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Jammu & Kashmir Bank Limited (J&K Bank) is a regional monopoly enjoying structural
advantages like lowest cost of funds and the legislative status of being the Banker to the
Jammu & Kashmir (J&K) State. Its diversified lending portfolio with 50% exposure outside
J&K State and ~20% exposure to J&K Government and its employees inspires confidence
in the future growth potential of J&K Bank. We expect a 32% upside in J&K Bank over 9
months and initiate coverage with an absolute LONG and relative Overweight rating. Our
Excess Return on Equity (ERoE) based Target Price (TP) of ` 977/share assumes 10 years
of growth, cost of equity of 14.6% and terminal growth of 3%.
Structural Advantages of Cost of Funds and Monopoly Status in J&K driven by
“Reserve Bank” Status of J&K Bank: J&K Bank enjoys the lowest cost of deposits of ~5-
5.5% among its peers due to its functional equivalence of being the Reserve Bank of J&K.
This has also led to monopoly status within J&K in the form of 87% share of advances and
70% share of total deposits in J&K.
Successful Business Consolidation post the FY05 MTM losses resulting in ~100% NPA
Coverage: J&K Bank has successfully consolidated its business post FY05 by a
combination of increased lending within J&K, focus on retail deposits and higher working
capital to term loans. This has led to higher provisioning coverage of 95.5% and an
improvement in the Net Non Performing Assets (NNPAs) from 1.0% in 2004 to 0.0% in
H2FY11.
Lending inside J&K State + High Growth Potential outside J&K State = Stable ~15%
Advances CAGR from 2010 to 2013: J&K Bank has achieved impressive NIMs of ~3-3.5%
alongwith a 30% EPS CAGR from 2006 to 2010 by following a two pronged strategy of
lending inside J&K State (a high yield, low volume business) focused on retail and SME
segments involved in agriculture and handicrafts, and lending outside J&K State (a low
yield, high volume business) focused on Large Corporate Groups like Tata, Birla and
Reliance. We expect that the diversified business mix and several capex focused
Government Schemes will lead to 3 year CAGR of ~15% in Loans & Advances.
Attractive Valuations in the Banking Space along with Strong Fundamentals: J&K
Bank’s attractive position in the banking space on a FY12 RoE to FY11 P/B basis is
accentuated by its impressive efficiency and profitability measures compared to its
peers. It is currently trading at median valuations on TTM P/BV and TTM P/E basis and we
consider the target TTM P/BV and TTM P/E multiples of 1.3x and 7.7x to be achievable
given the historical trading ranges.
Concern on Recent Change of Leadership and Managing Growth in Loans and
Advances: The key challenge before J&K Bank is to ramp up its loans and advances given
its relative failure in the past few quarters and the recent change of leadership from Dr.
Haseeb Drabu to Mr. Mustaq Ahmad.
Our Key Investment arguments:
Structural Advantages of Cost of Funds and Monopoly Status in J&K driven by “Reserve
Bank” Status of J&K Bank: J&K Bank enjoys the lowest cost of deposits of ~5-5.5% among
its peers due to its functional equivalence of being the Reserve Bank of J&K. This has also
led to monopoly status within J&K in the form of 87% share of advances and 70% share of
total deposits in J&K.
Successful Business Consolidation post the FY05 MTM losses resulting in ~100% NPA
Coverage: J&K Bank has successfully consolidated its business post FY05 by a combination
of increased lending within J&K, focus on retail deposits and higher working capital to
term loans. This has led to higher provisioning coverage and an improvement in the Net
Non Performing Assets (NNPAs) from 1.0% in 2004 to 0.0% in H2FY11.
Lending inside J&K State + High Growth Potential outside J&K State = Stable ~14% EPS
CAGR from 2010 to 2013: J&K Bank has achieved impressive NIMs of ~3-3.5% alongwith a
30% EPS CAGR from 2006 to 2010 by following a two pronged strategy of lending inside
J&K State (a high yield, low volume business) focused on retail and SME segments involved
in agriculture and handicrafts, and lending outside J&K State (a low yield, high volume
business) focused on Large Corporate Groups like Tata, Birla and Reliance. We expect that
the diversified business mix and several capex focused Government Schemes will lead to 3
year CAGRs of ~13% and ~15% in Loans & Advances and EPS respectively.
Risk to Our View
Future Growth in Loans and Advances, Credit Crisis in J&K which could impact the near
term liquidity of the bank
Key Triggers
Higher than expected growth of Loans and Advances, Increase in Allocation of
Government Spending to J&K State and Higher Dividend Payout Ratios
Based on ERoE, considering 10 years of 13% CAGR growth in Loans and Advances and 10%
CAGR growth in EPS along with average ROE of ~17%, we derive current fair value of `
885 and 30th Sep 2011 fair value of ` 977.
