IBSPECIAL

There is no doubt in anyone's mind on which side of the fence billionaire banker Uday Kotak would like to sit. Seeped in the roots of business culture that shuns reckless bets, he will prefer caution to high risk.

Uday, who was raised in an upper-middle-class joint family, has built a mighty financial services empire by erring on the side of caution. Among the pieces in his treasure chest, the jewel in the crown is Kotak Mahindra Bank, India's fourth-largest private sector bank in terms of assets and the second-largest by market value. The bank's market capitalisation is about Rs 3.1 lakh crore, while rival ICICI Bank's is at Rs 2.7 lakh crore.

"The trouble with risk is that the downside is unlimited. If you have the approach to build your franchise, there is a defined amount of money you will need. Our bias will always be towards building the franchise and generally being more conservative on the risk front," he recently told analysts.

But in the first decade of the 21st century, a banker-turned-entrepreneur was creating ripples with his contrarian approach. Born in 1957, Rana Kapoor was two years older than Uday, but Yes Bank, which Rana founded along with Ashok Kapur, was a year younger than Kotak Mahindra Bank. Since its inception in 2004 as a new-age bank with robust technology, Yes Bank saw a meteoric rise and became the fourth-largest lender in the private sector. The loan book grew in five years from Rs 55,633 crore in March 2014 to Rs 2.41 lakh crore in March 2019.

Uday could have been tempted to grow his loan book aggressively, but he remained focused on mobilising deposits and being conservative on the asset side. His business philosophy emerged triumphant when Yes Bank crumbled under the weight of bad loans and allegations of fraudulent divergence, which are now under the scrutiny of the investigating agencies.

The strategy of loan concentration to a few large corporates such as the Anil Ambani group, Essel group, DHFL and IL&FS initially worked but finally broke the bank. Yes Bank's market cap has shrunk to Rs 31,118 crore and its per-share price dropped to Rs 12.42 from its heady days of Rs 393 in August 2018. Kapoor fell prey to greed and is currently lodged at Taloja Jail, Maharashtra, on charges of money laundering.

For us to understand Uday's brand of capitalism, it is important to go back to his childhood. He was in a household where "60 people stayed under one roof sharing a common kitchen". He grew up in an ecosystem which he called "capitalism at work and socialism at home". The concept of equilibrium got ingrained in him and cosmopolitan Mumbai allowed him the space to be "different" and "bold".

He studied in a Hindi-medium school and imbibed the whole ethos of a "traditional Indian Gujarati family". After his studies, he decided not to pursue the family business of cotton trading or work in a multinational company but set up a small bill discounting business. His father, who had migrated back from Karachi in 1947, gave him a 300-sq ft office space in the Flora Fountain area of South Mumbai.

For Uday, there are three qualities that go into building an outstanding financial institution. "These are prudence, simplicity and humility," he tells Shekhar Gupta on the TV show 'Walk the Talk'. By prudence he means "not to leverage excessively".

He is, however, not averse to taking risks, provided the deal comes at the right price and offers great value. In November 2014, Kotak Mahindra Bank acquired Bengaluru-headquartered ING Vysya Bank in an all-stock deal valued at around Rs 15,000 crore, to expand its presence in South India. With more than 65% of ING Vysya's branches being in urban and metro regions, it became a natural fit for Kotak Mahindra Bank and helped improve its liabilities franchise.

"There would be very little overlap in terms of branches and the top eight cities would account for a third of the total number of branches of the merged entity," Uday had said then.

The deal also enabled Kotak Mahindra Bank to diversify its loan portfolio as ING had a sizeable small-and-medium-enterprise (SME) clientele while Kotak had strength in the retail business. Besides, Uday could cut his stake in the bank from 40% to 34%. The RBI had asked him to lower his holding to 30% by December 2016.

