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Moderating the valuation to factor slower growth

Moderating the valuation to factor slower growth City Union Bank Ltd. (CUB), the oldest private sector bank in India, is a mid-sized commercial bank headquartered in Tamil Nadu, with a network of 752 branches spread across the country and a loan book size of Rs.43,009cr .

* Business growth was subdued compared to industrial growth, with advances and deposits growing flat sequentially.

* The bank has been focusing on low yield gold loan disbursement and as a result, the portfolio grew by 31% YoY, constituting 25% of the total loan book

* Yield on advances declined 23bps sequentially to 9.16% and as a result, NIM contracted 21bps sequentially to 3.88%.

* Due to the impact of NPA divergence, net profit declined 21% QoQ

* Asset quality took a hit due to higher slippages. GNPA/NNPA stands at 4.62%/2.61%, against 4.36%/2.61% during Q2FY23.

* We recommend Accumulate rating on the stock based on 1.35x Adj BVPS of FY25E with a target price of Rs. 159 .

Muted business growth

In Q3FY23, banks total business witnessed a muted growth of just 9% YoY while remained flat on QoQ. Deposits grew by 7% YoY and stayed flat sequentially, while advances grew 12% YoY and 1% QoQ. As per the management, due to lag in deposit growth, management refrained from aggressive loan disbursement despite having excess liquidity of around Rs.3,000cr. Management also expects credit growth to be slower in FY23 compared to previously guided 15-18%. The bank has been focusing on gold loan disbursement and as a result, the portfolio grew by 31% YoY, constituting 25% of the total loan book. On the deposit front, CASA declined 6% sequentially as funds moved to fixed deposits as the interest rates inched up. Fixed deposits grew by 8% YoY and 3% QoQ. As a result, CASA ratio of the bank declined to 29.2% compared to 31.3% QoQ. We expect a moderate growth of 11% in advances and 10% in deposits over FY23-25E. Capital Adequacy Ratio of the bank stands strong at 20.5%.

RBI divergence impacted quarter’s performance

Net Interest Income (NII) for the quarter grew by 13% YoY while declined 2% QoQ as interest income witnessed a growth of 17% YoY and 2% QoQ and interest expense grew by 19% YoY and 6% QoQ. Net Interest Margin showed a sequential decline of 21bps to 3.88%. Cost of deposit increased by 11bps sequentially to 4.62% while yield on advances declined 23bps sequentially to 9.16%. Decline in yield despite rate hike was partly due to non-recognition of interest income amounting to Rs.32cr and because of increasing mix of gold loan which have a lower yield compared to the average yield of the bank. Other income grew by 40% YoY while operating expenses remained flat due to lower employee expense, keeping cost-income ratio low at 36%. As a result pre-provision profit of the bank grew by 35% YoY and 9% QoQ. However, due to the impact of NPA divergence, provisioning for the quarter remained elevated at Rs.225cr compared to Rs.105cr in Q2, resulting in 21% QoQ decline in net profit

Asset quality expected to improve gradually

During the quarter, asset quality took a hit due to higher slippages. Total slippages for the quarter stood at 1%. Of the total gross slippage of Rs.439cr, the impact of NPA divergence amounts to Rs.140cr. As a result GNPA for the quarter surged 26bps to 4.62%. Total restructured book stood at 4.0% of the advances, compared to 4.6% last quarter. Management expects slippage ratio of 2.5%-2.8% in FY23 and gradually subside to 2.0%-2.5% going forward. We anticipate a gradual recovery in asset quality, with GNPA at 4.0% by the end of FY24.

Outlook and valuation

Bank has shown a dismal performance with lower than industry growth and elevated slippages. We expect business growth and asset quality to improve gradually going forward. Higher slippage guidance of 2.0%-2.5% will keep credit cost elevated. With cautious growth outlook, we downgrade our valuation to 1.35x FY25E Adj BVPS. Considering the recent correction in the stock, we expect decent upside and recommend Accumulate rating with a target price of Rs.159

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