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Investing for future, but near-medium term return ratios may moderate a bit

* Credit growth healthy; but rising CoF and share of low-yielding portfolio may put pressure on otherwise high NIMs:

The bank has guided for continued strong disbursements in Q1 and 25-30% growth in FY23, led by strong momentum in commercial banking (CB) and acceleration in wheels (personal/commercial), small business loans (SBL) and home loans (albeit on a low base). However, we believe higher credit growth would call for equally strong fund mobilization amidst rising interest rate scenario, which coupled with increasing share of relatively low yielding (CB + HL + BB) portfolio and higher share of fix rate loan book could lead to moderation in its otherwise high NIMs (40bps over FY22-25E).

* Improved provisioning buffer comforting amid increasing stress in rural and small business segments:

The bank’s GNPA ratio improved to 2% in Q4 from a high of 4.3%, but the restructured/ECLGS gross book remains elevated at 2.5%/1.8%. We believe that a prolonged inflationary situation and weakening rural cash flows amid an erratic monsoon pattern could derail the recovery cycle and even pose fresh credit risk in SBL/CV business. However, the bank claims that the relapse rate in the restructured book has been lower at ~10-12% and may not inch up beyond 15% based on the current assessment. It carries a counter-cyclical provision buffer of 0.8% of loans to deal with any eventuality.

* Accelerated investments in phygital capabilities may keep cost ratios elevated:

The bank saw a sharp jump in the cost-to-income ratio in FY22 to 57% and the cost-to-asset ratio to 4%, mainly due to new business initiatives (Cards, QR, VB), distribution expansion and brand building. It believes that cost ratios could remain elevated in the near- to medium-term given its strategy to accelerate investments in branches (take it to ~1000), digital capabilities, people and products to sustain its long-term business growth trajectory and migrate into a full-scale universal bank.

* Strengthening capital buffers, management/board structure:

The bank plans to raise Rs20-30bn in capital (add 550-800bps to current Tier I of 19.7% without factoring in market/operational risk) to support its growth trajectory for the next 2-3 years, hopefully at a better price (CMP<last QIP @Rs625 post-bonus). After swift attrition in risk/audit teams last year, the bank has filled these positions internally to bring stability. It has also increased the number of independent directors to eight from five to strengthen its board governance structure. 

* Rich valuations to limit upside; Retain Hold:

Factoring in incremental margin pressure and higher opex, we trim our earnings estimates for FY23-25 by 4-9% and reduce our RoA/RoE estimates to 1.8/18-20% from 1.9%-20-21% (without factoring in capital raise). Despite recent correction stock still trades at rich valuations - 3.7x FY24E ABV. Retain Hold with a revised TP of Rs650 (earlier Rs670 post bonus), valuing the bank now at 3.9x Jun’24E ABV vs. earlier 4.2x FY24E ABV, given moderation in the RoE trajectory. Key risks: more-than-expected slowdown in margins amid rising interest rate scenario, higher NPA formation in Wheels/SBL portfolios and key management attrition.

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