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Strong growth and steady improvement in asset quality

* Canara Bank reported a strong beat on PAT at Rs20bn in Q1 (est.: Rs15bn), driven by higher treasury income, PSLC fees and lower LLP, partly offset by higher NPI (mainly on Future Group/Bajaj Hindustan and a telecom co). Treasury losses were relatively lower at Rs3.6bn, and there could be Rs1-1.5bn more losses, if the yield rises in Q2

* Overall credit growth surprised positively - up 15% yoy/6% qoq on strong corporate, RAM and gold loan growth. However, NIMs were flat at 2.8% due to a moderation in loan yields as growth was mainly driven by the corporate book, partly offset by better investment yields. The bank has guided for double-digit credit growth and stable-to-better margins.

* Asset quality continued to improve in Q1, with the GNPA ratio down 53bps qoq to 7%, helped by lower slippages, while the restructured book declined by 20bps to 2.6% of loans. The relapse rate in the restructured book has been 10%, and the bank expects the overall relapse rate to be 18-20% in restructured book. Slippages in the ECLGS book remain low at 3%, and thus do not pose any risk. NARCL transfers in Q2 should further reduce NPAs.

* We expect a gradual improvement in the bank’s RoA/RoE to 0.6-0.7%/12-15% over FY23- 25E from 0.5%/11% in FY22, driven by better growth and lower LLP. That said, we believe the bank will need to shore up capital, given CET 1 is sub-optimal at 10.5%. Retain Buy with a TP of Rs282, based on 0.7x FY24E ABV and subs/investment value of Rs23.

Strong credit growth but NIMs remain stable: Credit growth was better than expected at 15% yoy/6% qoq, mainly led by strong growth in the corporate book (14% yoy/9% qoq). Growth in the RAM segment was driven by mortgages and agri/gold loans. The bank’s CASA ratio declined to 32% in Q1 from 34% in Q4, which, coupled with an increase in TD rates, led to a slight increase in CoF. This, along with lower loan yields, mainly due to higher growth in the corporate book and interest reversals on lumpy NPAs, led to nearly flat NIMs at 2.8%. The bank has guided for double-digit credit growth and stable-to-better margins.

Slippages shoot up; needs to shore up provision buffers: Despite the recognition of Future Retail in Q1, overall slippages were contained at Rs39.5bn/2.4% of loans. This, coupled with better recovery/upgrades and higher credit growth, resulted in a 50bps reduction in the GNPA ratio to 7%. The restructuring book remained elevated at Rs195bn (2.8% of loans). The restructured book contracted by 20bps to 2.6% of loans. The relapse rate in the restructured book has been 10%, and the bank expects the overall relapse rate to be 18-20%. Slippages in the ECLGS book remain low at 3%, and thus do not pose any risk. We believe that NARCL transfers in Q2 will further reduce NPAs.

Outlook and valuations: We expect a gradual improvement in the bank’s RoA/RoE to 0.6- 0.7%/12-15% over FY23-25E from 0.5%/11% in FY22, driven by better growth/leverage and lower LLP. That said, we believe the bank will need to shore up capital, given CET 1 is suboptimal at 10.5%. Retain Buy with a TP of Rs282. Key risks: Higher-than-expected NPA formation, a slower growth trajectory, and a sharp rise in G-Sec yields which could lead to MTM losses in the investment book

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