Best Mid-Cap Bank Stocks To Buy Now By IIFL

Private Banks capitalizing on PSU banks’ waning loan market share

The market share of total private sector banks (largecap + midcap) in total domestic bank credit has improved over the last 8 years vs. public sector banks (PSU banks). It has increased from 18.1% in FY10 to 29.8% in FY18, while that of PSU banks contracted from 77.2% to 64.4% over the same period. The loss in the market share of PSU banks is attributed to their weak capital position due to higher stressed assets & provisions and balance sheet deterioration.

The credit market share of all midcap private sector banks has increased from 2.27% in FY14 to 3.22% (~Rs 2.9 lakh cr) in FY18. Moreover, expanding credit growth, better capital position and branch expansion would aid mid-sized Pvt. banks to further improve their credit market share to 3.78% (~Rs 4.2 lakh cr) by FY20E. Among the mid-sized private banks, our preferred picks are RBL Bank, Karur Vysya Bank and City Union Bank.

We prefer

(1) RBL Bank, owing to its improving return profile, due to better advances & loan mix, higher CASA, lower cost ratios and better asset quality. The bank’s strategy to lend to quality clients with prudent cash flows and its C&IB division’s (Corporate & Institutional Banking) focus on working capital finance (~70% lending to short term working capital finance) will help it to maintain asset quality;

(2) Karur Vysya Bank (KVB), due to digital banking initiative, asset quality improvement and advances growth; resolution in NCLT cases and focus on better rated corporates will lead to asset quality improvement;

(3) City Union Bank (CUB), due to increasing loan book led by better traction in MSME and retail loan segments. The bank’s focus on small-ticket secured lending (99% of loan portfolio secured) has helped maintain sound asset quality.

Of its total loan book, ~66% comprises working-capital loans, which are completely collateralized. Further, its focus on lower slippages and higher recovery will lead to declining credit cost over next couple of years.

RBL Bank

RBL Bank’s strategy of lending to quality clients with prudent cash flows and its C&IB division’s focus on working capital finance (~70% lending to short term working capital finance) has helped maintain asset quality. We expect its slippage ratio to decline from 1.4% in FY18 to 0.7% in FY20E, due to its focus on lending to better rated corporates.

We project the GNPA ratio to decline by 30bps over FY18-20E to 1.1%. In addition to improving loan book in coming years, it will also see an improvement in NIMs supported by better product mix and lowering cost funding profile. We project its NIM to surge by 41bps over FY18-20E to 4.2%. We project RoA and RoE to increase by 24bps and 317bps to 1.4% and 14.6% respectively over FY18-20E.

Karur Vysya Bank

Karur Vysya Bank, in H2FY19, will launch all its products and services on a completely digital platform, which will provide a boost to its loan book. Further, we believe the bank is in its tail end in terms of corporate NPAs. We expect its slippage ratio to decline from 4.6% in FY18 to 1.3% in FY20E (due to declining share of corporate loans in total loans, which accounts for ~80% of slippages).

According to us, the GNPA ratio would decline by 136bps to 5.2% over FY18-20E due to lower slippages and higher recoveries owing to resolution in NCLT cases. Over FY18-20E, lower loan loss provisions and interest reversal (due to lesser slippages) would drive an improvement in return ratios. We forecast its RoA & RoE to increase by 48bps and 540bps to 1% and 11.5% respectively over FY18-20E.

City Union Bank

City Union Bank to benefit from its increasing loan book led by better traction in MSME and retail segments. The proportion of MSME + retail in total loan book is expected to increase by 160bps over FY18-20E. Its focus on small-ticket secured lending has helped to maintain sound asset quality in the past few years despite the industry being under severe asset quality stress. Its focus on lower slippages through better NPA management (99% of its loan book is secured) and higher recovery will lead to declining credit cost over next couple of years.

We expect slippage ratio to decline from 2.1% in FY18 to 1.4% in FY20E. In addition, focus on high yielding products, better CASA & CD ratio and lower cost ratios to support return profile. Its return ratios are likely to remain superior to that of regional peers, including SFBs over FY18-20E. We forecast its RoA & RoE to increase by 7bps and 13bps to 1.64% and 15.4% respectively over FY18-20E.

Improving return metrics to aid valuations

RBL Bank

RBL Bank enjoys better asset quality than its peers and has delivered industry leading loan growth over last few years. The stock has traded at ~3x P/BV over last 1.5 years. Going ahead, we believe, earnings growth potential (36.8% CAGR over FY18-20E) & improving return profile over FY18-20E, makes a case for re–rating the stock’s multiple. It presently trades at 12-15% discount to its peers, and we believe that the valuation gap should narrow over next one year.

Karur Vysya Bank

Karur Vysya Bank, in H1FY18, was trading at attractive valuation i.e. above 2x P/BV, on the expectation of waning asset quality concerns and better loan growth. However, on account of demonetization, its exposure to the SME segment and February 12 circular by RBI, the bank’s asset quality deteriorated in FY17 and FY18, which resulted in the stock trading at lesser multiple.

However, as things are expected to improve on asset quality front coupled with better earnings & improved return ratios over next couple of years, we believe the stock would fetch above 2x multiple. Karur Vysya Bank is expected to deliver earnings CAGR of 50.9% over FY18-20E aided by higher NII and asset quality improvement providing a room for valuation upgrade.

City Union Bank

City Union Bank, over last few years, has witnessed relatively better and stable valuations owing to consistent return profile vis-à-vis midsized private bank peers. It is expected to continue with higher return profile going ahead. It has better grip on asset quality as ~99% of its portfolio is secured.

The stock, over last 1.5 years, has fetched the valuation multiple in the range of 2.1-2.6x P/BV. We believe, CUB, as a compounding play with greater bottom-line visibility over the medium term should continue to fetch higher multiple.