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Substantial earnings beat on strong asset quality

USFB delivered a substantial 59% PAT beat driven by much lower-than-estimated credit cost (rather negligible), which was underpinned by continuance of strong collection trends on Std. non-OTR pool and encouraging collections even from OTR and NPL portfolios. Consequently, PAR 0 declined to 7.9% as of June vs 9.6% as on March and GNPA/NNPA declined to 5.9%/0.1% from 7.1%/0.6%. Write-offs in Q1 FY23 were moderate at Rs790mn (<0.5% of gross adv.) versus Rs2.7bn in Q4 FY22. NII and PPOP were in-line with our estimates and represented 56% and 68% growth on yoy basis. Annualized RoA and RoE was at 3.4% and 28% respectively

OTR resilience surprised; stress pool looks adequately covered

GNPL addition in Q1 FY23 was markedly lower at Rs1.5-1.6bn and upgradations & recoveries remained strong at Rs2.1-2.2bn. In Micro Banking, behavior of the OTR book was not very different from the Std. book. Collections on OTR portfolio was ~80%, as customers’ income stabilized further. SMA pool was miniscule within OTR as of June (being billed since Dec), reflecting little incremental flow risk. Quality of loan originations in MSE Finance and Affordable Housing has improved over the past 18-24 months with GNPL of <1% on disbursements. Besides GNPLs being nearly fully provided for, the bank has a significant 59% cover on OTR book which looks adequate given its dpd construct and collection trends. On the non-OTR Std. portfolio, the bank is holding 80-85 bps provisions which is matching current collection experience.

Guidance on Key Performance Indicators for FY23

Bank expects a) 30% growth in Gross Advances and faster growth in deposits, b) credit cost of below 1% with further decline in PAR 0 and GNPLs, c) NIM improvement even without lending rate hikes, d) cost/Income ratio of 60-62% and e) RoA of 2.3%+. In Micro Banking, the focus is back on new customer acquisition (incl. in rural areas). Growth in Affordable Housing is being driven by more formal customers and semiurban geographies. Focus for deposits growth would be on granular retail deposits (the bank has raised retail TD rates post the policy rate hikes).

Favourable growth and credit cost cycle; upgrade to BUY

Our earnings estimates undergo significant upgrades mainly from lowering of credit cost assumption. It seems cyclically a right time to upgrade USFB to a BUY (from ADD), considering robust collection trends, a significantly shrunk PAR 1-90 bucket in Micro Banking, substantial provisions on stress pool (OTR + GNPL), encouraging repayment pattern of the stress pool and recoveries showing-up even from written-off portfolio. A capital raise to meet SEBI’s MPS criteria is impending. In a normal scenario, we see the bank delivering PPOP/Credit Cost/RoA of 4-4.5%/1-1.5%/2-2.25%. The stock currently trades at 0.9x FY24 P/ABV for estimated RoE delivery of 16-17%.

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