Company Description:
J&K Bank, incorporated in 1938 is designated as RBI’s agent for banking business. It has
enjoyed four decades of uninterrupted profitability and dividends and is rated P1+ by
S&P. It is present throughout J&K state with 426 branches out of a total of 536 branches
within J&K and 254 ATMs within J&K. It has a virtual monopoly in the form of 87% share
of advances and 70% share of deposits. The bank offers stock broking services through
J&K Financial Services and has an insurance joint venture with Metlife International apart
from being a stakeholder in J&K Grameen Bank.
Investment Rationale
A. Structural Advantages of Cost of Funds and Monopoly Status
in J&K driven by “Reserve Bank” Status of J&K Bank
Unique Bank by way of being the Banker to the Government of Jammu & Kashmir
(GoJK) while the same function is carried out by the Reserve Bank of India (RBI) for
all the other Indian States
Reserve Bank Status along with Monopoly in J&K State (87% share in advances and
70% share in deposits in J&K) leading to strong possibility of systemic support for
meeting its payment obligations in the event of distress
Possibility of systemic support to be a huge sentiment booster regarding soundness
and solvency of the bank among retail and institutional investors
Reflected in easy availability of resources and a high CASA/Total Deposit Levels
leading to lowest Cost of Funds among other regional peers
B. Successful Business Consolidation post the FY05 MTM losses
resulting in ~100% NPA Coverage and best in industry
efficiency and profitability
72% drop in PAT and EPS in FY05 due to a high Mark to Market (MTM) loss in a
hardening interest rate environment on account of high allocation in Available for
Sale (AFS) category
Successfully consolidated the business from FY05 to FY10 and resurrected the EPS
from ` 23.7/share to ` 105.7/share at a CAGR of 35%
Followed a strategy of:
a) increasing lending exposure within J&K State which has higher margins (evident in
the change of the mix from 34:66 in FY04 to 51:49 Within J&K State/Outside J&K
State Lending in FY10) along with reduction in exposure to sensitive sectors (like
Real Estate, Capital Markets and Commodities) leading to improvement in asset
quality
C. Lending inside J&K State + High Growth Potential outside
J&K State = Stable ~15% Advances CAGR from 2010 to 2013
Lower Lending Growth of J&K Bank with a 5 yr CAGR of ~12% compared to
CAGR of ~25% for regional peers due to focus on increasing assets within J&K
State, higher provisioning and efficiency improvements
Currently enjoys the highest NPA coverage in India and one of the lowest
cost of funds along with a renewed focus post H1FY11 on growth of loans
and advances
Two major lending themes of Within J&K State and Outside J&K State
1. Within J&K State
Focus on lending to State and its employees, individuals and SMEs involved
in trade, handicrafts, saffron, horticulture (apples mainly), agriculture and
tourism as shown in the higher proportion of Within J&K State lending
More than ~40% of the advances in the J&K state to the State Government
and its employees which improves the asset quality and leads to lower
default rates
Innovative lending schemes and economy specific products like All Purpose
Agri Term Loan, Apple Advances Scheme, Dastakar Finance, Craft
Development Finance, Saffron Scheme and Giri Finance
Currently enjoys the highest NPA coverage in India and one of the lowest
cost of funds along with a renewed focus post H1FY11 on growth of loans
and advances
Two major lending themes of Within J&K State and Outside J&K State
1. Within J&K State
Focus on lending to State and its employees, individuals and SMEs involved
in trade, handicrafts, saffron, horticulture (apples mainly), agriculture and
tourism as shown in the higher proportion of Within J&K State lending
More than ~40% of the advances in the J&K state to the State Government
and its employees which improves the asset quality and leads to lower
default rates
Innovative lending schemes and economy specific products like All Purpose
Agri Term Loan, Apple Advances Scheme, Dastakar Finance, Craft
Development Finance, Saffron Scheme and Giri Finance
2. Outside J&K State
Majorly comprises of corporate finance to large corporates like Reliance,
Tata and Birla and project finance to hydro power and roads sector for
infrastructure creation within the state
Expect a steady growth of ~18% in Loans and Advances from H1FY11 to FY13
with higher growth contribution from outside J&K State given the current
strong position of the bank in terms of high CASA, low cost of funds and
95.5% NPA coverage.
Forecast: Key Assumptions & Sensitivity
Growth of Assets and Liabilities
Growth in Loans and Advances: J&K Bank has experienced muted growth in Loans
and Advances in H1FY11 due to the cautious outlook of the bank regarding the
economic recovery. Given the current positioning of the bank in terms of its
adequate capitalization, low cost of funds and the focus of the management on
growth in loans and advances, we have assumed a high growth in the coming
quarters leading to a high growth of 19.2% for H2FY11 (after low growth in H1FY11)
and 19.2% for FY12. We have considered slowdowns in asset growth in 2014 and 2019
due to the cyclical nature of the industry.
