Hold IndusInd Bank Ltd For the Target Rs. 1,000 By PL Capital- Prabhudas Lilladher
Accounting irregularity and MD&CEO tenure extension only by 1-yr to drag valuations
Quick Pointers:
* Derivative accounting irregularity to hit Dec’24 equity by 2.35%.
* Cut FY25 PAT by 25%; stock may underperform in near term.
We downgrade IIB to ‘HOLD’ from ‘BUY’ as we cut multiple to 1.0x from 1.4x driven by uncertainties relating to earnings quality and future leadership. Woes continue for IIB since an irregularity was unearthed in derivative accounting. This discrepancy spanned across a 5-7yr period till 31st Mar’24, however, due to an RBI directive, there are no irregularities w.e.f. 1st Apr’24. While an external review is underway to ascertain the exact impact, internal review suggests a 2.35% hit to equity. Impact on Q4FY25 PAT may be Rs15.8bn post-tax or Rs21bn pre-tax which could be split into interest expense and treasury suggesting a cut of ~25% in FY25 PAT and a CET-1 hit of 37bps to 14.8%. In our view, this episode had a bearing on RBI’s decision to extend MD&CEO’s tenure only for 1yr. Valuation is 0.9x on FY27 ABV and we trim TP to Rs1,000 from Rs1,400.
* Accounting discrepancy in derivatives:
Derivatives are used by treasury to convert forex deposits/borrowings into INR. Prior to 1st Apr’24, both internal and external trades were conducted. Internal trades were being hedged basis swap-cost while external trades were marked-to-market (MTM). If forex borrowings were repaid during the contract, internal trades were unwound triggering differences between swap-cost and MTM which was unaccounted. This practice of swap-cost accounting for internal trades was followed for the past 5-7 years till 31st Mar’24. However, as per RBI directive issued in Sep’23, internal trades were discontinued from 1st April’24 and as per an internal review the bank noted some discrepancies in derivative account balances. While an external agency has been hired to review the same, the internal review estimated a net worth impact (one-time) of 2.35%.
* Management comments relating to the irregularity:
Bank started reviewing the internal trade book and discrepancies were identified by Sep/Oct’24, post which an external agency was hired for a review. Management expects the final amount to be crystallised by Mar/Apr’25. Reversal of an accumulated amount cannot be routed through the general reserve. Hence prima-facie the P&L would be hit by Rs21bn (pre-tax), mainly effected in interest expense while the remaining would be adjusted against trading income although an exact split has not been given. As per the bank, this irregularity would not impact the overall growth and business prospects.
* Our analysis of the financial impact:
Bank's internal review has estimated an adverse one-time impact of ~2.35% of Bank’s net worth as of Dec’24 which was Rs671bn suggesting a post-tax impact of Rs15.77bn or Rs21bn pre-tax. Hence Q4FY25 could report a loss (previous PLe Rs15.7bn) which would hit overall FY25 earnings by ~25%. CET-1 for Dec’24 would decline by 37bps to 14.8%. Our ABV for FY25/26/27E has been revised downwards by 2.3-2.7%; we have not materially cut FY26/27E earnings.
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