Bandhan Bank: Visible Recovery Trends

Bandhan Bank is a commercial bank focused on serving underbanked and underpenetrated markets in India. The company has a PAN-India presence and offers a wide range of banking products & services and asset & liability products and services designed for micro banking and general banking.

Bandhan Bank's loans and advances have crossed Rs.1 lakh crore at the end of March with a strong rebound in credit demand in step with steady economic recovery. The loans grew 16% year-on-year to Rs.1.01 lakh crore.

The asset quality trend seems to be stabilizing:

- Par 1-30 has seen a declining trend in Q3FY22, with a strong recovery trend a sustained improvement is expected. Moreover, lower bucket roll forward rates have also been declining.  
- Write-offs have been elevated. A further negative surprise on write-offs, sans any new covid wave, is not expected.  
- Overall, the stress in West Bengal and Tamil Nadu remains high but seems to be stabilizing. The bank has already classified stress loans as nonperforming loans (NPLs), of which it has already provided greater than 50% and is seeing better than expected recovery trends.

Growth seems to come back with a focus on new borrowers as well:  

- The trend of a declining borrower base for the bank seems to have settled down – incrementally players are seeing new borrowers coming on board as well.  
- The customer inquiry trend is improving with a growing share of new-to-credit customers.  
- While there are signs of top-up loans being given to help borrowers, improving underlying borrower cash flows renders some comfort. But, this will remain to be key monitorable for the sector.

Regulations have turned lax and idiosyncratic state risk settled:  

- Regulatory risk is settling and turned out to be much laxer than earlier anticipated. It provides a level playing field for all players with a wider operating landscape.  
- Idiosyncratic state risk settling – two of the major reasons for our negative outlook on Bandhan was based on: i) uncertainty on Assam they being the leading players - the outcomes from which have been by and largely bounded in nature; and ii) elections in West Bengal.  

Diversification and building a buffer are right, but execution is the key: 

- With the intent of smoothening volatility, management is focusing on product and geographical diversification. 
- While the road map looks credible, operational challenges (team setup, investment heavy businesses, and different underwriting challenges, among others) are higher and hence execution/transition will be critical.
- From a five-year perspective, Bandhan bank aims to diversify its product mix—with micro-financial institutions forming 30%, housing 30%, MSME 40%, and other retail 10%. This, from a stability perspective, holds water.  Also, given the volatility seen over the last 2-3 years, the bank now intends to create provision buffers, which may suppress peak Return on Equity. 

Key Risks:

- Asset quality in Assam and West Bengal performs better: Micro Financial Institutions loans cater to the unorganized sector, and this category of customers is very vulnerable to political, cultural changes, etc. A change in government policy or disruption/shocks in MFI segments could completely alter the credit discipline and cause non-performing loans to spike. Bandhan has had a successful run in West Bengal by being the first player in the market and their consequent deep understanding of that geography. In this context, if the asset quality holds up in Assam and West Bengal, the credit cost might turn out to be lower. 

- Better execution of accelerated diversification strategy: The management’s road map to accelerated diversification, albeit seems credible, might suffer greater operational challenges (team set-up, investment-heavy businesses, and different underwriting challenges, among others) and thus execution/transition will be critical to watch out for. The better than expected execution on this would render stability to earnings and drive re-rating.

The Bandhan Bank stock has seen significant underperformance – with >20% underperformance to Bank Nifty over nine months. With early signs of normalization trends visible, earnings are driving some stability. That said, given the impending diversification execution, some red flags around the sector (impact of inflation on underlying borrower base), and inherent volatility in the business model, Bandhan bank tracing back to its earlier levels is highly unlikely.