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Stressed pool recognition in Wholesale led to elevated credit costs

* PIEL reported a consolidated loss of ~INR15.4b (PY: +INR4b) in 2QFY23. NII grew 36% YoY, but fell 15% QoQ, to INR8.4b. This included interest income reversals of ~INR2.3b due to the movement of Wholesale exposures to Stage 2 from Stage 1. PPOP declined by 16% YoY to ~INR4b.

* Total AUM declined by 5% YoY to ~INR638b, while Retail loans grew 12% to ~INR249b. The share of the Retail loan book rose to 43% (v/s 12% premerger). PIEL recently launched its Microfinance business under the BC model and has started offering Salaried Personal loans from its branches.

* It has raised ECL provisions to 8.6% (PQ: 6.2%), due to: a) the movement of ~INR59b of Wholesale assets to Stage 2 from Stage 1, and b) the increase in regular ECL provisioning in line with the growth in the Retail book.

* We estimate an AUM/PAT CAGR of ~13%/~9% over FY22-25, including consolidation in the Wholesale book over the next two years. We maintain our Buy rating with a revised FY24 SoTP-based TP of INR1,160.

Elevated credit costs due to stress recognition in the Wholesale segment

* GS3 was stable QoQ at 3.7% of AUM. NS3 improved to 1.3% (PQ: 1.8%). The company increased PCR on S3 loans to ~67% (PQ: 54%).

* Credit costs increased sharply to ~INR33b (PQ: INR902m). It included ~INR10b on account of loss on fair value changes and write-offs of ~INR3.6b. There were also a few investment instruments where PIEL took a haircut and closed its exposures as they are fully settled now.

* Exposures of ~INR59b, which moved to Stage 2 from Stage 1, were spread across 18 accounts and most of them were in the Real Estate sector. Within this, a Stage 2 exposure of ~INR1.5b got repaid in early Nov’22.

* PCR on Stage 2 and Stage 3 (30+ dpd) assets stood at 36% (PQ: 43%). While there can be some flows to Stage 3 from Stage 2 assets, the management said it will not be imminent, and exposures that eventually move to Stage 3 from Stage 2 will not require any significant provisioning.

* PIEL said the asset recognition cycle was largely complete. It expects the Wholesale book to moderate over the next two quarters, led by a higher focus on recoveries and monetization.

Improvement in the Retail product mix will aid expansion in the NIM

* Retail disbursements grew 62% QoQ to INR39.7b. Excluding embedded finance, disbursement yields improved to 12.3% in 2QFY23 (PY: 11.8%), led by a better product mix. Digital Embedded Finance disbursements of INR8.4b in 2QFY23 contributed 21% to overall Retail disbursements.

* PIEL launched Salaried Personal loans and disbursed INR310m in 2QFY23. ATS for the same stood at INR430k, with average yields of 19%.

* Average CoB fell by ~70bp YoY and was stable QoQ at 8.8% on account of its ability to borrow funds at a lower cost after the DHFL acquisition and the improved proportion of Retail in the loan mix.

Pockets of value will be accretive to profitability and Balance Sheet strength

* We expect PIEL to continue to exhibit recoveries from the POCI book. It has cumulatively recovered ~INR15.2b from the POCI book.

* The management plans to monetize its stake in SHTF after the Shriram group corporate merger is completed in 3QFY23.

* We strongly believe that the company will be able to utilize the DTL of ~INR33b in 2HFY23, which will accrue as an extra-ordinary (or exceptional) gain and will be accretive to profitability in FY23. We have modeled this in our FY23 PAT estimate of INR19.8b (after associate and exceptional).

Highlights from the management commentary

* The management will look to consolidate and reduce the size of its Wholesale book over the next two quarters. A part of this reduction will occur via resolutions or a run-down in Stage 2 and the remainder from Stage 1 assets.

* It wants to build a diversified Retail portfolio so that no economic or credit cycles in a single product will have a material effect on the Retail business.

Valuation and view

* Over the past two years, PIEL has: a) strengthened its Balance Sheet by running down its Wholesale loan book; b) improved the texture of its borrowings, c) targeted lower cost borrowings; and d) fortified itself against contingencies, with ECL provisions at 8.6% of AUM.

* Over the next three years, we expect PIEL to make meaningful inroads into Retail, led by Mortgages and complemented by shorter tenure loans originated through digital partnerships. Product diversification within Retail will help PIEL deliver strong growth and reduce concentration risks. We expect the business to deliver a consolidated RoA/RoE of ~2.3%/7-8% in the near term.

* We have cut our target multiple to 0.8x P/BV (earlier: 1x) for the Lending business. We arrive at our SoTP-based TP of INR1,160 (FY24E based) and maintain our Buy rating.

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