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New MD allays concerns about kitchensinking risk; upgrade to Buy on valuation

* RBL reported a better-than-expected PAT of Rs2bn in Q1 (est.: Rs1.4bn), mainly driven by contained provisions and higher treasury income, partly offset by higher opex and margin normalization on a high base. The GNPA/NNPA ratios improved by 32bps/18bps qoq to 4.1%/1.2% amid fear of kitchen sinking by the new management. 3

* Credit growth was subdued at 7% yoy, mainly due to the bank’s conscious growth stance and MFI disbursements coming to a halt in Q1 on regulatory changes. However, it expects growth to improve, led by the high-margin card and MFI book, as asset-quality issues are largely behind. That said, RBL should recalibrate its loan book toward secured loans, including housing and vehicle loans (new/used) to bring quality and profitable growth.

* The bank has guided for steady margin improvement, but higher opex due to investments in branches, tech and new products should keep operating profit growth in check. However, LLP should be down >50% in FY23E, supporting profitability. We expect the bank’s RoA to improve to 0.8-1.2% over FY22-25E and RoE to 7-11% from a loss in FY22.

* We appreciate RBL’s steady improvement in the liability profile and healthy capital buffers, while the new MD’s assurance to focus on asset quality and profitable growth is comforting. We believe that the bank’s regulatory compliance should also improve, thus reducing the risk of regulatory friction. We upgrade the stock to Buy from Hold with a revised TP of Rs125 (rolling fwd to 0.5x Jun’24E ABV), providing a decent upside of 32% from CMP.

Growth to re-accelerate as asset-quality hiccups are behind:

Overall credit growth was sub-par at 7% yoy, mainly due to MFI disbursements coming to a halt as the bank integrated its processes with the new regulatory guidelines. However, MFI disbursements have resumed and the bank expects healthy growth with a clear focus on quality. Growth in the card business is also gradually accelerating, which could be a key growth and margin driver. Continuing with earlier management’s strategy, RBL should focus on increasing the share of the secured portfolio, including housing, vehicle loans (new/used), tractors and gold, thus bringing stability and longevity to the portfolio. The bank has seen a meaningful improvement in the CASA ratio to 36%, while it plans to invest in franchisee network and building granular deposit base, which we believe will gain more importance in a rising interest rate scenario.

Asset quality improves amid the risk of kitchen sinking:

Although fresh slippages were marginally higher than expected at 6.5bn/4.6% of loans, higher recoveries/w-offs led to a 32bps qoq decline in the GNPA ratio to 4.1%. Specific PCR improved to 72%, which should keep incremental LLP on the stock of NPAs in check. The restructured book moderated to 2.3% of the loans, partly due to the relapse into NPAs and is expected to run down as repayment improves. The bank has guided for slippages to normalize around 2% from the current 4.6% and LLP to be <2.3% for FY23.

Outlook and valuations:

We have raised our FY23/FY25 earnings estimates by 1%/4%, factoring in lower LLP and expect the bank to return to profitability with a RoE of 7-11% over FY23-25E vs. a loss in FY22. We roll forward our TP to 0.5x Jun’24E ABV, leading to a revised TP of Rs125 (Rs110 earlier). We also upgrade the stock to Buy from Hold, given the decent upside (32% from CMP). Key risks: slow growth, resurgence of NPAs in MFI due to floods in a few states and middle management attrition.

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