Growth in deposits: J&K enjoys the status of the Reserve bank of Kashmir and we
expect this to reflect in consistent ~14% annual growth of deposits.
Business Mix Within J&K and Outside J&K State: We have considered slightly higher
growth in the Outside J&K State Portfolio due to the relative low cost advantage,
challenges in identifying quality credit Within J&K State and ease in ramping up
corporate assets Outside J&K State.
Profitability Parameters
Yield on Advances: We expect a slight increase in yields on advances in the coming
quarters due to the increasing interest rate environment and yields to stabilize
around 10.6% in the long run given the business mix between Within and Outside J&K
State.
Cost of Funds: We expect a slight increase in the cost of funds in the coming year
which is in line with the expectation of increasing interest rates and then stabilize
them around 5.5% on account of the inherent advantage of low cost deposits.
Yield on Investments: The yield on investments have been conservatively projected
in the coming quarters due to the increasing interest rate environment and have
then maintained a consistent level slightly below the past mean level.
Provisions/Productive Assets: The provisions are expected to be slightly lower than
past levels given the high NPA coverage levels and stabilize around 0.75%.
Productive Assets/Total Assets: The proportion of Productive Assets/Total Assets
drops gradually from 0.90 in 2012 to 0.76 in 2020 due to the high levels of cash and
the assumptions related to conservative growth.
Capital Structure
Capital Adequacy Ratio (CAR): We expect a stable CAR level of 12-13% and do not
expect a fall in the same which may occur in case of higher growth of loans and
advances and this may be an upside risk in the future.
Investment Risk & Concerns
Growth in Loans and Advances
J&K Bank has experienced a relatively lower growth of loans and advances in the form of
a CAGR of ~15% from FY05 to FY10 compared to 20-25% in the same period for other
peers. It has experienced muted growth of 0.6% in Loans and Advances in H1FY11 due to
the cautious outlook of the bank regarding the economic recovery.
Given the current positioning of the bank in terms of its adequate capitalization, low
cost of funds, low base of loans and advances and the focus of the management on
growth in loans and advances, we expect a higher growth in H2FY11 and FY12.
Recent Change in Management
There has been a recent change at the top in J&K Bank with Dr. Haseeb Drabu, former
Economic Advisor to the State and J&K’s top notch economist being replaced by Mustaq
Ahmad, a long serving employee of J&K Bank who has risen from the ranks and joined
J&K Bank in 1972. Dr. Drabu’s tenure was expected to end in Sep 2011 and the early
replacement has led to concerns regarding the near term performance and asset growth
within the bank.
However, it is to be noted that J&K Bank is managed by the state and is not expected to
be over influenced by a single individual. It had struggled in H1FY11 to ramp up its asset
book even under Dr. Drabu’s leadership.
Presence in a terrorist affected region
J&K Bank is located in a sensitive area with high terrorist threats and this may affect the
day to day operations of the bank. This may also affect the long term development of the
state.
We observe that the bank has enjoyed four decades of uninterrupted profitability and
dividends, making it one of the most consistent companies in India. It is also important
to understand that we have considered conservative growth of loans and advances and in
case of a sustained terror attack or war, the bank will benefit from higher financial
allocations from the state and we expect it to grow its loans and advances by lending to
J&K State Departments and Outside J&K State in such a scenario.
Corporate Governance
Auditors: K B Sharma & Co., Verma Associates, O P Garg & Co., K K Goel &
Associates and P.C.Pindal & Co. are among the firms eligible for the panel of
statutory central auditors of public sector banks for FY10.
Board of Directors: The Board of Directors comprises of 12 directors. There are 3
Executive Directors, 9 Non Executive (8 Independent) Directors comprising IAS
Officers and Senior State Officials of J&K.
Change of Management: There has been a recent change in the Chairman and CEO
of J&K Bank and Dr. Haseeb Drabu has been replaced by Mustaq Ahmad, a long
serving employee of J&K Bank who has risen from the ranks. Dr. Drabu was also the
Chief Economic Advisor to the state and he was mainly responsible for the strong
business consolidation of J&K Bank from 2005 to 2010. He resigned in August 2010
while his tenor was expected to end in September 2011.
Past Fiascos: J&K Bank suffered severe MTM losses in FY05 and underwent a long
period (FY05-FY09) of consolidation wherein it focused on improving its profitability,
efficiency and asset quality. It also changed its asset growth strategy by increasing
its exposure to Within J&K State and reducing exposure to sensitive sectors Outside
J&K State. This has led to a superior asset quality and coverage in the form of 0.0%
Net NPAs and 95.5% NPA coverage. It suffered the MTM losses mainly due to a very
high proportion of AFS and HFT category on investments. Its current investment book
comprises ~70% HTM category and is expected to yield a stable return on
investments.
Competitor Analysis
We have compared the Return on Equity (RoE) Trees of Public Sector Banks including
Andhra Bank, Allahabad Bank, Oriental Bank of Commerce and Dena Bank due to the
common element of being a regional play and similar size and scale of operations.
