Kotak Mah Bk may face litigation on MTM losses

Excerpts from CNBC-TV18’s exclusive interview with Uday Kotak:

Q: How do you see your NIM picture over the next few quarters, given the interest rate expectations you have now after listening to the RBI Governor’s policy?

A: You are moving into a banking business which is going to be much more back to basics. In this situation, if you look at our NIM last year, on a consolidated basis we have 5.6% which his amongst the highest in the industry.

Banks and financial institutions should be focused on the traditional lending business. We are seeing a reasonably strong demand for credit, particularly with ECBs having slowed down. Back to basics focuses on getting deposits and lending at a reasonable spread and making your returns risk adjusted. Therefore, at this stage, banks have a significant ability to build a strong spread business as distinct from businesses which were more market-driven.

Therefore, the traditional models of pure and simple getting your strategy right on deposits and lending at good rates is going to be the key. You are also going to see a situation where there is going to be a significant differentiation between banks and non-banks, in terms of ability to access deposits and gather liabilities. Therefore, back to basics is the key focus for players in financial services.

Q: That is an interesting point because it comes on the back of a couple of years where a lot of banking entities have seen their overall revenues being topped up by generous doses of fee income from various markets including forex business, derivatives etc. Are you saying that is a thing of the past and you would see those avenues and streams of income diminishing visibly?

A: No, there is going to be a mixed change. Even in the fee income, you are going to see a mixed change pretty dramatically. For example-in an investment banking business, a lot of the fee income earlier was from IPOs, QIPs and private placements and things like that. The way the model will change on the fee side and on investment banking is that you are going to get a significant opportunity to build an intermediate investment banking model by fee income, servicing and financial sponsors i.e. private equity.

There are more than 100 institutions from around the world operating in India, servicing these financial sponsors and making sure that companies which need capital and cannot raise capital easily on public markets because of the volatility can raise money from them. Therefore, the investment bank has to move its model in that direction.

Secondly, as markets correct we are beginning to see significantly more interest and activity in the strategic space in M&A. So, the investment banking business, which was primarily driven on the fee side by IPOs and QIPs, has shifted into M&As. Financial sponsors and banks like us therefore have changed focus on this side.

Q: You have already spoken about the provisions and mark-to-markets. Do you think any of those transactions between your clients and the bank have the potential of opening up any kind litigation, the likes of which we have seen with a few of your peer banks taking you to Court because of what went wrong?

A: Yes, some of the companies have contested this. But in my view, in our case we have a very modest total MTM, which is Rs 612 crore and have made a total provisioning of Rs 86 crore against that.

As I look at the situation, this is a very fundamental issue about governance of Indian companies, which enter into principle-to-principle contracts. It is an issue about the boards of these companies and about how they govern, what are the authorities.

It is a deeper issue about governance, particularly of corporate India in this context. Some of them will look at litigations as an option. But from our point of view, as long as we have disclosed to the market our total MTMs and our provisioning, we are ready to do what is right for the bank.

Q: One word on the performance of securities arm as well, because the market seems a bit concerned about where that wing will go. Volumes have also dried up. Do you see the kind of growth that you saw in FY08 being sustained or maintained in the next financial year for the securities arm in specific?

A: If you look at numbers of our securities arm for the quarter-ended March 2008, i.e. January to March, w have already begun to see the impact of slower volumes. Our profit after tax, or PAT, for the quarter is about Rs 101 crore up from same quarter last year, which was Rs 75 crore. We have been able to manage a pretty decent growth in that business, even in a market which had become significantly slower and more volatile.

You have just got to keep on doing the right things. We see significant consolidations happening in the securities industry from a structural point of view over the next 12-24 months. We feel it is the right time to consolidate our position as the industry may go through some cyclical pain. Therefore, rather than getting worried, we think the next 12-24 months provides opportunity for the industry to consolidate. The industry will be more consolidated from the current levels of fragmentation post that.

Q: We have been talking a lot about food inflation, but concerns have been raised that business inflation has scaled up quite significantly. Do you think that is a big threat for growth going into FY09 and something that people across industries or sectors will have to worry about?

A: If you had asked me three-six months ago, my top of the mind worry would have been rentals and salaries. But today, there is moderation in both. There is much more realism on the ground in terms of rentals for properties, which are getting moderated, and expectations of people in terms of the kind of companies they are looking for. If we achieve 7.5-8% growth moderation on a GDP basis next year, we will also have a touch of reality for the various components of price inflation cost, particularly in the financial services sector.

Q: How do you see interest rates panning out in this high inflation zone? The RBI Governor did not send you the signal. But do you think he will get away with this high inflation phase without any further interest rate tightening?

A: It is primarily linked to the price of oil and its impact on the Indian situation, translating through significant dollar outflows into oil bonds and related issues. If oil remains like this and inflation continues to be in the range of more than 6.5%, my assessment would be interest rates would have a tendency to firm during the year. They would at the best be stable but likely to actually firm up. From the bank’s point of view, they have to focus on the right spreads for risk-adjusted returns as the core business model.