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Stressed asset formation within guided range; asset quality outlook encouraging

City Union Bank’s (CUBK) Q4FY21 / FY21 performance was characterised by incremental stressed asset formation at lower end of the guided range as reflected in: 1) gross slippages at 3% vs guidance of 3-3.5%, and 2) total restructuring at 5% of advances vs guidance of 5-6%. ECLGS disbursements stood at ~Rs21bn, or 5.6% of advances. Despite elevated credit cost at 2.3% (due to total stressed pool {NNPL+ restructuring +ECLGS} at ~13.6%, strong core operating profitability {PPoP at ~3%} and lower tax rate of 14%, RoA improved to 1.15% in FY21 vs 1% in FY20.

Management expects FY22E slippages to be lower than the FY21 level as it derive comfort from prudent recognition of covid first wave related stress and 40bps of provision buffer (~Rs1.5bn). While near-term asset quality concerns persist due to the second wave disruption, we repose faith in CUBK’s SME financing niche, coupled with its robust retail liability franchise to manage the crisis effectively, and take RoA to the pre-covid level of 1.5% in H2FY23E (as guided earlier). Maintain BUY with a revised target price of Rs200 (earlier: Rs185), valuing the stock at 2x FY23E BVPS.

* Superior execution with incremental stressed asset formation at lower end of guidance. Despite its relatively higher exposure to vulnerable borrower-groups (>50% of loans in SME segment), incremental stressed asset formation at lower end of guidance speaks for superior execution. Improved collections resulted in lower slippages at Rs11bn in Q4FY21 vs proforma slippage of Rs11.5bn in Q3FY21, resulting in GNPL settling lower at 5.1%. Total stressed pool (with NNPL at 2.97%, restructuring at 5% and ECLGS disbursements at 5.6%) stands at ~13.6% as at Mar’21. Taking cognisance of improved cashflow of SMEs between Jan-Apr’21 and thus far limited impact on business activities, accelerated recognition of covid first wave related stress and ~40bps (Rs1.5bn) of provision buffer, CUBK expects lower slippages in FY22E than the FY21 level and reach a historically high RoA of 1.5% by H2FY23E.

* Calibrated lending via ECLGS and gold loans led to lower capital consumption. Total credit growth remained muted at 7% YoY due to the bank’s cautious stance in expanding the balance sheet amid a challenging macro environment. It has judiciously grown the SME book by disbursing under ECLGS scheme and via gold loans. With majority of incremental lending having come from lower risk weightage segments, capital consumption stood lower leading to an improved CRAR of 19.5% in FY21. CUBK expects credit growth in FY22E to remain at mid-to-high single digit.

* Margins impacted due to interest reversal of Rs0.7bn in Q4FY21. Net interest income fell 12% QoQ due to higher interest reversal of Rs0.7bn in Q4FY21 (the same dragged down NIM to 3.72% vs 4.16% in Q3FY21). Adjusted for the interest reversal, NIM would have been >4%. Cost of deposits fell ~11bps QoQ to 5.05% vs 5.16% in Q3FY21. CASA ratio reached an all-time high of 29.2%. Despite elevated credit cost at 2.3% in FY21, CUBK reported RoA improvement to 1.15% in FY21 compared to 1% in FY20 driven by margin improvement and cost optimisation. It expects the earnings trajectory to continue improving and RoA to reach historically high of 1.5% by 2HFY23E. Key risk – 1) stress unfolding higher than expectation and B) prolonged RoA recovery

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