Conclusion
The yields of all the above banks are comparable in the range of 8.5% to 10.5% and J&K
Bank has maintained a consistent cost advantage in the form of lower cost of funds and
operating costs. The RoE of J&K Bank has further scope of improvement by way of higher
leverage and asset growth. We expect it to be able to attain this growth due to its
superior asset quality, cost of funds and management focus on asset growth.
Valuation
We have valued J&K Bank on the basis of ERoE basis and have also carried out a relative
Price to Book (P/B) to Return on Equity (RoE) analysis on FY10 P/B to FY11 RoE and FY11
P/B to FY12 RoE bases.
Excess Return on Equity Basis
We have assumed a cost of equity of 14.6%, a 10 year growth period and a terminal
growth of 3%. We have assumed the variables as per the rationale provided in the
Assumptions Section.
P/B to RoE Analysis: A Relative Approach
We have plotted the comparable public sector banks on their Returns on Equity and
Price/Book multiples to depict the current market valuations on these parameters. These
charts are indicating a very low R square due to the inclusion of different kinds of banks
in terms of their sizes and political environments.
It can be noticed that J&K Bank is attractively valued on the basis of both 2011 RoE to
2010 P/BV and 2012 RoE to 2011 P/BV. This is because of the inability of the bank to
expand its loans and advances at a rapid pace from FY06 to FY10 as compared to its
competition
The band charts in Exhibits 17 and 18 indicate that J&K Bank is trading at median
valuations of TTM P/E<7x and TTM P/B<1.2x. We expect the target multiples of TTM PE
of 8.3x and TTM P/B of 1.4x to be achieved given the past trading multiples (it has
consistently traded above TTM P/B of 1.3x and TTM P/E of 7.7x as can be seen in Exhibit
19), robust asset quality and efficiency measures of the bank
Annexure 1: Company Overview
How does the company make money?
The company undertakes banking operations and makes money by way of conducting
normal banking operations wherein its raises capital by accepting deposits and borrowing
money at a particular rate, say, cost of funds and deploys the same in investments and
advances at a higher rate, say, yield on productive assets apart from maintaining a
certain proportion in cash for its liquidity requirements. It makes money out of the
spread between cost of funds and productive assets. It is governed by RBI and follows the
regulations applicable to banks.
Key Management profile
Mushtaq Ahmad, Chairman and Chief Executive Officer
Mr. Mushtaq Ahmad has recently been appointed as the Chairman and CEO after the
resignation of Dr. Haseeb Drabu who was also the Chief Economic Advisor to the State.
Mr. Ahmad has a distinguishing career of 36 years as a prudent banker. He joined the
Bank in 1972 as Probationary Officer (PO). Mushtaq Ahmad lays great emphasis on talent
search, human resources development, skill enhancement, besides team building. His
person makes an ideal blend of specialized knowledge and practical experience in almost
all the critical fields of contemporary banking.
Ashok Mehta, Executive Director and Chief Operating Officer
Mr. Mehta has a longstanding association with the Bank, dating back to 1972 and has
served Bank’s hierarchy in various executive capacities as a part of Bank’s Corporate
Management Team. Mr. Mehta has been instrumental in setting up of the joint insurance
venture with MetLife International, USA and has played a key role in forging ties with
Bajaj Allianz General Insurance Co. and MetLife India Insurance Co. Ltd. for distribution
of Non-Life and Life Insurance Products.
Abdul Majid Mir, Executive Director and Chief Financial Officer
Mr. Abdul Majid Mir, Executive Director of our Bank, has more than 37 years of
experience in banking. He has special knowledge and practical experience in the fields of
Finance, Credit, Trade Finance, Foreign Exchange, Treasury, Corporate and Retail
Banking, Deposits & Liability Management & Risk Management.
Special Features of J&K Bank
The special features of J&K Bank are aimed at highlighting the difference between J&K
Bank and other states.
Only public sector bank with a State Ownership
The GoJK runs the J&K Bank and this is a unique ownership pattern given that all the
other Public Sector Banks are owned by Central Government. The decisions regarding
the appointment of senior management and the bank operations are made by the
Board of Directors. The State Government has the right to appoint at most 4
directors or one third of the total directors not exceed 4 directors. Currently they
have appointed one State Government Nominee.
Only Bank to be the State Banker
J&K Bank has been designated as the State Banker as per the legislature and is
engaged in the function otherwise carried out by the RBI for other states. It is
expected to receive systemic support for meeting its payment obligations in the
event of distress.
