Nasty Surprise at Indian Bank
At Bank of India, a recent profit disappointment reflects a reversal of the previous administration’s dubious profit inflation, not systemic woes. The state-run bank’s long-term outlook is bright.
When Pratip Chaudhuri swept into his new Mumbai office on April 7, he was determined to confound expectations. Succeeding the gregarious O.P. Bhatt as chairman of State Bank of India was never going to be easy for a 36-year insider long seen as a taciturn, faceless bureaucrat.
So Chaudhuri glued on a smile and softened up India’s competitive and often abrasive media corps. But the honeymoon lasted only 10 days, until he unveiled a nasty set of figures: In the final quarter of India’s fiscal year, ended March 31, the bank’s net profit slumped 99% year over year, to 200 million rupees ($4.5 million) from INR18.7 billion, despite a slight rise in sales. Not surprisingly, the bank’s stock (ticker: SBIN.India) took a pounding, losing 20% in the next two months. After recovering slightly since mid-June, it now trades around INR2,440, down 13% on the year.
Although SBI’s long-term prospects look healthy, Chaudhuri’s announcement threw into sharp relief an unsavory aspect of Indian bank successions—the practice known as kitchen-sinking. It’s a simple concept: The outgoing chairman racks up as much profit as possible in his final quarter, throwing in everything but the proverbial sink, which leaves the incoming chairman to correct mistakes and undo bad decisions.
The chief reason for the practice is compensation. The head of a government-controlled bank gets a bigger pension if he leaves when profits are high, irrespective of the stock price. Thus, according to Devam Modi, an analyst at Equirus Securities in Ahmedabad, “It is in the interest of a chairman to cut profits when he arrives, and to increase profits” in the last few years of his tenure.
An incoming chairman often needs to unwind actions spurred by the exuberance of his predecessor. For example, Bhatt offered low-interest “teaser” loans for years to first-time house buyers with low credit ratings. Despite warnings (but no action) from the Reserve Bank of India, SBI continued this Indian version of subprime lending until Chaudhuri scrapped it in April.
Part of the profit decline in the first quarter reflected a rise in provisions to cover future losses from teaser loans. But investors were shocked by the magnitude of the increase, as Chaudhuri raised provisions for loan losses by 82%, to $1.35 billion. The bank “probably could have made a profit of $220 million in the final quarter,” says Pathik Gandotra, head of equities at IDFC Securities in Mumbai.
Before April, kitchen-sinking was a quietly accepted, if unwelcome, facet of Indian banking. When Bhatt took charge of SBI in 2006, profits fell 35% in the next quarter, while earnings slipped 28% in the first quarter under his predecessor, A.K. Kumar. At Bank of India, earnings slumped 57% after Alok Kumar Misra took over in August 2009.
In a recent research note, Keefe, Bruyette & Woods analyst Brian Hunsaker noted a “cloudy” outlook for SBI in the next six to 12 months, along with “concerns” over the bank’s loan quality. KBW lowered its 12-month stock-price target to INR2,200 from INR2,500. It rates the stock Market Perform. Longer term, the firm sees profit rising to $2.4 billion in fiscal 2012, and $3.1 billion in fiscal 2013, from $1.86 billion in fiscal 2011.
The events of the past two months have reverberated throughout the Indian banking industry. SBI’s April surprise announcement likely will make some state bank chairmen think twice about repeating past practices.
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