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Encouraging growth; pristine asset quality

Kotak Mahindra Bank’s (KMB) broad-based and robust advance growth of 8% QoQ/14.7% YoY was encouraging. Strengthened liability franchise, liquidity buffer, built-up capabilities and portfolio quality provided confidence to not only catch up, but far outpace peers on growth, sequentially. Earnings surpassed expectations on asset quality front as well: i) Credit cost settled much lower at 63bps (vs 130bps in Q1FY22); ii) slippages contained at 2.4%; iii) GNPAs declined QoQ to 3.19% (vs 3.56%); iv) cumulative restructuring was contained at 54bps of advances. NIMs at 4.45% reflect strength of the liability franchise. Higher opex led by franchise investment led cost offsets strong fee income build-up. Maintain ADD with revised target price of Rs2,412 (earlier: Rs2,023) assigning it 4.75x FY23E book value with improving growth visibility. Key monitorables: 1) Behaviour of ECLGS and restructuring pool; 2) succession planning related to MD & CEO retirement in Dec’23.

* Spike in auto financing earnings; life insurance profit normalises: Consolidated profit was flat YoY/up 65% QoQ to Rs30bn. Life insurance business after reporting a loss of Rs2.4bn in Q1FY22 was back to profit of Rs1.6bn in Q2FY22. Auto financing business earnings spiked to Rs2.4bn aided by recoveries (Rs790mn in Q1FY22 and Rs5.4bn for full year FY21). Earnings momentum in Kotak Securities at Rs2.4bn, KMCC at Rs580mn and Kotak AMC at Rs1bn was stable.

* GNPAs decline to 3.19%; restructured pool at 54bps: Management highlighted slippages of Rs13.5bn (2.4% run-rate vs 2.8% in Q1FY22/>4% in H2FY21). Bulk of slippages seems to have flowed from retail and commercial segments. Corporate portfolio would be resilient and MSME behaviour too was steady. GNPA decline was much better than expected to 3.19% (from 3.56% in Q1FY22/3.25% in FY21). Bank has not resorted to sale of any assets to ARC. SMA-2, even in these challenging times, constituted mere 17bps of advances at Rs3.9bn (compared to Rs4.3bn in Q1FY22/Rs1.1bn in FY21). Cumulatively, it has restructured loans of Rs12.6bn (compared to Rs5.5bn) i.e. 54bps of advances. This includes covid-related restructuring of Rs.4.95bn (Rs2.4bn in Q1FY22) and MSME pool of Rs7.7bn (Rs3.2bn). With overall macro environment transitioning from pandemic to endemic, it is getting more confident on credit risk having sailed through the covid second wave relatively well.

* Credit cost at 63bps; net stress pool at 50bps: Credit cost was lower than expected at mere 63bps (vs 1.33% in Q1FY22) as provisioning was primarily towards incremental stress. Over and above this, provisions further comprised investment provisioning of Rs386mn. No covid provision was dipped in Q2FY22 and was retained at Rs12.8bn. Provisioning coverage improved further to 67% and net NPAs were contained at 1.06% (higher than the average of 0.7-0.9%). This needs to be looked in conjunction with standard provisioning (Rs12bn) + covid-related buffer of Rs12.8bn (55bps of advances). Considering the Q2FY22 trend, we are building-in credit cost at 1.1%/0.9% for FY22E/FY23E, respectively.

* Upbeat growth, not only catching up but outpacing peers: Advance growth was broad-based and robust at 8% QoQ/14.7% YoY (vs 6.6% YoY in Q1FY22). Strengthened liability franchise, liquidity buffer, built-up capabilities and portfolio quality provided confidence to not only catch up, but far outpace peers on growth, sequentially. The trend is very encouraging especially after a decline of 2.8% QoQ in Q1FY22. Growth was broad-based across all segments except CV/CE; corporate banking was up 9% QoQ. Home loan/LAP with competitive rate offering grew upwards of 10% QoQ.

KMB has been aggressive in mortgage lending with competitive pricing (lowest pricing in the industry taking the benefit of low cost of deposits). It is focused on quality customer acquisition, strengthening market share and consolidating relationships for cross-sell and home loan/LAP portfolio grew >10% QoQ. The focus is on deeper penetration in the salaried segment.

Corporate advances too were up 9% QoQ (after declining 4% QoQ in Q1FY22). Incremental financing was towards working capital. KMB continued to invest in transaction banking and has upgraded its trade as well as cash management platform for better customer experience.

It is now getting constructive on unsecured lending (PL, credit card, MFI) with better ability to analyse data and this portfolio was up 12% QoQ. New business activation in MSME segment has gained further traction. The bank has enhanced significant capacity for sales/services and is revamping its risk models and analytics setup for a better credit evaluation process.

It is also open to any inorganic opportunity that would help it build customer franchise, business capabilities and necessarily physical branch presence. With growth settling better (than expectations), we revise our credit growth assumptions to 18%/20% for FY22E/FY23E, respectively (vs 15%/19% earlier).

* CASA ratio improves further: Build-up of robust, sustainable and granular deposit franchise was reflected in 25% YoY and 3% QoQ growth in CASA deposits. CASA ratio further improved 40bps to 60.4%. Cost of savings deposits remained steady at 3.7%. Nature of deposits continued to be granular with 90% of retail deposits being below Rs50mn. The benefit of low cost of deposits would aid the bank in offering competitive rates (in-line with large players) among various secured lending products, thereby, gaining market share.

* Increased investments led to higher opex and employee costs: Overhead costs were up 43% YoY/16% QoQ) due to increased cost of asset (home loan, credit card) acquisitions, marketing spend, insurance on deposits, recovery/collections cost, etc. It is incurring incremental cost for customer acquisition, digital and technology infrastructure and investing into franchise. Employee cost growth after being contained at 4% in FY21 (Rs2bn of retirement benefit savings in FY21), rose 9% QoQ / 19% YoY. Core fee income sustained its momentum with 34% YoY rise (up 21% QoQ).

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