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Merger pain behind; strengthening provision/capital buffer should be priority

* Despite moderate credit growth and lower margins, Canara Bank reported a strong beat on PAT at Rs10.1bn (est. Rs4.9bn), driven by higher recovery from the written-off accounts, including Bhushan Power.

* Reported GNPA was flat at 8.9% vs. pro forma GNPA in Q3, mainly due to higher recovery and write-offs. The overall restructuring pool is low at 1.3% of loans, which is positive. The bank guides for FY22 slippages to be ~2.1-2.3% with higher recoveries following resolutions in some lumpy corporate accounts.

* CBK has gradually increased specific PCR to 60%, while the Covid-19-related contingent buffer stood at 0.1% of loans, which we believe needs to be further strengthened. CET 1 remains sub-par at 8.6%, and thus the bank may consider raising capital soon. The bank has the option to offload stake in subsidiaries, but it is not exploring as of now.

* In our view, merger related concerns are largely behind and the bank should report gradual improvement in its RoA/RoE to 0.4-0.5%/8-10% by FY23E-24E (without factoring in dilution), led by better growth/moderate LLP. Retain Buy with a revised TP of Rs175 (from Rs155), factoring in upgrades in earnings/multiple (core bank valued at 0.6x vs. 0.5x).

Focus to shift to growth, and thus better LDR feeding into NIMs:

Credit growth has moderated to 3.6% yoy/0.8% qoq mainly due to corporate debulking and tepid growth in MSME (up 2.5% yoy/down 4.7% qoq). The retail portfolio clocked 12% yoy growth, led by housing and vehicle segments.

Deposit growth has come in strong at 11.5% yoy/3.9% qoq, driven by a healthy momentum in CASA (up 14% yoy) and Retail TD (up 16.3% yoy). Reported NIM was moderate at 2.75%, mainly impacted by NPA recognition and interest waiver. The bank believes that it is well prepared to face the second Covid-19 wave and expects credit growth to improve in FY22. Better credit growth should lead to better LDR, which will structurally support core margins in the long run.

Stress still remains elevated; need to shore up provision buffer:

Reported GNPA was flat qoq at 8.9% (pro forma basis) due to higher recoveries and write-offs. The overall restructuring book stands low at Rs81.4bn - 1.3% of loans (including MSME restructuring of Rs36bn under the Jan’19 circular), while OTR pool stands low at Rs45bn - 0.7% of loans (Corporate- Rs27bn, MSME- Rs11.7bn, Retail- Rs6.4bn) under the RBI RE scheme.

CBK used up the entire contingent buffer created earlier and provided Rs5bn (0.1% of advances) toward Covid-19 effects and has additionally provided Rs4.9bn on the OTR book. SMA (0-2)- above Rs50mn A/Cs improved to 3.2% as of Mar’21 (down 41bps qoq). That said, lower collection efficiency of 89% in Apr’21 (92% in Mar’21) remains a concern. CBK expects both credit cost and slippages to be in the range of ~2.1-2.3% for FY22.

Outlook and valuations:

We believe that merger related concerns are largely behind and the bank should report gradual improvement in its RoA/RoE to 0.4-0.5%/8-10% by FY23E24E (without factoring in dilution), led by better growth/moderate LLP. Retain Buy with a revised TP of Rs175 (from Rs155), factoring in upgrades in earnings//multiple (core bank valued at 0.6x vs. 0.5x). Key risks to our call/estimates: Higher-than-expected NPA formation, slower growth trajectory and sharp rise in G-Sec yields leading to lower treasury gains.

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