Karnataka Bank Research Report By Centrum

Solid performance; reiterate BUY

We retain Buy on Karnataka Bank (KBL) with TP unchanged at Rs200 (valued at 1.3x FY19E ABV). Q2’18 results were strong on all fronts – loan growth accelerates, margins improve, fee income strengths further and asset quality – ie slippages moderate. Commentaries on each of the above key parameters remain encouraging and thus even as we factor in elevated provisioning; we believe RoE’s are set to inch towards 12% levels by end-FY19E. Capital position remains strong; valuations at 1x FY19E ABV remain undemanding.

– Q2FY18 result – Solid performance: Q2’18 NII at Rs4.4bn grew 10.8% YoY and was led by 12.3% YoY growth in loans and further expansion in NIM (calc) to 2.75% (+9bps QoQ 3bps YoY). Non-interest income too came in higher (fees grew 36% YoY; treasury were up 21% YoY) and with stable costs saw operating profit grow 57% YoY. Slippages stood at Rs3.74bn (3.6% of loans annualised) vs. Rs4.98bn QoQ and after providing for the same including tax related provisioning, net profit came in at Rs934mn (down 25% YoY). While sequential decline in slippages is positive, provision coverage ratio at 27.3% (flat QoQ) is still on the lower side to peers and needs some attention. Deposits grew by 6.5% YoY led by 15.6% YoY growth in CASA deposits; CASA ratio has inched to 28.6% (vs. 26.3% YoY).

– Margins on upmove; slippages set to moderate: NIM at 2.75% (calc) for the quarter is on an upward trajectory and is following continued efforts at a) containing overall cost of deposits (6.23% in Q2’18 vs. 6.3% in Q1’18) b) scaling overall loan-to-deposit ratio higher (Q2’18 LDR at 72.7% vs. 68.4% QoQ / 69% YoY) and c) garnering CASA deposits including recent reduction in SA rates (effective August, 2017). Levers are in place and will see overall NIM (calc) inch towards 2.9% by FY19E. Q2’18 slippages at Rs3.74bn included one large account of Rs2.3bn (housing-infra sector) that was downgraded to NPA. This account was earlier recognised as SDR and the bank carries adequate provisioning thereon. Standard restructured loans stood at Rs6.9bn and coupled with GNPA, SDR and S4A make for 6.5% of loans (vs. 8.6% in FY17). Commentaries on incremental slippages remain encouraging and we have factored the same into our estimates.

– Provisioning to impact near-term profitability; underlying trend intact: The trends on the operating front remain encouraging – loan growth momentum accelerating, NIM, loan-to-deposit ratio on an up-move, increasing contribution from core-fee income, improving CASA and stable operating costs. We thus have revised our NII / PPOP estimates upwards and are now factoring in 15.5% / 23.9% CAGR respectively over FY17- 19E. Slippages are set to moderate / decline in H2’18; provisioning however is set to remain higher given a) NPA ageing b) provisioning towards IBC cases and c) any markdown (if required) on the security receipt (SR) portfolio. The quarter saw SR related provisioning of Rs250mn; the bank has Rs4.5bn of O/s. SR. Given the above factors including the need to increase overall PCR we are factoring in 130bps of credit cost over FY17-19E. We expect the bank to report 24% CAGR in PAT over the similar time-frame

– Valuation, view and key risks: KBL Q2’18 results were in-line with our estimates on several fronts. We, however have tweaked our estimates on provisioning front. Though at a nascent stage of transformation, the bank has made strong in-roads in its journey of RoE improvement. The transformational exercise as envisaged will further augment overall RoE’s. Valuations at 1x FY19E ABV remain attractive. Retain Buy with TP at Rs200 (valued at 1.3x FY19E ABV). Higher than expected slippages and lower than expected credit growth remain near-term risks.