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Strong quarter, business growth to pick up; upgrading to a Buy

A steep rise in margins and negative provisions led to Karnataka Bank’s Q2 strong profitability, with its RoA at 1.7%. With most pandemicrelated stress already recognised/re-structured, the focus now shifts toward growth. Key positives were 1) strong traction in retail loans, 2) moderation of slippages and 3) strong margin improvement. With credit growth picking up and moderating credit costs, earnings are expected to normalise in the medium term. We upgrade our rating to a Buy, with a higher TP of Rs140, valuing the stock at 0.6x P/ABV on its FY25e book

Asset quality improves. GNPA decreased 67bps sequentially to 3.4%, caused by lower slippages and strong recoveries. Slippages were Rs3bn (2% of loans), less than previous quarters and better than we expected. The re-structured book was Rs33.3bn, down 8.9% q/q.

Medium-term RoA to move toward 1%. Q2 NIM rose 45bps q/q to 3.78% on the sharp rise in yields (incl. one-off recovery). We expect NIM to stabilise near 3.5%. We are working with a 190bp credit cost for this year, to account for a tail risk from accelerated slippages in the restruc-tured book. We expect credit costs to moderate in a couple of quarters, leading to normalisation in RoA. We estimate 0.9% RoA for FY25

Valuation. Our Nov’23 target (of Rs140) is based on the two-stage DDM model. This implies a ~0.6x P/ABV multiple on its FY24e book. Risks: High provisioning, large slippages from its agriculture and MSME books.

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