The bad loan clean-up cycle, which has now stretched out over two years, has not been kind to Axis Bank Ltd.
The lender, once seen as a potential challenger to larger peer ICICI Bank Ltd., paid the price for aggressive growth in the 2009 to 2011 period as it saw bad loans surge by more than six times over the last two years. While ICICI Bank has higher bad loan ratios, the street has punished Axis Bank more severely for the increase in the quantum of gross non performing assets. Such loans have jumped from Rs 4,451 crore in September 2015 to over Rs 27,402 crore now. As a proportion of total loans, Axis Bank’s gross NPAs stand at 5.9 percent compared to ICICI Bank’s 8.8 percent.
Axis Bank has also had to contend with criticism on under-reporting bad loans. For two consecutive financial years, it has reported a material divergence in the assessment of bad loans between the lender and the regulator. To be sure, similar under-reporting has been detected in other banks as well. Along the way, there has been speculation that the bank may be an acquisition target. All this uncertainty, around the bank, the soundness of its management and its future, has reflected in the under-performance of a once-loved private bank stock.
It is against this backdrop that Axis Bank’s recent capital raising should be seen. In a deal announced on Friday, the bank said that it would raise Rs 11,626 crore via an issue of shares and warrants. Bain Capital puts in more than half of this with a capital commitment of Rs 6,854 crore. Capital International and Life Insurance Corporation of India come in with the rest.
Brokerages have noted that the capital infusion will allow the bank to increase provisions. Axis Bank will need to set aside more funds to cover for stressed assets and also to make the transition towards the new Ind-AS accounting standards, which are likely to kick in starting April 2018. While providing capital for provisioning, the fund raise will leave enough on the table for Axis Bank to deploy towards growing its balance sheet should the investment cycle pick-up, said brokerage houses in their notes issued after the announcement. Prior to the fund raising, Axis Bank had a tier-1 capital adequacy ratio of 12.36 percent, which will rise by about 180 basis points after the fund infusion.
The fundraising will help absorb credit costs and aid growth, said CLSA in a note on Saturday. This should provide a clear path for growth, even as some capital (~50 percent) will likely be used for IND-AS provisioning, said Morgan Stanley.
But Axis Bank’s ability to raise capital, despite all its issues, was never in doubt. As such, a bigger benefit of the fundraising will likely accrue through intangibles such as the possibility of renewed confidence in the bank.
The perception of the lender has deteriorated significantly over the past two years. This is reflected in the chart below which shows a notable decline in the proportion of ‘Buy’ calls on the stock. Bain Capital’s entry may signal upside for the bank’s valuations, unless unforeseen and unknown issues crop up once again.
“We believe that the capital raising will be an important step in taking Axis Bank closer to its historical level of return ratios,” said Motilal Oswal in a report on Monday. The journey, however, will take a few years to complete, the brokerage house added.
But Axis Bank’s attempt to revive its standing in the market doesn’t end with the fundraising. It only marks the start of it.
Like in other banks, there has been no change in the top management at Axis Bank following the surge in bad loans. In July, the board reappointed Shikha Sharma as the chief executive officer for a period of three years.
The top team will need to convince the market that it has learnt its lessons and intends to be more prudent in the next cycle.
The management will also need to ensure that it puts a firm end to any divergence in bad loan assessment between the lender and the regulator. No matter how insiders explain these divergences, to the outside world, it suggests under-reporting of stress.
The banks will also need to cap concentration risk and ensure that its book is a little bit more diversified than it has been in the past. To be sure, the lender has moved in this direction. The exposure to top 20 borrowers as a proportion of Tier-1 capital has reduced from 287 percent in March 2011 to 118 percent now, shows an investor presentation by the bank. Percentage of loans sanctioned to borrowers rated A- and above has increased to 85 percent from 68 percent in FY12.
But all of this has happened during the clean-up part of the business cycle. The bank will need to ensure that its new-found prudence is not abandoned as growth returns.
Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.