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Normalisation some time away; modest return profile for now

RBL Bank management continues with its stance of reducing inherent business risk and lowering earnings volatility through: 1) consolidation of the wholesale banking portfolio, 2) cautious/selective approach in MSME/LAP, and 3) ramp-up of secured retail products (home loans). On a positive note, credit card sourcing and spends are showing signs of resurgence (key growth driver in the near term). On asset quality, credit cost stabilisation still seems some time away given: 1) stress in MSMEs and a few pockets of MFIs; 2) incremental stress recognition on credit card portfolio and known corporate accounts; and 3) inadequate contingency buffer. Bank will take some more quarters to normalise its earnings trajectory, delivering modest RoA/RoE in the interim. This will cap valuation rerating beyond 1x FY22E adjusted book. Maintain HOLD. Key risks: 1) credit card / wholesale businesses exhibiting better stability and quality; 2) premium deposit rate may weigh on NIMs.

* Slippages to be elevated in Q4FY21 as well; normalisation likely to set in from FY22E: Expectations from RBL Bank on stress accretion was relatively higher than peers – given the vulnerability of the pool (credit card, MFI, MSME, commercial banking, etc.). True to this, proforma slippage run rate was higher (>10% annualised for Q3FY21 and ~4% for 9MFY21). We expect slippage run rate to be >7% in Q4FY21 as well given flow-through from SMA-2 pool in credit card, stress in MSME and micro banking, and slippage in some corporate accounts known to be stressed. Management highlighted earlier that proforma GNPAs will rise for MFI advances (from 2.6% to 5.0-5.5%) and business lending (from 4.5% to 6%) along with some upfront stress recognition in credit cards. We expect slippages to retrace to normalcy from FY22 onwards.

* Not much provisioning buffer available; stabilisation of credit cost some time away: Bank reported ~440bps annualised credit cost in Q3FY21 as it utilised contingency buffer of 50bps (50% of existing buffer), while corporate slippages too were contained at lower levels. With similar levels of stress anticipated in credit card, MSME and MFI segments, and risk of some provisioning requirement on corporate portfolio, we expect Q4FY21 credit cost to be higher QoQ. Getting into FY22E, we are building-in credit cost of 2.6%, which suggests the bank is still some time away from stabilisation.

* Corporate asset quality holding on for now: The corporate portfolio is demonstrating stability and holding up well. During Q3FY21, corporate banking constituted hardly 12- 15% of the total slippages. Bank is not witnessing any incremental stress in its corporate book. There are a couple of known stressed accounts and few small-size accounts that may be either restructured or might slip - but it is on guided or expected lines.

* Overall, RoE is unlikely to be in double digits for FY22E: For FY22E, considering mid-teens credit growth of 12%, slightly elevated credit cost at 2.6% vs FY17-FY12E average of 2.1%, fee income growth of 18%, NII growth of 10%, and cost to income ratio at 48% -- we believe RoA for the bank should settle around 1.2%, translating into RoE of 9.3%. For FY23E, we estimate RoE to cross the 10% mark (12.7%) largely led by credit cost normalisation to its 5-year average

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