The financial performance of CSB Bank for the quarter ended 30 Sep. 2023 has caught the attention of many investors and analysts. Despite a significant rise in Interest Income, the bank’s net interest income has only slightly improved. The bank’s cost-income ratio, which is the ratio of interest expense to interest income, has reached its highest level in three years, leading to concerns about its profitability.
However, CSB Bank still maintains its competitive position relative to its peers in South India on core business parameters such as cost of funds, net interest margin (NIM), and cost-income ratio. In this article, we will analyse the bank’s financial performance, its competitive position, and future growth prospects.
Briefing
CSB Bank, despite a 23.8 percent rise in Interest Income for the quarter ended 30 Sep. 2023, saw its net interest income rise by only 5.8 percent due to a much larger spike in interest expenses – by 49.27 percent – for the quarter.
The cost-income ratio – the ratio of interest expense to interest income – at 50 percent for the quarter is the highest in three years. The corresponding values for the previous three quarters (June 2023, March 2023, Dec 2022) were 46.7 percent, 45.3 percent, and 40.9 percent, respectively.
The asset quality seems stabilised at 1.27 percent (gross NPA) and 0.33 percent (net NPA) over the last three quarters: previously, non-performing assets (NPAs) had declined steadily for five years (FY18-FY23).
The bank’s deposits and advances grew at 21.21 percent and 27.41 percent year-on-year, respectively, during the quarter. Net worth grew 20.22 percent year-on-year during the quarter. The latest return-on-equity stood at 16.6 percent; this was 17.08 percent in the March 2023 quarter, and 17.80 percent in the Sep. 2022 quarter: a declining trend in profitability is obvious.
Before the Sep. 2023 quarter results announcement, for 2023, the shares of CSB Bank had gained 52 percent from ₹237 per share to ₹360 per share. However, the stock dropped 12.3 percent – to ₹320 per share – in the week following the results announcement; later, it recovered to ₹340 per share. The initial share price drop indicates the market’s disappointment at the results; however, we could conjecture, from the share price recovery afterward that markets have realised that things are not as bad as initially thought.
Analysis
The most remarkable aspect of CSB Bank is that it was able to bring down its cost of funds (%) to 3.9 percent in FY23 from 8.0 percent a decade ago. Generally, banking is a commoditised business; therefore, those with the lowest cost will surely enjoy a competitive advantage. CSB Bank has the lowest cost of funds compared to its peers – South India-based, similar-sized banks: South Indian Bank, Federal Bank, City Union Bank, Tamilnadu Mercantile Bank, and DCB Bank. These banks have a median cost of funds of 4.23 percent for FY23, higher than CSB Bank’s cost of funds of 3.9 percent for FY23. CSB Bank, also, has the lowest cost-income ratio among peers: 42.5 percent in FY23 against the median of 55.06 percent for peers.
However, the bank had to endure a rise in its cost of funds over the last three quarters, particularly in the Sep. 2023 quarter. The cost-income ratio for the Sep. 2023 quarter stood at 50.0 percent – a steep rise from 42.5 percent in FY23. The cost of funds, too, rose to an annualised 4.86 percent for H1FY24 from 3.90 percent in FY23. However, the rise in the cost of funds is not unique to CSB Bank, but rather an industry-wide phenomenon: the median cost-income ratio for CSB Bank’s peers increased to 59.64 percent in H1FY24 from 55.06 percent in FY23, and similarly, the peers’ median cost of funds rose to an annualised 5.26 percent in H1FY24 from 4.23 percent in FY23. Therefore, CSB Bank maintained its ‘low cost’ competitive position, despite a spike in its cost of funds for H1FY24, because the cost spike was an industrywide event, and not specific to CSB Bank.
The bank’s management seems optimistic on the interest rate front. “I am confident that our NIM has bottomed out in this quarter and as per our plan, we should be able to report a NIM higher than 5 percent on a full-year basis,” says Pralay Mondal, the bank’s CEO, in the earnings call post the Sep. 2023 quarter results. This could be achieved either by an increase in yield on assets or a drop in the cost of funds in H2FY24.
