IndusInd Bank: Ghost of microfinance comes back to haunt

Recall that the bank’s September quarter (Q2FY25) financials were hit owing to its exposure to microfinance. IndusInd’s slippages in microfinance lending (MFL) jumped almost 18% sequentially in Q2 to ₹398 crore. MFL is generally unsecured and does not require collateral, which makes recovery difficult. With this, gross non-performing assets (GNPAs) as a percentage of microfinance loans rose to 6.5% last quarter, making it the fourth straight quarter of sequential increase. For perspective, the bank’s overall GNPAs as a percentage of total loans stood at 2.1%.

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Unsurprisingly, the intensity of investor selling picked up following the Q2 results, with the stock tanking 19% in a single day on 25 October.

Sure, slippages in vehicle financing, too, rose 5% sequentially in Q2 to ₹692 crore, but the slippage in MFL is more alarming considering that the book size at the beginning of the quarter was ₹37,046 crore, much smaller than vehicle finance book at ₹89,818 crore. Moreover, vehicle finance NPAs are relatively easier to recover as they are a secured form of lending.

As such, the near-term challenges are only going to increase with the MicroFinance Institutions Network (MFIN) tightening lending norms with effect from January. The norms include capping the number of lenders to a single borrower, capping the indebtedness level and also more restrictions for lending to delinquent or defaulting borrowers.

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IndusInd’s microfinance woes are relatively more pronounced after its merger with Bharat Financial Inclusion (earlier known as SKS Microfinance) in 2019. At the time, IndusInd’s management was optimistic about boosting its net interest margin from microfinance lending. The microfinance loan book has tripled to ₹39,192 crore in five years to FY24 from about ₹13,000 crore in FY19.

But amid rising pressures, IndusInd scaled down its MFL book to ₹32,723 crore in Q2. This was achieved through a combination of repayments and curtailing incremental lending. It intends to focus more on secured lending ahead. The shift will come at a cost though as the MFL loans are a part of the high-yielding consumer banking book that fetches interest rate of 15% plus vis-à-vis around 9% interest that corporate banking fetches.

IndusInd’s shares trade at a price-to-adjusted book value (P/ABV) of 1.1x, based on Bloomberg consensus estimate for FY25. The valuation might appear tempting to those who want to bottom fish as most leading private sector banks are quoting at P/ABV of more than 2x for FY25. However, it is worth noting that IndusInd Bank’s annualized return on assets (RoA) of 1% for Q2 is much lower than around 2% or more for its large private peers. The lower RoA could be attributed to higher credit cost at around 1.4%, while other banks have had credit cost of below 0.5%.

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The key monitorable issues are evolving stress and asset quality of MFL book and the pending approval from the Reserve Bank of India for a fresh term of the current chief executive. While most analysts tracking IndusInd have a positive recommendation on the stock, some brokerages like Motilal Oswal Financial Services have repeatedly cut their earnings estimates and target price twice in the last two quarters. Their target price at ₹1,500 per share (previous quarter ₹1,700 and before that ₹1,800) is far higher than IndusInd’s current market price of ₹987.