Although volatile & wider vs expectation, trends broadly reflect a strengthening core profitability, peak stress but elevated provision needs. Q4 is unpredictable—insolvency resolution, last few lumpy slippages, steeper yield curves would likely make it extra noisy, but a 14-15% RoE by FY20e is plausible. Maintain Hold, price target of `178.

Stressed assets lower
Gross NPL for the quarter at 11.33% increased sequentially; however most of the corporate slippages were from already earmarked stress pool. Net stressed book at 8.2% reduced 136 bps sequentially as the provision coverage ratio (PCR) improved 132 bps to 59.05%. Including technical write-offs, PCR was 68.03% and management plans to take it to 70% over a period of time. We believe NPL recognition has nearly run its course — perhaps just a few lumpy NPLs left. The focus is clearly on resolution & recovery and core profitability going forward.

Core PPOP better
NII was up 40.2% y-o-y (18.2% ahead of JEFe) and NIM at 2.72% (v/s 2.31% JEFe). The improvement in NIM is driven by higher income from tax refund (`3.3 bn) and a change in accounting policy (gross of `2+ bn — NPL recovery being credited to unapplied interest income vs. principal amount). As a result, adj. NIM at 2.37% is up 6 bps sequentially. The share of higher yielding retail assets increased and from borrowing costs benefited from higher CASA ratio (40.6%, up 140 bps sequentially). Core fee income was up 22% y-o-y. Loan growth too has improved with better traction in domestic book with a pick-up in loan-deposit ratios.

Change in estimates
We have tweaked our estimates to account for better loan growth, stable NIM, lower slippages & higher recoveries in FY19/20. However, we cut our FY18 earnings to account for higher credit costs. As a result, estimates for FY18e/19e/20e move by 47.4% /+19.2%/+16.1% respectively. We believe NPL formation and recognition cycle is closer to the peak although provision costs may remain high in the next couple of quarters. We expect RoE to improve to 14.5% only by FY20, baking in `53.5 bn capital infusion under SOE recap plan in Q4FY18.

Valuation/Risks
BOB trades at 1.1x book (Dec’17) & 9.3x earnings (12m to Dec’18). At PT of `178, implied multiples are 1.1x P/B (Dec’18) and 6.4x P/E (12m to Sep’19) v/s 10-year averages of 1.4x & 6.9x, respectively. Downside risks: Asset quality deterioration, NIM compression, growth slowdown. Upside risks: PPOP trajectory improvement, stronger recoveries

Net stressed assets reduces q-o-q
The total stressed assets (net NPA + net outstanding restructured assets + standard 5/25 + Standard SDR + S4A + security receipts) stood at 8.2% at quarter close, down 136 bps sequentially and 231 bps y-o-y. But most of this improvement is on account of increasing coverage on stressed assets as recoveries remain low.

The gross NPAs increased sequentially owing to higher slippages, even as write-offs remained high. Gross NPL was at 11.33% (14 bps higher q-o-q) while net NPL was at 4.97% (8 bps lower q-o-q) as provision coverage (ex-ACU) improved 132 bps to 59.05%. While SDR and S4A schemes are fully folded in to the restructured assets, 5/25 cases only have partial overlap. The total stressed loans under various schemes are 3.2% of loans vs. 4.5% of loans in Q2 as most of the slippages (~55%) were from restructured accounts only.

NCLT cases: BOB had exposure to all the 12 accounts under IBC #1 list. The current exposure to these accounts is `76.72 bn. BOB has about `42 bn of exposure to potentially 18 accounts under IBC #2 list. Management indicated that provision coverage on these accounts stands at around 50% and additional provisions to be made w.r.t these accounts in Q4FY18 will be `8.57 bn. The provision coverage ratio improved q-o-q with the PCR including and excluding technically written off accounts being 68.03% and 59.05%, respectively.