Kotak Mahindra Bank’s Sonata acquisition a small step for more yield

A deal would see the lender join a number of other Asian banks pursuing tie-ups for their insurance arms.

Microfinance is a high-yielding loan segment that has lured many banks looking to increase the yield of their loan assets. In fact, some lenders have made multiple acquisitions in a serious pursuit of this loan market. The latest is Kotak Mahindra Bank to take a convincing step into this segment through the acquisition of Sonata Finance.

Analysts have taken a favourable view towards the private sector lender post this acquisition. Jefferies India Pvt Ltd believes that the lender will be able to increase its presence in North India. “This ties with the bank's aim to lift unsecured loans from 9 percent to the mid-teens,” the brokerage said in a report.

But investors don’t seem to be moved by it. That’s reflected in the lacklustre movement seen in Kotak Mahindra Bank’s shares since the announcement of the acquisition on February 10.

Sonata Finance is a microfinance company with a book size of Rs 1,400 crore and more than 500 branches. Kotak Mahindra Bank’s microfinance book has been growing slowly and steadily to Rs 5,300 crore now. Against its own large-sized loan book of Rs 3.10 lakh crore, the acquisition of Sonata isn’t significant for Kotak Mahindra Bank.

The Rs 537-crore all-cash consideration for the deal, analysts believe, isn’t a big deal for the private sector lender. Jefferies’ calculation shows that the deal values Sonata at 1.7 times its book value as of December.

The question is whether Kotak Mahindra Bank will be able to squeeze more profit as it grows its microfinance business?

The right motivation

The motivation for the purchase of Sonata is clear. Kotak has been a conservative lender so far, keeping away from aggressively lending to high-yielding segments, such as unsecured retail loans. It dipped its toes into microfinance with the acquisition of BSS Microfinance Pvt Ltd in 2016. Since then, the lender has been circumspect about increasing the share of this segment quickly. The pandemic years vindicated Kotak Mahindra Bank’s conservative approach as the microfinance market came under immense strain. When peer banks began reporting a surge in restructuring loans, Kotak was able to keep its own slippages under control.

Analysts point out that the lender would need to seek out high-yielding assets when credit growth is booming lest it loses ground to peers. For FY21 and FY22, the yield on loans for Kotak was 8.4 percent and 7.8 percent respectively. That matched peers ICICI Bank and Axis Bank which reported yields in the 8.0-8.5 percent band. But these lenders are already aggressively targeting high-yield loan segments.

Kotak Mahindra Bank’s enviable low-cost current account and savings account (CASA) deposits have kept low yields from crimping on margins. But this will now change, as deposit rates are on the rise and with most banks clamoring for more deposits, Kotak too will need to continue raising deposit rates to attract them. The only way to maintain margins is to shed conservatism and plunge deeper into unsecured lending. To maintain the current trend of superior margins compared with peers, the bank would need to sweat more now.

As of December, Kotak Mahindra Bank’s net interest margin was 5.47 percent, which was superior to 4.65 percent of ICICI Bank and 4.3 percent of HDFC Bank.

Until now, Kotak Mahindra Bank has stayed away from riskier credit despite the lure of high returns. Microfinance loans are unsecured and far more vulnerable to economic cycles. In 2016, when Kotak bought BSS Microfinance, Chairman Uday Kotak had said that the goal was to learn about this segment and build capacity. Its peers that have made similar acquisitions have valuable lessons to offer. IndusInd Bank’s purchase of Bharat Financial Inclusion Ltd (BFIL) shows how managing asset quality is critical. The private lender’s earnings came under pressure as it integrated BFIL into its books. The microfinance portfolio had its own set of problems, including a concerning episode of loans disbursed without borrower consent in March 2022.

IndusInd Bank has managed to bring down the stress progressively, but not without considerable pain.

Where is growth?

Investors simply want the bank to show consistent high growth and improvement in yield. For the past two quarters, the bank’s management has made all the right noises in its desire to tone down conservatism and go for high-yielding lending opportunities. “In the last two-three quarters, they have consistently grown, but that trend must continue. What the street is concerned about is sustainable growth,” said Gaurva Jani, Analyst at Prabhudas Lilladher. He added that Kotak Mahindra Bank’s microfinance acquisitions are still small to make a big difference to valuation. “They have a CET (common equity tier) ratio of 21 percent, which is way too high,” he said.

The lender needs to utilise its capital and increase lending. So far, superior asset quality has been one of the driving factors of Kotak Mahindra Bank’s profitability and valuation. That may not be enough at a time when loan growth of every lender is booming. Morgan Stanley analysts believe that the bank’s stock is priced to perfection at the current valuation of 2.7 times FY24 estimated book value.