Monopoly status in J&K
J&K Bank enjoys a monopoly status in J&K in the form of 87% share of advances and
70% share of deposits. This is due to the state wide presence in the form of 426
branches and 254 ATMs. It is expected to be one of the prime beneficiaries from
future growth in SGDP and capital allocations to the State.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Jammu & Kashmir Bank Limited (J&K Bank) is a regional monopoly enjoying structural
advantages like lowest cost of funds and the legislative status of being the Banker to the
Jammu & Kashmir (J&K) State. Its diversified lending portfolio with 50% exposure outside
J&K State and ~20% exposure to J&K Government and its employees inspires confidence
in the future growth potential of J&K Bank. We expect a 32% upside in J&K Bank over 9
months and initiate coverage with an absolute LONG and relative Overweight rating. Our
Excess Return on Equity (ERoE) based Target Price (TP) of ` 977/share assumes 10 years
of growth, cost of equity of 14.6% and terminal growth of 3%.
Structural Advantages of Cost of Funds and Monopoly Status in J&K driven by
“Reserve Bank” Status of J&K Bank: J&K Bank enjoys the lowest cost of deposits of ~5-
5.5% among its peers due to its functional equivalence of being the Reserve Bank of J&K.
This has also led to monopoly status within J&K in the form of 87% share of advances and
70% share of total deposits in J&K.
Successful Business Consolidation post the FY05 MTM losses resulting in ~100% NPA
Coverage: J&K Bank has successfully consolidated its business post FY05 by a
combination of increased lending within J&K, focus on retail deposits and higher working
capital to term loans. This has led to higher provisioning coverage of 95.5% and an
improvement in the Net Non Performing Assets (NNPAs) from 1.0% in 2004 to 0.0% in
H2FY11.
Lending inside J&K State + High Growth Potential outside J&K State = Stable ~15%
Advances CAGR from 2010 to 2013: J&K Bank has achieved impressive NIMs of ~3-3.5%
alongwith a 30% EPS CAGR from 2006 to 2010 by following a two pronged strategy of
lending inside J&K State (a high yield, low volume business) focused on retail and SME
segments involved in agriculture and handicrafts, and lending outside J&K State (a low
yield, high volume business) focused on Large Corporate Groups like Tata, Birla and
Reliance. We expect that the diversified business mix and several capex focused
Government Schemes will lead to 3 year CAGR of ~15% in Loans & Advances.
Attractive Valuations in the Banking Space along with Strong Fundamentals: J&K
Bank’s attractive position in the banking space on a FY12 RoE to FY11 P/B basis is
accentuated by its impressive efficiency and profitability measures compared to its
peers. It is currently trading at median valuations on TTM P/BV and TTM P/E basis and we
consider the target TTM P/BV and TTM P/E multiples of 1.3x and 7.7x to be achievable
given the historical trading ranges.
Concern on Recent Change of Leadership and Managing Growth in Loans and
Advances: The key challenge before J&K Bank is to ramp up its loans and advances given
its relative failure in the past few quarters and the recent change of leadership from Dr.
Haseeb Drabu to Mr. Mustaq Ahmad.
Our Key Investment arguments:
Structural Advantages of Cost of Funds and Monopoly Status in J&K driven by “Reserve
Bank” Status of J&K Bank: J&K Bank enjoys the lowest cost of deposits of ~5-5.5% among
its peers due to its functional equivalence of being the Reserve Bank of J&K. This has also
led to monopoly status within J&K in the form of 87% share of advances and 70% share of
total deposits in J&K.
Successful Business Consolidation post the FY05 MTM losses resulting in ~100% NPA
Coverage: J&K Bank has successfully consolidated its business post FY05 by a combination
of increased lending within J&K, focus on retail deposits and higher working capital to
term loans. This has led to higher provisioning coverage and an improvement in the Net
Non Performing Assets (NNPAs) from 1.0% in 2004 to 0.0% in H2FY11.
Lending inside J&K State + High Growth Potential outside J&K State = Stable ~14% EPS
CAGR from 2010 to 2013: J&K Bank has achieved impressive NIMs of ~3-3.5% alongwith a
30% EPS CAGR from 2006 to 2010 by following a two pronged strategy of lending inside
J&K State (a high yield, low volume business) focused on retail and SME segments involved
in agriculture and handicrafts, and lending outside J&K State (a low yield, high volume
business) focused on Large Corporate Groups like Tata, Birla and Reliance. We expect that
the diversified business mix and several capex focused Government Schemes will lead to 3
year CAGRs of ~13% and ~15% in Loans & Advances and EPS respectively.
Risk to Our View
Future Growth in Loans and Advances, Credit Crisis in J&K which could impact the near
term liquidity of the bank
Key Triggers
Higher than expected growth of Loans and Advances, Increase in Allocation of
Government Spending to J&K State and Higher Dividend Payout Ratios
Based on ERoE, considering 10 years of 13% CAGR growth in Loans and Advances and 10%
CAGR growth in EPS along with average ROE of ~17%, we derive current fair value of `
885 and 30th Sep 2011 fair value of ` 977.
