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Higher margins, NPA recovery fuel ROA to a decadal high

* Despite higher provisions including hit on SR book, KVB reported a 13% beat on PAT at Rs2.9bn (vs est: Rs2.6bn), mainly due to continued margin expansion, recovery from written-off accounts (Rs0.85bn) and lower effective tax rate (due to higher w-offs). As promised, the bank has brought down NNPA below 1% (to 0.9%), and expects incremental LLP to be lower; it thereby guides for exit RoA of 1.35% in 4Q (1.3% in 3Q).

* Overall gross credit growth was healthy at 16% YoY/4% QoQ, while net credit growth at 16% YoY/3% QoQ was due to higher w-offs. However, higher asset re-pricing of the MCLR portfolio led to 25bps QoQ improvement in NIMs at 4.3%. Bank has started the pilot run for its MFI business via BC tie-up, sensing a high-margin business opportunity and a granularized portfolio.

* The Board has extended MD & CEO Ramesh Babu’s term (ending on July 29, 2023) for another 3 years, subject to approval by the RBI; this is comforting, given his contribution in the current transformational journey of the bank. We raise our FY23/24/25 earnings estimates by 6%/2%/4%, mainly driven by better NIMs and lower opex & LLP.

* KVB remains one of our top picks in the small banking space, given expected improvement in its RoA/RoE to a decadal high of 1.4%/16%, healthy capital ratios and emerging Management credibility. We retain BUY, with a revised TP of Rs155, up from Rs125, and now value the bank at 1.2x Dec-24E ABV (vs earlier 1x Sep-24E ABV earlier).

Margins shoot up, led by healthy growth/asset re-pricing: Overall gross credit growth was healthy at 16% YoY/4% QoQ due to strong corporate & retail growth, while SME book growth slowed down a bit. Bank’s retail growth was mainly driven by mortgages/LAP and gold loans; the bank has now entered into tie-ups with BCs to launch its MFI business. This is mainly to diversify growth vectors without compromising on margins and also to avoid dependence on lumpy, consortium-based corporate loans, as in the past. Deposits growth was decent at 14% YoY/3% QoQ, due to faster growth in TDs; as a result, CASA ratio declined to 34%. However, higher asset re-pricing of its MCLR portfolio led to a 25-bps QoQ improvement in NIMs at 4.3%. Bank expects NIM to remain above 4%, given the changing loan composition and better asset-liability management.

NPAs continue to trend down due to negative net slippages and accelerated w-offs: Fresh slippages were lower than expected at Rs1.6bn/1.2% of loans, which coupled with better recovery and accelerated write-offs, led to a sharp 1.3% reduction in GNPA ratio to 2.7%/NNPA to 0.9%. Bank expects continued net negative slippages, which should thus keep GNPA below 2.5%. The restructured pool too declined, to 1.9% of loans from 2% in Q2. With the heavy lifting on PCR improvement largely behind, Bank targets LLP at below 1% in FY24E.

Outlook and valuations: KVB remains one of our top picks in the small banking space, given the expected improvement in its RoA/RoE to a decadal high of 1.4%/16%, healthy capital ratios and emerging Management credibility. We retain BUY with a revised TP of Rs155/share, up from Rs125, and now value the bank at 1.2x Dec-24E ABV (vs earlier 1x Sep-24E ABV earlier). Key risks: Slower than expected growth, faster decline in CASA leading to cost pressure, and resurgence of NPAs in the retail/SME sector due to macro dislocation

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