After an in-depth discussion last week with the management of Axis Bank, we are reducing our uncertainty rating for Axis Bank to High from Very High, driven by our greater confidence in management’s ability to drive growth in retail loans without severely compromising its underwriting standards.
In our meeting, management shared how it has grown retail exposure 37% over the last year, to constitute 30% of its loan book as of September 2013, while continuing to focus on quality lending. In our view, Axis has limited its downside risk by ensuring that close to 86% of all retail loans are secured against some assets--such as home, property, gold or deposits--while keeping the loan-to-value ratio at 60%-65%. We believe this is a good strategy to contain potential defaults on loan repayments. Furthermore, the bank has adopted HDFC Bank’s strategy to focus on lending to existing clients that already have a deposit account with the bank, which gives Axis better insights into a customer’s cash flows and payment history, prior to taking an exposure to the individual.
Management also articulated how it plans to expand its branch network by establishing a network of smaller-sized branches, which will require lower capital investments, thereby containing operating expenses at historical cost-to-income levels. Additionally, as revenues grow ahead of costs we believe Axis bank will continue to maintain its efficiency ratio at the 40%-45% mark going forward. As such, we are holding our narrow economic moat rating on Axis unchanged, as we believe the firm’s cost advantages from a loan loss, operating expenses, and funding cost perspective will remain intact. In our opinion, the stock continues to look attractive trading significantly below our fair value estimate, and we would recommend investors continue building exposure to this stock.