Company Description:
J&K Bank, incorporated in 1938 is designated as RBI’s agent for banking business. It has
enjoyed four decades of uninterrupted profitability and dividends and is rated P1+ by
S&P. It is present throughout J&K state with 426 branches out of a total of 536 branches
within J&K and 254 ATMs within J&K. It has a virtual monopoly in the form of 87% share
of advances and 70% share of deposits. The bank offers stock broking services through
J&K Financial Services and has an insurance joint venture with Metlife International apart
from being a stakeholder in J&K Grameen Bank.
Investment Rationale
A. Structural Advantages of Cost of Funds and Monopoly Status
in J&K driven by “Reserve Bank” Status of J&K Bank
Unique Bank by way of being the Banker to the Government of Jammu & Kashmir
(GoJK) while the same function is carried out by the Reserve Bank of India (RBI) for
all the other Indian States
Reserve Bank Status along with Monopoly in J&K State (87% share in advances and
70% share in deposits in J&K) leading to strong possibility of systemic support for
meeting its payment obligations in the event of distress
Possibility of systemic support to be a huge sentiment booster regarding soundness
and solvency of the bank among retail and institutional investors
Reflected in easy availability of resources and a high CASA/Total Deposit Levels
leading to lowest Cost of Funds among other regional peers
B. Successful Business Consolidation post the FY05 MTM losses
resulting in ~100% NPA Coverage and best in industry
efficiency and profitability
72% drop in PAT and EPS in FY05 due to a high Mark to Market (MTM) loss in a
hardening interest rate environment on account of high allocation in Available for
Sale (AFS) category
Successfully consolidated the business from FY05 to FY10 and resurrected the EPS
from ` 23.7/share to ` 105.7/share at a CAGR of 35%
Followed a strategy of:
a) increasing lending exposure within J&K State which has higher margins (evident in
the change of the mix from 34:66 in FY04 to 51:49 Within J&K State/Outside J&K
State Lending in FY10) along with reduction in exposure to sensitive sectors (like
Real Estate, Capital Markets and Commodities) leading to improvement in asset
quality
C. Lending inside J&K State + High Growth Potential outside
J&K State = Stable ~15% Advances CAGR from 2010 to 2013
Lower Lending Growth of J&K Bank with a 5 yr CAGR of ~12% compared to
CAGR of ~25% for regional peers due to focus on increasing assets within J&K
State, higher provisioning and efficiency improvements
Currently enjoys the highest NPA coverage in India and one of the lowest
cost of funds along with a renewed focus post H1FY11 on growth of loans
and advances
Two major lending themes of Within J&K State and Outside J&K State
1. Within J&K State
Focus on lending to State and its employees, individuals and SMEs involved
in trade, handicrafts, saffron, horticulture (apples mainly), agriculture and
tourism as shown in the higher proportion of Within J&K State lending
More than ~40% of the advances in the J&K state to the State Government
and its employees which improves the asset quality and leads to lower
default rates
Innovative lending schemes and economy specific products like All Purpose
Agri Term Loan, Apple Advances Scheme, Dastakar Finance, Craft
Development Finance, Saffron Scheme and Giri Finance
Currently enjoys the highest NPA coverage in India and one of the lowest
cost of funds along with a renewed focus post H1FY11 on growth of loans
and advances
Two major lending themes of Within J&K State and Outside J&K State
1. Within J&K State
Focus on lending to State and its employees, individuals and SMEs involved
in trade, handicrafts, saffron, horticulture (apples mainly), agriculture and
tourism as shown in the higher proportion of Within J&K State lending
More than ~40% of the advances in the J&K state to the State Government
and its employees which improves the asset quality and leads to lower
default rates
Innovative lending schemes and economy specific products like All Purpose
Agri Term Loan, Apple Advances Scheme, Dastakar Finance, Craft
Development Finance, Saffron Scheme and Giri Finance
2. Outside J&K State
Majorly comprises of corporate finance to large corporates like Reliance,
Tata and Birla and project finance to hydro power and roads sector for
infrastructure creation within the state
Expect a steady growth of ~18% in Loans and Advances from H1FY11 to FY13
with higher growth contribution from outside J&K State given the current
strong position of the bank in terms of high CASA, low cost of funds and
95.5% NPA coverage.
Forecast: Key Assumptions & Sensitivity
Growth of Assets and Liabilities
Growth in Loans and Advances: J&K Bank has experienced muted growth in Loans
and Advances in H1FY11 due to the cautious outlook of the bank regarding the
economic recovery. Given the current positioning of the bank in terms of its
adequate capitalization, low cost of funds and the focus of the management on
growth in loans and advances, we have assumed a high growth in the coming
quarters leading to a high growth of 19.2% for H2FY11 (after low growth in H1FY11)
and 19.2% for FY12. We have considered slowdowns in asset growth in 2014 and 2019
due to the cyclical nature of the industry.
