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Asset quality hurts in Q2, but hopes abound for recovery in H2

* Bandhan Bank reported a miss on PAT at Rs2.1bn (vs. estimate of Rs5.4bn) due to higher-than-expected NPA formation leading to higher LLP/lower margins and elevated opex due to business normalization. The bank expects H2 to see recovery in growth/margins as asset-quality pain recedes.

* The bank reported significantly higher slippages mainly due to stress flow from the restructured pool and impact of Assam floods, but higher write-offs led to a 6bps qoq fall in GNPA ratio to 7.2%. Overall, EEB stress pool still stands elevated at Rs95bn (18% of MFI loans/11% of overall loans), but better improved recovery (CGFMU recovery of Rs9.5bn in Q3 and Assam loan relief scheme) and higher write-offs should contain NPA formation.

* Overall, AUM growth was moderate at 17% yoy/down 1% qoq mainly dragged by weakness in MFI book, which the bank expects would improve in H2FY23. Mortgage and commercial book continues to grow at a healthy pace and should help the bank diversify away from high-risk MFI book in the long run.

* We trim our FY23-24E earnings estimates by ~5%, factoring higher NPAs and opex, but we expect the bank to gradually move back towards normalcy with RoEs at 20-22% in FY24/25E. We reduce our TP to Rs330 from Rs340 (valuing the bank at 2x Sep-24E ABV); however, given reasonable upside (>15%), we upgrade the rating to Buy from Hold.

* What we liked: Healthy non-MFI secured growth and lumpy recognition of NPA after dragging its feet for long. What we didn’t like: Margin pressure and higher opex, which may continue in the near term, leading to some moderation in PPoP growth

* MFI growth remains subdued, but mortgage growth accelerates: Bandhan Bank once again reported moderate credit growth at 17% yoy/-1% qoq mainly due to slower disbursements in the MFI business. This was mainly due to underlying asset-quality weakness in MFI, seasonal weakness, and stringent MFI lending norms. However, the bank expects its growth trajectory to improve due to seasonal pick-up in MFI disbursements and continued strong growth in mortgages/commercial lending book. The bank remains determined to diversify its loan portfolio towards secured loans, which could have some impact on margins in the long run, while reducing asset-quality volatility

* Asset quality takes a hit as the bank accelerates stress from the restructured pool/Assam floods: Gross slippages remained elevated at Rs39.5bn mainly due to recognition of stress from the restructured pool and impact of Assam flood. However, GNPA ratio declined marginally by 6bps to 7.2% on account of accelerated write-offs, while the restructured pool has declined to 0.2% from 6% in Q1. The overall MFI stress pool declined sharply to Rs95bn (% of loans) from Rs121bn in Q1. Slippages are expected to remain high in Q3 as the current SMA-2 book will flow to NPA, but slippages should moderate in Q4. The bank expects robust recovery in Q3 (CGFMU recovery of Rs9.5bn and ~Rs1bn recovery from the government’s Assam loan relief scheme in Q3). The bank has guided for higher credit cost at 3% of loans for FY23 vs. 2.5% earlier on.

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