: The bank has raised a first tranche of capital of Rs2.4bn, mainly from insurance companies at <1x BV, while plans to raise another Rs7.5bn-10bn, largely via the equity route to initially clean up the balance sheet and then secure growth (plans to reach Rs1trn loan book by FY24 @16% CAGR). However, our back-of-the-envelope calculation suggests that the bank may require >Rs15bn in equity capital till FY24 to maintain the threshold Tier I ratio of 10%. Given its past struggle to raise capital, we believe securing sustained flow of capital without much dilution risk for existing investors will need a near-perfect execution on milestones, which will be a daunting task. Another Kerala-based bank plagued with similar issues has staged a turnaround by adopting a much aggressive approach to deal with legacy NPAs and belligerent unions, given strong capital and executional backing of a strategic investor. Though current management is open to explore a strategic investor to secure sustained flow of capital, we believe securing board and union support in regional banks such as SIB is always a challenge.

* Outlook & valuation: In our view, the appointment of a private banker for the first time, followed by recent capital raise after a long struggle, augurs well for the bank in the near term. However, a sustainable long-term turnaround would depend on broad-based management transformation, effectively dealing with legacy asset-quality issues, strengthening risk/compliance practices to avoid future debacles, securing continued capital flow, and delivering sustainable growth and profitability. The stock currently trades at trailing Dec’20 P/ABV of 0.5x. Currently, we do not have a rating on SIB.

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