Growth in deposits: J&K enjoys the status of the Reserve bank of Kashmir and we
expect this to reflect in consistent ~14% annual growth of deposits.
Business Mix Within J&K and Outside J&K State: We have considered slightly higher
growth in the Outside J&K State Portfolio due to the relative low cost advantage,
challenges in identifying quality credit Within J&K State and ease in ramping up
corporate assets Outside J&K State.
Profitability Parameters
Yield on Advances: We expect a slight increase in yields on advances in the coming
quarters due to the increasing interest rate environment and yields to stabilize
around 10.6% in the long run given the business mix between Within and Outside J&K
State.
Cost of Funds: We expect a slight increase in the cost of funds in the coming year
which is in line with the expectation of increasing interest rates and then stabilize
them around 5.5% on account of the inherent advantage of low cost deposits.
Yield on Investments: The yield on investments have been conservatively projected
in the coming quarters due to the increasing interest rate environment and have
then maintained a consistent level slightly below the past mean level.
Provisions/Productive Assets: The provisions are expected to be slightly lower than
past levels given the high NPA coverage levels and stabilize around 0.75%.
Productive Assets/Total Assets: The proportion of Productive Assets/Total Assets
drops gradually from 0.90 in 2012 to 0.76 in 2020 due to the high levels of cash and
the assumptions related to conservative growth.
Capital Structure
Capital Adequacy Ratio (CAR): We expect a stable CAR level of 12-13% and do not
expect a fall in the same which may occur in case of higher growth of loans and
advances and this may be an upside risk in the future.
Investment Risk & Concerns
Growth in Loans and Advances
J&K Bank has experienced a relatively lower growth of loans and advances in the form of
a CAGR of ~15% from FY05 to FY10 compared to 20-25% in the same period for other
peers. It has experienced muted growth of 0.6% in Loans and Advances in H1FY11 due to
the cautious outlook of the bank regarding the economic recovery.
Given the current positioning of the bank in terms of its adequate capitalization, low
cost of funds, low base of loans and advances and the focus of the management on
growth in loans and advances, we expect a higher growth in H2FY11 and FY12.
Recent Change in Management
There has been a recent change at the top in J&K Bank with Dr. Haseeb Drabu, former
Economic Advisor to the State and J&K’s top notch economist being replaced by Mustaq
Ahmad, a long serving employee of J&K Bank who has risen from the ranks and joined
J&K Bank in 1972. Dr. Drabu’s tenure was expected to end in Sep 2011 and the early
replacement has led to concerns regarding the near term performance and asset growth
within the bank.
However, it is to be noted that J&K Bank is managed by the state and is not expected to
be over influenced by a single individual. It had struggled in H1FY11 to ramp up its asset
book even under Dr. Drabu’s leadership.
Presence in a terrorist affected region
J&K Bank is located in a sensitive area with high terrorist threats and this may affect the
day to day operations of the bank. This may also affect the long term development of the
state.
We observe that the bank has enjoyed four decades of uninterrupted profitability and
dividends, making it one of the most consistent companies in India. It is also important
to understand that we have considered conservative growth of loans and advances and in
case of a sustained terror attack or war, the bank will benefit from higher financial
allocations from the state and we expect it to grow its loans and advances by lending to
J&K State Departments and Outside J&K State in such a scenario.
Corporate Governance
Auditors: K B Sharma & Co., Verma Associates, O P Garg & Co., K K Goel &
Associates and P.C.Pindal & Co. are among the firms eligible for the panel of
statutory central auditors of public sector banks for FY10.
Board of Directors: The Board of Directors comprises of 12 directors. There are 3
Executive Directors, 9 Non Executive (8 Independent) Directors comprising IAS
Officers and Senior State Officials of J&K.
Change of Management: There has been a recent change in the Chairman and CEO
of J&K Bank and Dr. Haseeb Drabu has been replaced by Mustaq Ahmad, a long
serving employee of J&K Bank who has risen from the ranks. Dr. Drabu was also the
Chief Economic Advisor to the state and he was mainly responsible for the strong
business consolidation of J&K Bank from 2005 to 2010. He resigned in August 2010
while his tenor was expected to end in September 2011.
Past Fiascos: J&K Bank suffered severe MTM losses in FY05 and underwent a long
period (FY05-FY09) of consolidation wherein it focused on improving its profitability,
efficiency and asset quality. It also changed its asset growth strategy by increasing
its exposure to Within J&K State and reducing exposure to sensitive sectors Outside
J&K State. This has led to a superior asset quality and coverage in the form of 0.0%
Net NPAs and 95.5% NPA coverage. It suffered the MTM losses mainly due to a very
high proportion of AFS and HFT category on investments. Its current investment book
comprises ~70% HTM category and is expected to yield a stable return on
investments.
Competitor Analysis
We have compared the Return on Equity (RoE) Trees of Public Sector Banks including
Andhra Bank, Allahabad Bank, Oriental Bank of Commerce and Dena Bank due to the
common element of being a regional play and similar size and scale of operations.
