Earnings miss was driven by higher-than-expected provisions partially offset by higher PPoP. Slippages rose q-o-q and recoveries stayed muted. GNPLs were stable given higher write-offs. PPoP was helped by higher fees, write-back in staff provisions and interest income on IT refund. Stay UW.
Asset quality – challenges are unlikely to be over yet
GNPL formation was Rs 31 billion vs. Rs 22 billion in last quarter. Upgrades/recoveries stayed low at Rs 7.7 billion. Higher write-offs kept GNPLs stable. GNPL ratio was 9.7% vs. 10% in the last quarter. The bank guided to lower slippages at 1.5%, which we believe is aggressive given still-high stressed loans in the non-GNPL category. On asset quality divergence from the Reserve Bank of India, the bank highlighted a difference of Rs 5 billion, which is fully adjusted in FY17 numbers. Further, credit cost is unlikely to come down over the next couple of years given high impaired loans and low coverage ratio – GNPL coverage is 37%,and will be significantly lower on overall impaired loans. For the quarter, credit cost was 3.2% of loans vs. 1.7% in the last quarter.
Core PPoP – mixed bag
NII was up 14% y-o-y, but was helped by interest on IT refund. Adjusted for that, margins were broadly flat q-o-q. Loan book was up 5% y-o-y. Fees surprised positively and rose 45% y-o-y, helped by higher fee income on the sale of PSL certificates. Opex was flat y-o-y, driven by lower-than expected retirement-related provisions. Non-staff costs grew 9% y-o-y.
Net capital gains were flat q-o-q. We expect PPoP to remain under pressure in FY2018 given: 1) lower margins after lower lending rates and bond spreads;2) muted loan growth;and 3) higher opex, Note that the banks will begin the five-yearly wage hike cycle in Nov-17. Capital gains should also moderate notably as bond yields have stopped declining.
We think Canara bank will see continued earnings pressure given its high level of bad loans, low coverage and deteriorating PPoP. We view its CET 1 ratio at 8.9% to be low, implying frequent capital raises amid low internal rate of capital generation.