Six years after gobbling up ING Vysya, there are rumblings that Uday may snap up IndusInd Bank, owned by the Hinduja brothers. Bloomberg reported that talks are on for a merger in an all-stock deal. This would create India's eighth-largest lender by boosting the assets of the combined entity to Rs 7 trillion ($950 billion). Though its ranking as the fourth-largest private bank would remain unchanged, it would narrow the gap with Axis Bank.

There are three reasons Uday Kotak should begin the acquisition hunt for IndusInd Bank. First and foremost is, of course, scale and size of the deal. According to Macquarie Capital Securities analyst Suresh Ganapathy, Kotak has always found it difficult to build scale organically. "Acquiring IndusInd Bank will result in Kotak's asset book, loan book and branch network increasing by 85%, 94% and more than 100%. This gives it tremendous scale and size benefits," he says.



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Next is the valuation at which the deal could conclude. IndusInd is now trading at closer to book value on a forward basis. Kotak could benefit from low valuation of 1.1x forward price to book, while it paid closer to 2x price/ book value for ING Vysya Bank.

Third is the Reserve Bank of India's regulatory need to scale down the promoter holding in the bank to 15%. An all-stock deal with IndusInd Bank will help Uday to pare his stake, which is currently 26%, but the extent of the scaling down will be decided by the share-swap ratio. In the Vysya Bank deal, he was able to bring down the promoter group shareholding to 34%. He has been able to further reduce it to 26% but as per the agreement with the RBI in January 2020, the promoters' voting rights in the bank are capped at 15%.

"By taking the inorganic route through a merger, he will be able to bring down his stake and at the same time ensure growth for Kotak Mahindra Bank," says Karthik Srinivasan, group head - financial sector ratings, ICRA.

Uday does not want to be chained to the thought that the inorganic route is the only option to grow in size. He has used the months since the outbreak of Covid to make his bank future-ready for growth with a focus on consumers, consumer segments and digital. The best way to build a finance business, as he so clearly understands, is to keep working on the common-sense principles of what works for consumers.

In 1989, he went into the car financing business with a value proposition to consumers that he would give them immediate delivery of the vehicles, but they had to agree on the commercial terms they had with Citibank. Those were the days when cars were in short supply and Citibank was the only bank financier in this segment. He booked Maruti cars, gave delivery to customers and financed car loans this way. His vehicle-lending business just zoomed.

There is a conservative side to Uday which has stayed stuck even after his entrepreneurial successes. As the coronavirus pandemic has wreaked havoc on the economy, Uday has been quick to trim the bank's loan book by 7% in the first six months of this fiscal. He believes Covid has disproportionately hit the lower end of the strata and urban stress is more in the unsecured book.

"This year, we have brought down our unsecured credit card and personal loans by design. We are more comfortable with home loans, loans against property, working capital loans, construction equipment and agri MSME (micro, small and medium enterprises) loans," he says.

Saumya Agarwal, who has worked as a banking analyst in various organisations and is now insight provider at SmartKarma, believes shrinking the loan book and also re-balancing the portfolio towards safer segments was a prudent strategy to have amid the pandemic. "Kotak Mahindra Bank also played on its strengths-high CASA and a strong treasury, which more than offset the impact of muted revenue drivers in the second quarter of FY21. Once the economy revives, the bank will be one of the biggest beneficiaries of credit growth," she says.

In 2011, Kotak Mahindra Bank took a strategic decision to build a long and stable deposit franchise. This may have come at a higher cost but after nine years, the journey has been effective. The current and savings account (CASA) ratio is over 57%, and close to 65% of the bank's deposit base is in the low-cost and sustainable category. "In many ways after 2011, we got an opportunity to play on our terms on the liability side," Uday told analysts.

Sitting on a high pile of low-cost deposits, excess capital and a healthy balance sheet, many feel that the management's conservative approach to loans should go. Uday himself feels the need to relax the tight grip on the asset side a bit more. "We are now very clearly focused on opening the asset engine for a broader single banking system. The approach is to bring assets and liabilities much closer together," he emphasises.

