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Modest operating performance

Improved 2H outlook; Strong contingent provisions provide comfort

* Axis Bank (AXSB) delivered a weak operating performance in 2QFY22 that was characterized by margin weakness (7bp QoQ decline) and a muted trend in Core PPoP. However, lower provisions (INR17.3b) aided earnings which surpassed our estimate by 13%. Business growth was tepid and was pulled down by a 5% QoQ decline in corporate advances, while a strong sequential recovery was witnessed in SME/Retail loans.

* On the asset quality front, fresh slippages remained elevated at INR54.6b although higher upgrades/recovery of INR47.6b aided an improvement in the GNPA/NNPA ratio. The bank’s restructured book remained under control at 0.7% of loans. We estimate AXSB to deliver FY23E RoA/RoE of 1.5%/14.6% in FY23. We remain watchful of a recovery in the bank’s operating earnings. Maintain Buy.

Corporate portfolio down QoQ; Asset quality ratio improves

* PAT for 2QFY22 stood at INR31.3b (13% above our estimate; 86% YoY growth), aided by controlled provisions. On the other hand, PPoP growth was weak and declined by 11% YoY (13% below our estimate) due to the impact of muted NII. NIM declined 7bp QoQ to 3.39%. For 1HFY22 - NII grew 9.4% and PPoP declined 3% YoY while PAT grew 89% YoY.

* Other income growth was also weak at 6% YoY due to the impact of lower treasury gains (INR4.7b – down 36% YoY), while fee income grew 17% YoY. Opex rose 36% YoY due to an increase in staff costs (+37% YoY) as the bank increased its focus on hiring new employees. Also, higher collection costs and investments in technology led to elevated operating expenses. As a result, C/I ratio increased sharply at 49.3% (v/s 44.4% in 1QFY22).

* Total provision declined sharply by 47% QoQ to INR17.3b, while provision for NPA declined sharply by ~68% QoQ to INR9.3b, resulting in credit costs for the quarter standing at ~0.6% (annualised). The bank did not utilise any COVID-19 provisions during the quarter and currently holds an additional provision buffer (incl. standard asset provisions) at ~2.1% of loans.

* Loan book grew 10% YoY (up 1.1% QoQ) with retail loans up 16% YoY (4% QoQ). Retail loan disbursements were up 54% QoQ. Strong trends were witnessed in the SME portfolio as well which grew 18% YoY (7% QoQ), while corporate growth remained weak (down 5% QoQ). On the liability front, deposits grew ~3% QoQ, led by a 6% QoQ growth in CASA deposits. As a result, the CASA ratio improved by 100bp QoQ to 44% (quarterly avg. CASA stood at 42%).

* On the asset quality front, slippages were elevated at INR54.6b, primarily led by retail while higher upgrades/recovery of INR47.6b aided an improvement of 32bp/12bp QoQ in the GNPA/NNPA ratio to 3.53%/1.08%. PCR remained stable QoQ at ~70%. The bank’s restructured portfolio stood at INR44.6b (~0.7% of loans) - lowest among top private banks. PCR on the restructured portfolio stood at 24%. BB & below pool (Fund/Non-Fund) declined to INR117.5b (1.9% of loans) v/s INR131b in 1QFY22.

* Segmental Restructuring: Corporate (0.7%) and Retail (0.8%) had a negligible contribution under the Commercial Banking Group.

Highlights of management commentary

* AXSB’s margin is likely to improve in the near-term on the back of an improvement in its product mix which is expected to change in favour of retail segments, granular liability franchise, and a reduction in the mix of RIDF bonds.

* The bank will continue to invest in technology which will keep its opex levels elevated. Overall, AXSB’s cost to asset is likely to remain 8-10bp higher than management’s guidance of 2%.

Valuation and view

AXSB delivered a weak core operating performance in 2QFY22, led by a margin decline, higher opex, and sluggish business growth. However, controlled provisions resulted in the bank’s earnings surpassing our estimate. On the other hand, AXSB’s asset quality was stable, supported by higher recoveries and upgrades while its slippages remain elevated. Total restructuring was controlled at ~0.7% of loans. We expect the trend of elevated slippages to subside from 2HFY22, enabling a decline in credit costs. A healthy PCR of ~70%, coupled with additional provision buffer of 2.1%, is likely to protect the bank’s balance sheet from any potential stress. We cut our earnings estimates for FY22/FY23E by 6%/4% to factor in the higher operating expenses and lower NII, and remain watchful of a recovery in the bank’s operating earnings. We estimate AXSB to deliver RoA/RoE of 1.5%/14.6% in FY23. Maintain Buy with revised TP of INR975 (2.0x FY23E ABV+ INR134 from Subs).

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