Karnataka Bank Rating: Buy; Weak core operating performance

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Published: July 20, 2019 2:13:36 AM

Going forward, higher exposure to NBFCs (15% including Rs 1 bn towards DHFL), CRE (6%) and 1.2% of standard lower-rated exposure (in C and D categories, including Sintex and DHFL) would be the key variables.

We believe the bank’s ability to propel core profitability and fee income are key variables that are critical for its RoA improvement.

Karnataka Bank (KBL) reported weak Q1FY20 core operating numbers (PPoP down >5%); PAT, however, outperformed due to a tax reversal. Persistent pressure on NIMs along with below-trend loan growth (up merely 11% y-o-y) led to muted NII growth (sub-6%). Softer fee income and muted CASA growth (<10% y-o-y) impacted core operating profitability. The silver lining is steady asset quality as slippages were curtailed sub-4% (high still). Furthermore, lower  SMA-2 accounts (sub-1%) lend comfort. While KBL’s asset quality has been broadly steady, sustaining it coupled with NIM improvement is critical to earnings trajectory. A higher share of retail (45%) and a 0.6x FY21e P/ABV (capturing risks, limited downside) lends comfort. Maintain Buy with a target price of `145. Core momentum soft; performance improvement key

Loan book growth softened to 11% y-o-y down 4% q-o-q, primarily driven by a conscious run-down in the large corporate segment (down >15% q-o-q). That said, better retail growth (up 11% y-o-y) lent support—the proportion of retail loans improved from 43% in FY19 to 45%. Moreover, sustained pressure on NIMs (down >10bps q-o-q to 2.8%) impacted NII. This coupled with softer core fee led to muted core PPoP. Furthermore, the liability franchise expansion has been weaker than we expected (CASA growth sub-10% y-o-y with sub-28% CASA ratio). We believe the bank’s ability to propel core profitability and fee income are key variables that are critical for its RoA improvement.

Asset quality broadly steady

Slippages came in a tad higher at `5.3 bn (3.8%), mainly due to corporate slippages. Going forward, higher exposure to NBFCs (15% including `1 bn towards DHFL), CRE (6%) and 1.2% of standard lower-rated exposure (in C and D categories, including Sintex and DHFL) would be the key variables. We expect credit cost to remain high.

Outlook: Retail tilt continues

The key from now on would be to improve the performance given the bank’s volatile operating history. Going forward, while improving revenue traction (with NIM bottoming out, focus on retail segment) is likely to aid operating profit growth, elevated credit cost (coverage sub-30%) could cap earnings growth.

 

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