Conclusion
The yields of all the above banks are comparable in the range of 8.5% to 10.5% and J&K
Bank has maintained a consistent cost advantage in the form of lower cost of funds and
operating costs. The RoE of J&K Bank has further scope of improvement by way of higher
leverage and asset growth. We expect it to be able to attain this growth due to its
superior asset quality, cost of funds and management focus on asset growth.
Valuation
We have valued J&K Bank on the basis of ERoE basis and have also carried out a relative
Price to Book (P/B) to Return on Equity (RoE) analysis on FY10 P/B to FY11 RoE and FY11
P/B to FY12 RoE bases.
Excess Return on Equity Basis
We have assumed a cost of equity of 14.6%, a 10 year growth period and a terminal
growth of 3%. We have assumed the variables as per the rationale provided in the
Assumptions Section.
P/B to RoE Analysis: A Relative Approach
We have plotted the comparable public sector banks on their Returns on Equity and
Price/Book multiples to depict the current market valuations on these parameters. These
charts are indicating a very low R square due to the inclusion of different kinds of banks
in terms of their sizes and political environments.
It can be noticed that J&K Bank is attractively valued on the basis of both 2011 RoE to
2010 P/BV and 2012 RoE to 2011 P/BV. This is because of the inability of the bank to
expand its loans and advances at a rapid pace from FY06 to FY10 as compared to its
competition
The band charts in Exhibits 17 and 18 indicate that J&K Bank is trading at median
valuations of TTM P/E<7x and TTM P/B<1.2x. We expect the target multiples of TTM PE
of 8.3x and TTM P/B of 1.4x to be achieved given the past trading multiples (it has
consistently traded above TTM P/B of 1.3x and TTM P/E of 7.7x as can be seen in Exhibit
19), robust asset quality and efficiency measures of the bank
Annexure 1: Company Overview
How does the company make money?
The company undertakes banking operations and makes money by way of conducting
normal banking operations wherein its raises capital by accepting deposits and borrowing
money at a particular rate, say, cost of funds and deploys the same in investments and
advances at a higher rate, say, yield on productive assets apart from maintaining a
certain proportion in cash for its liquidity requirements. It makes money out of the
spread between cost of funds and productive assets. It is governed by RBI and follows the
regulations applicable to banks.
Key Management profile
Mushtaq Ahmad, Chairman and Chief Executive Officer
Mr. Mushtaq Ahmad has recently been appointed as the Chairman and CEO after the
resignation of Dr. Haseeb Drabu who was also the Chief Economic Advisor to the State.
Mr. Ahmad has a distinguishing career of 36 years as a prudent banker. He joined the
Bank in 1972 as Probationary Officer (PO). Mushtaq Ahmad lays great emphasis on talent
search, human resources development, skill enhancement, besides team building. His
person makes an ideal blend of specialized knowledge and practical experience in almost
all the critical fields of contemporary banking.
Ashok Mehta, Executive Director and Chief Operating Officer
Mr. Mehta has a longstanding association with the Bank, dating back to 1972 and has
served Bank’s hierarchy in various executive capacities as a part of Bank’s Corporate
Management Team. Mr. Mehta has been instrumental in setting up of the joint insurance
venture with MetLife International, USA and has played a key role in forging ties with
Bajaj Allianz General Insurance Co. and MetLife India Insurance Co. Ltd. for distribution
of Non-Life and Life Insurance Products.
Abdul Majid Mir, Executive Director and Chief Financial Officer
Mr. Abdul Majid Mir, Executive Director of our Bank, has more than 37 years of
experience in banking. He has special knowledge and practical experience in the fields of
Finance, Credit, Trade Finance, Foreign Exchange, Treasury, Corporate and Retail
Banking, Deposits & Liability Management & Risk Management.
Special Features of J&K Bank
The special features of J&K Bank are aimed at highlighting the difference between J&K
Bank and other states.
Only public sector bank with a State Ownership
The GoJK runs the J&K Bank and this is a unique ownership pattern given that all the
other Public Sector Banks are owned by Central Government. The decisions regarding
the appointment of senior management and the bank operations are made by the
Board of Directors. The State Government has the right to appoint at most 4
directors or one third of the total directors not exceed 4 directors. Currently they
have appointed one State Government Nominee.
Only Bank to be the State Banker
J&K Bank has been designated as the State Banker as per the legislature and is
engaged in the function otherwise carried out by the RBI for other states. It is
expected to receive systemic support for meeting its payment obligations in the
event of distress.
Monopoly status in J&K
J&K Bank enjoys a monopoly status in J&K in the form of 87% share of advances and
70% share of deposits. This is due to the state wide presence in the form of 426
branches and 254 ATMs. It is expected to be one of the prime beneficiaries from
future growth in SGDP and capital allocations to the State.
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