Karur Vysya Bank – Caution welcome, buy gradually in consolidation phase

Highlights:

• A quarter where caution came to the fore
• Business in a slow lane with advances getting granular
• Deposit drive to create more liquidity
• Guidance on slippage heartening
• Earnings may remain lacklustre in FY20

• Buy gradually in the consolidation phase

We exercised caution on Karur Vysya Bank (KVB, CMP: Rs 66 mcap: Rs 5,283 crore) two quarters ago when it had reported a rather elevated figure of expected slippage for five quarters. The bank definitely deserves kudos for recognising the problem early (which is now becoming a system-wide issue), but the business continues to be in a very slow lane.

However, in the prevailing environment, this is a positive as exercising caution is a sign of prudence rather than weakness. But meaningful earnings revival will have to wait for longer. The valuation is undemanding at 1.2x adjusted book for FY20e. Investors should gradually accumulate the stock amid all the negative noise in the market.

Key Positives

After-tax profit growth of 59 percent was heartening although core performance was tepid. Pre-provision profit declined by 3 percent. The jump in profit came on the back of lower provisions.

Asset quality so far has been behaving on guided lines. The total gross slippage in the quarter was Rs 474 crore, but the net slippage was only Rs 60 crore. The total net slippage in Q4 FY19 and Q1 FY20 have been Rs 450 crore and that gives the bank confidence about the net slippage in five quarter period not exceeding Rs 1,300 crore - something that we have factored in our estimate as well.

The overall growth has slowed, which has got to do with superior risk management practices of the bank, as it is watching the environment closely and new proposals are put on the credit screen for a more stringent evaluation. The bank has also shifted its focus on more granular lending. In the commercial banking space, for instance, the focus is going to be business banking – ticket sizes of Rs 2-15 crore. Retail is another area of focus where it has seen strong 32 percent YoY growth.

Source: Company

On exposure to rather sensitive sectors, their exposure to the NBFC space is limited to high quality names in South India. On commercial real estate, the management has clarified that their developer exposure is limited. On the quality of the book of its traditional large exposure to textile, the management feels that albeit the lower demand, there is still not any reason for worry.

The bank is clearly seeing pricing power in the market with the incremental yield on advances at 10.75 percent, much higher than its on-book blended yield of 9.61 percent.

KVB is also creating sufficient liquidity in the balance sheet, especially in light of the prevailing challenges in the environment. Total deposits of the bank grew by over 7 percent while low cost CASA (current and savings accounts) was supportive with CASA ratio at 29.7 percent. The big contribution came from term deposits where the bank has deliberately pushed the pedal in recent times. Interestingly, 93 percent of the term deposit is of stable retail nature.

 

 

Source: Company

The credit to deposit ratio has moderated to 80 percent, from 85 percent in the preceding quarter. This should help the bank participate in any growth opportunity that comes its way.

The Capital Adequacy Ratio stands at a healthy 15.99 percent with core CET 1 at 14.27 percent that should take care of future growth without any need for dilution.

Key negatives

Business is definitely in a slow lane, with advances de-growing sequentially mainly due to commercial and corporate banking. On a YoY basis too, advances grew by 3 percent, with retail as the only driver.

The slowdown in advances as well as the caution on the non-funded book due to the rather challenging environment had its impact on core fee income that de-grew YoY. Treasury gains were the sole saviour.

The additional liquidity in the balance sheet, thanks to a much higher deposits growth vis a vis credit, led to an increase in treasury assets and negatively impacted the bank’s net interest margin – decline from 3.88 percent in Q4 to 3.49 percent in the current quarter. The management explained that 8 basis points (bps) of margin in Q4 was ad-hoc. The 6 bps loss in margin in Q1 reflected the impact of extra liquidity in balance sheet, with 4 basis points due to reversal of agricultural advances and another 5 basis points due to low-yielding IBPC (inter-bank participation certificate) in the books. The management, however, doesn’t see incremental headwinds on the margin front.

The calculated provision cover (amount of provision held against non-performing assets) is 49 percent and reported cover 59 percent. The bank may continue to see elevated provision as it tries to maintain or improve its provision cover that matches the best in class in the industry, especially in light of its exposure to the SME space.

Outlook
The initiatives on technology implementation is gathering steam and new CEO P R Seshadri (ex-Citi banker) appears to be guiding the bank in the right direction although the overt results are not fully visible yet.

As of now, home loan, loans against property, unsecured personal loan and working capital renewal are on the digital platform and the bank is putting commercial banking on this platform which will lead to better pricing of risk.

The bank is strengthening risk management processes and consciously reducing the ticket size of corporate loans. It is introducing new scorecard method of underwriting that will reduce the judgemental element in decision making. The effort is also to centralise key decision making.

In this quarter, the bank rationalised its commercial banking into three entities to bring in sharper focus on lower-ticket businesses. Going forward, it is likely to leverage technology for strengthening the liability profile.

However, the ongoing efforts of the management might bear fruit only gradually. Numbers are likely to remain uninspiring in the near term. While we do not rule out a better FY21 should all bad asset recognition get complete in FY20, investors with a long-term horizon should get in only gradually with every decline.