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Asset quality little off beat but manageable; shows intent to grow

* Despite subdued credit growth, PAT strongly beat estimates in Q3FY21, rising 16% yoy to Rs18.5bn mainly due to contained provisions. However, proforma GNPA came in higher than expected at 3.3% (up 57bps qoq) for KMB and >4% for Kotak Prime (car fin subsidiary).

* As per management, nearly 40% delta in proforma NPAs was from unsecured loans (BL/PL/Cards), which has been largely recognized upfront. The one-time restructuring pool stands lower at 0.28% of loans, given the bank’s long standing stance to avoid deferment of stress, and thus lower tail-end risk.

* KMB now has the industry-best liability profile with a low cost CASA ratio at 59%, but the credit growth trajectory has been sub-par for the last two years due to its conservative management style. However, the bank has shown strategic intent to accelerate growth, led by secured retail products and high quality corporates to begin with.

* We retain Hold with a TP to Rs2,000, based on 4.1x core P/ABV FY23 and subs valuation of Rs452. We believe that Kotak’s asset quality is manageable. The immediate concern regarding top management change is now behind with the RBI extending MD’s term by 3 years, but the bank needs to deliver on growth and drive higher RoE to sustain its rich valuations.

Sluggish growth but management shows intent to accelerate growth:

Loan growth was up 4.5% qoq with some momentum seen in retail (mainly mortgages), corporate and SME book (mainly driven by ECLGS). KMB has recently turned aggressive in the secured mortgage business, offering the lowest rate in line with large players with cost on its side, which reflected in mortgage growth of 9% yoy/5% qoq. The bank has also disbursed ~Rs97bn to SMEs under the ECGLS scheme, which is nearly 5% of systemic disbursement and higher than its overall credit market share. The deposit base has been largely flat for past the nine months as KMB has been shedding TDs. SA momentum has slowed down due to recent rate cuts (SA cost at 3.8% vs. 5.3% in Q3FY20). That said, CASA ratio remains industry best at 59%. Reported NIM was flat qoq at 4.5% without interest reversal on proforma NPAs (provided for), which if adjusted would have been lower at 4.3%.

Higher proforma NPAs tad disappointing, but risk manageable:

Reported GNPA ratio was low qoq at 2.3% mainly due to SC stay on NPA tagging, but proforma GNPAs were higher than expected at 3.3% (up 57bps qoq) mainly from unsecured retail loans and the bus segment in CV book. As per management, collections vs. demand for Dec’20 is back to pre-Covid levels for secured loans, while for unsecured advances, collection are nearing pre-Covid levels, improving month on month. The bank holds Covid-related contingent provisions of Rs12.9bn and provision of Rs8.1bn for loans under SC stay. The overall provision buffer stands at 98bps of loans. The onetime restructuring pool is low at 0.28% of loans, reflecting management’s stance to avoid deferment of stress. SMA 2 book has increased to Rs6.5bn (0.31% of loans), but is still lower than the industry. KMB’s car finance subsidiary too has reported elevated NPA formation of >4%, which is slightly disappointing. Overall, management believes that the worst in terms of asset quality/growth is largely behind and the best is yet to come.

Outlook and valuation:

We expect the bank to deliver superior RoA around 2.1% in FY23, up from 1.8% in FY20, led by better margins, contained opex and moderation in LLP. However, RoE still looks optically depress at 13%, which would be higher at 17% after adjusting excess Tier I capital over & above new optimal for large private banks in uncertain times (~15%). We retain Hold with a TP to Rs2,000, based on 4.1x core P/ABV FY23 and subs valuation of Rs452. Key risks to our call: Higher-than-expected NPA formation mainly in retail/SME book, failure to deliver on growth and management attrition.

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