Axis Bank Prunes Risk To Limit Credibility Hit From Bad Loan Surge

Axis Bank Ltd., the country's third largest private bank by assets, is in the midst of an overhaul of its corporate lending practices as it seeks to reassure investors that the recent surge in bad loans is a one-off.

The process involves reducing the concentration of loans across high-risk sectors and highly-leveraged borrowers while also changing employee incentive structures to ensure the experience of the last few years is not repeated, said Jairam Sridharan, chief financial officer of Axis Bank in an interview with BloombergQuint on Tuesday.

Axis Bank, not unlike other corporate lenders in the country, saw a jump in bad loans after the Reserve Bank of India (RBI) conducted an asset quality review in 2015 and asked banks to classify stressed loans appropriately. The impact of this review has been seen in bank earnings over the past five quarters. In the case of Axis Bank, bad loans or gross non performing assets (GNPAs) have jumped 360 percent – the steepest across the industry.

Sridharan disagrees that the bank's performance has been worse than others. He points to the fact that the increase in the GNPA ratio at Axis Bank is in line with what other corporate lenders have seen.

While defending its track record, Sridharan acknowledged that the bank has been left worse for wear after the infrastructure lending binge at the start of the decade. Loans given between FY10 and FY12, to companies in sectors like infrastructure, metals and power, continue to give the bank the most “heartburn”, said Sridharan.

At the end of March 2009, Axis Bank had a corporate loan book (excluding loans to small and medium enterprises or SMEs) of Rs 41,211 crore, shows data from the bank's investor presentations. By March 2012, this portfolio had grown to a size of Rs 91,055 crore.

The pain is still not over.

The bank had created a watchlist of Rs 22,000 crore in loans in April 2016, of which about half has slipped into the bad loan bucket already. “Substantially more than 60 percent” of this is expected to turn bad, said Sridharan. The bank is also seeing stress emerging from outside this watchlist. Thirty percent of slippages (or new bad loans) in the December quarter came from outside the watchlist, leaving analysts concerned.

Ravikant Bhat, research analyst at IDBI Capital said the view and valuations on the bank have corrected cyclically to reflect the bad loan problem.

Lack of clarity on the true extent of bad loans has meant that Axis Bank has lost its status as the market darling. The consensus estimate for the stock has slipped from Rs 660 per share at the start of September 2015 to Rs 494.59 now. The stock is currently trading at Rs 513 per share. Only a third of analysts have a ‘buy' rating on the stock now compared to more than 80 percent last year.

Once Bitten; Twice Shy

The bank's top management, including Sridharan, know this needs to be corrected. They are doing this by rebalancing the loan portfolio and reducing so-called concentration risk. “That's the first thing we are doing - tightening our concentration guardrails,” said Sridharan.

The proportion of corporate credit will be reduced to near about 40 percent of the loan book from 45 percent now, he said while adding that the bank will retail its corporate lending DNA. The bank is also reducing the ticket size of loans in the corporate and the SME segment.

In addition, the bank has substantially cut lending to its top 20 borrowers.

“If you look at exposure to top 20 borrowers as a percent of a Tier-1 capital, that ratio has come down to less than half of what it was in FY13,” said Sridharan without giving the exact ratio.

Meanwhile, the credit rating mix of the portfolio is being altered with most incremental lending going to firms with a rating higher than A. The focus of lending, too, is shifting towards lower risk working capital loans.

“These correctives have not gone unnoticed by the street. Even before they acknowledged the bad loan problem, they had started to diversify the book and had adopted a more retail focused strategy. That was timely. The bad loan problem could have been worse if they hadn't diversified,” said Bhat of IDBI Capital.

As corporate credit has been de-emphasized, Axis Bank, like many others, has increased its focus on retail lending over the last couple of years. Retail loans now form 43 percent of the bank's loan book and could rise to “the mid-to-high fourties”, said Sridharan.

Could this rapid lending to retail clients prove to be a risk in itself?

Retail lending has had a “dream run” with risk in the business reducing significantly between 2010 and 2016, explained Sridharan. This risk cycle slowly started to turn last year. “I think you have to think very seriously about the probability that risk (in retail lending) may be on its way up... So now is the time when you should have tightened your norms. We, at the bank, have done that and have been doing so for the last year and a half.”

Also Read: Why Uday Kotak May Stay Away From Axis Bank

Is The Bank More Vulnerable Now?

Bad loans are not the only cause for heartburn for the bank's top management. Over the past few months, the lender has found itself embroiled in a series of controversies.

In December, the Enforcement Directorate arrested two Axis Bank officials for alleged involvement in illegal activities during the currency exchange exercise kicked off by the government in November.

More recently, The Times of India reported that biometric identity (Aadhaar) data has been compromised via a business correspondent of the bank, leading to the Unique Identification Authority of India (UIDAI) temporarily halting all Aadhaar-based transactions by Axis Bank.

To top it all, there has been speculation about competitors like Kotak Mahindra Bank expressing unsolicited interest in merging with the bank.

“We see no reason for a merger at this stage,” said Sridharan repeating the bank's denial of merger talks.

Also Read: Axis' Merger With Kotak Mahindra Bank A Positive If It Happens, Says BofA ML

When asked whether the bank's poor run over the past few quarters has left it vulnerable to attack, Sridharan said that along with tightening lending practices the bank has also made internal processes more rigorous and strengthened its governance infrastructure.

To ensure that high growth (which could lead to high risk down the road) is not the only thing rewarded, the bank has also tweaked incentive structures.

Citing an example of this change, Sridharan said that five years ago the bank may have rewarded an employee based on how big a rainmaker she or he has been. Over time, this has morphed into an assessment based on the risk-adjusted return on capital. Employees are no longer measured on topline growth but on the risk profile of their portfolio, he said.