Some analysts want him to do more than that as they have seen him become "extremely conservative towards lending" when the "market conditions turn adverse". Says Ganapathy, "He has enough capital now and shouldn't let go the opportunity. He should look at portfolio or bank buyouts. With his attitude and approach to lending, growing organically is always going to be a challenge."

Does the bank need to grow in size? State Bank of India managing director Challa Sreenivasulu Setty, who oversees retail and digital banking, did not want to specifically comment on Kotak Mahindra Bank, but he said generally that size is needed to mobilise the retail asset portfolio for significant gain in market share. "From retail lending point of view, you can reach out digitally. But from retail deposit franchise point of view, you need branches. Retail deposits are the most important source for funding loans in India. For giving loans, you need to raise deposits. This situation does not arise in the developed markets where banks predominantly depend on market borrowings to fund loans. About 80% of the bank loans in the US, for instance, are funded by borrowings," he said.

Taking risks could be part of the solution now, not the problem. While the loan book has de-grown 4% in the quarter ended 30 September over the year-ago period, the deposit growth is 12% and capital adequacy ratio as high as 22%. The leveraging muscle is waiting to be put to exercise.

With Covid weakening most of the banks and the non-banking financial companies (NBFCs), Kotak Mahindra Bank and some 5-6 others would be in a position to lend aggressively. Having a 2-2.5% market share of the banking sector, there is a huge opportunity to grow this substantially. "We will be opening up a number of gates in the weeks to come. In addition to the liability side of customer acquisition, we will start focusing on the asset side for significant increase," Uday reassures analysts.

The easiest way to gain market share will be to acquire IndusInd Bank. Though it may not be a perfect fit, it will give Kotak immediate scale. "I am not too convinced about the complementary strengths of the deal. There could be a massive overlap of branches as IndusInd also has a large presence in western India. Unlike the ING Vysya deal where he got a strong foothold in South India, this could limit the synergistic benefits. But he gets immediate scale and pricing can be a big attraction as IndusInd Bank is trading low. Even if some assets turn sour and he has to do some write-offs, at that valuation he can absorb it and move on. For Kotak to grow organically to that scale, it will take several years," says Ganapathy.

But what will make the Hindujas sell? The prime reason being cited by media for the disposal of the bank could be the feud between the four brothers over the future of the family's $11.2 billion fortune. But if anything, there can be a counter-argument that the dispute among the brothers could halt the deal.

Price valuation could be the biggest thorn on the progress of the deal. IndusInd Bank's market value has shrunk from a 52-week high of Rs 1,596 per share to Rs 585 amid the shadow of the coronavirus, a crippled economy and rising bad debts. The stock price has been hammered due to fears of a deterioration in the bank's asset quality and erosion in low-cost deposits. So, will the Hindujas sell cheap? Being astute businessmen, they would rather wait for the economy to revive and carry out the corrective exercises than sell now.

IndusInd International Holdings (IIHL), the promoter of IndusInd Bank, has completely denied the rumour of selling out and considered it "malicious, untrue and baseless". The founders "reiterate their full support to the IndusInd Bank, now and always", a statement from IIHL said.

If IndusInd Bank is not put on the table, Uday can have a sniff at the other smaller private banks. He has so far been very prudent but now is perhaps the right time for him to be aggressive, analysts say.

"With the capital cushion that Kotak Mahindra Bank has, it is in a position where it can afford to take risks. The driving force for a deal will be to get a bigger loan market share. The purpose has to be asset-driven," says Agarwal.

A common grain of thought that runs across all the businesses of Uday Kotak is that the risk-reward ratio has to be worked out very cautiously. "A surplus cash position does not necessarily mean that he needs to do an acquisition. And when a loan is given, we need to make sure that the money comes back. That is how our NPAs have been low and we have never participated in most of the dodgy accounts. We want to be a sound bank," says a senior executive in the organisation who did want his name to be revealed. He may be just the person voicing out Uday Kotak's mind.