Other Recent Contents
- Analysis – Dynemic Products
- Analysis – Kovai Medical Center & Hospital
- A Brief Intro. to the Stock Market
The yield on assets (%) also saw an increase in H1FY24, but not to the same extent as the increase in cost of funds. CSB Bank’s yield on assets for FY23 was 8.75 percent higher than the median of 8.14 percent for its peers. The yields rose to an annualised 9.48 percent in H1FY24, still higher than the median yield of (annualised) 8.86 percent for its peers.
The high credit-deposit (CD) ratio of CSB Bank is an impediment to its future growth. The CD ratio for CSB Bank stood at 87.5 percent as of 30 Sep. 2023, steadily rising from 63.6 percent five years ago. A high CD ratio ensues when ‘advances’ growth outpaces ‘deposits’ growth for some time. At the present CD ratio, it is implausible to maintain the present advances growth without compromising on risk level. This will adversely affect profitability because advances are the source of a bank’s core income – interest income. Hence, due to the high CD ratio, we should expect a period of lower profitability for CSB Bank. This impediment could be rectified if deposit growth can outpace advance growth until the CD ratio can moderate to the 65 – 75 percent range: a range conducive for further growth in advances and interest income.
As we have seen before, CSB Bank is in a strong competitive position relative to its peers on core business parameters – cost of funds, NIM, and cost-income ratio. However, it has high operating expenses relative to its peers. Whether that is a drawback or not requires more deeper analysis. CSB Bank’s operating expenses as a percentage of interest income stood at 40.6 percent in FY23. The corresponding ratio for its peers stood at 29.26 percent. The largest component of operating expenses is employee benefits expense. Intuitively, it feels that a high-quality talent should warrant a competitive edge. However, acquiring high-quality talent requires higher compensation. If so, CSB Bank’s high employee benefits expense might not be a drawback, but rather a competitive edge. This pattern – a high employee benefits expense relative to peers – is commonly observed among companies with strong competitive positions in certain industries, particularly service-oriented ones.
Insight
Currently, CSB Bank is going through a period of capital expansion – as evidenced by the advances and deposits growth – while, at the same time, it is experiencing a contraction in margins and profitability. Such phases do not augur well for stock prices. Stock prices are expected to underperform during such phases, and we expect the same to happen with CSB Bank.
Nevertheless, what we generally observe in markets is that – this capital expansion phase will be followed by a capital contraction phase – during which capital growth slows down, margins and profitability improve, and stock prices outperform. This general trend of expansion and contraction in business activities at a firm is called the capital cycle.
The capital cycle is a fact of investing. We become better investors by understanding, accepting, and embracing it. It is not necessary to sell a stock going through capital expansion and margin contraction – as CSB bank presently does – even though we know stock prices are expected to underperform during such a phase – because the exact point of a pivot from contraction to expansion, or vice versa, is hard to determine. Rather what we could do, to our advantage, is that: a little further into the capital expansion phase – during which stock prices are expected to have underperformed –valuation may have turned attractive. Such situations offer opportunities to gobble up shares in quality companies at low prices and we should utilise them.
CSB Bank is a quality stock from the banking sector with a strong competitive position. However, it is currently facing challenges in the form of 1) a spike in the cost of funds, 2) a high credit-deposit ratio, 3) a declining CASA ratio, and 4) margin contraction. These challenges are short-term in nature and are expected to be transient. The long-term prospect remains bright and intact as of now. The stock is expected to underperform for some time which could be used as an opportunity to buy shares at a reasonable price.
At the current market price of ₹340 per share, the stock trades at a price-earnings ratio of 10.21 and price-to-book value of 1.70. Our estimated fair value for the stock is ₹333.45 – 1.67 times its book value.
AMN CAPITAL 
One thought on “CSB Bank Maintains its Competitive Position but Faces Impediments to Growth in the Near Term”