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Stressed asset formation under control; steady march to historical RoA of 1.5%

City Union Bank’s (CUBK) Q1FY22 performance was characterised by leash on fresh stressed asset formation with: 1) incremental restructuring of >50bps, 2) marginal increase in GNPL to 5.6%, 3) SMA-2 at 3.2% lower than pre-covid level, and 4) unchanged guidance of reaching 1.5% RoA by H2FY23E despite covid second wave.

Earnings at Rs1.7bn was largely driven by strong NII growth of 5% QoQ, utilisation of covid provision to the tune of Rs0.8bn, and treasury income of Rs1bn. Robust 6% YoY growth in gold loans (19% of total) was offset by decline in other segments, resulting in muted 2% QoQ decline in advances. However, 14bps QoQ NIM expansion supported 5% QoQ growth in NII.

Management expects FY22E slippages to be lower in FY21 as it expects recovery to pick up in H2FY22. We repose faith in CUBK’s ability to deal with stress effectively and take RoA to the pre-covid level of 1.5% in H2FY23E (as guided earlier). Maintain BUY with an unchanged target price of Rs200.

* Incremental stressed asset formation well under control despite covid challenges. Despite its relatively higher exposure to vulnerable borrower-groups (>50% of loans in SME segment) and covid-led challenges, incremental stressed asset formation of >1% (fresh restructuring + net slippages) speaks of superior execution. Improved recovery at Rs0.8bn vs 0.7bn in Q4FY21 and accelerated write-offs at Rs2.6bn vs Rs2.1bn in Q4FY21 resulted in lower net slippages and marginal increase in GNPL to 5.6% as against 5.1% in Q4FY21. Repayment behaviour of customers availing of ECLGS is encouraging as reflected in lower balance as at Mar’21 vs Mar20. SMA-2 at 3.2% lower than the pre-covid level, incremental restructuring possibility of ~1-1.25% in Q2FY22E, and improved recovery outlook gives us confidence on fresh slippages in FY22E being either at par with FY21 levels, or lower.

* Calibrated lending till economy turns conducive. Total credit growth remained muted at 5% YoY due to CUBK’s cautious stance in expanding its balance sheet amid a challenging macro. It has judiciously grown the gold loan book with conservative LTVs at 69%. With majority of incremental lending having come from lower risk weighted segments, capital consumption stood lower leading to an improved CRAR of 19.6% in Q1FY22. CUBK expects credit growth in FY22 to remain at mid-to-high single digit.

* Margins expanded 14bps QoQ; likely to remain in 3.75-4% range. Reduction in cost of deposits by 10bps QoQ to 4.95% and 20bps QoQ expansion in asset yields resulted in 14bps QoQ NIM expansion. The same supported 5% QoQ growth in NII. CASA ratio stood at 27.5% vs 29.2% in Q4FY21. Despite elevated credit cost at 1.9% in Q1FY22, CUBK reported RoA improvement to 1.29% during the quarter vs 0.8% in Q4FY21 driven by higher treasury income and utilisation of provision buffer to the tune of Rs0.8bn. It expects the earnings trajectory to continue improving and RoA to reach historical high of 1.5% by H2FY23. Key risks: 1) stress unfolding higher than expectations, and 2) prolonged RoA recovery.

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