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Growth to remain elusive as elevated asset quality risks persist

* Amid sub-par credit growth and elevated provisions with asset quality risk coming to fore, DCB reported a beat on PAT at Rs0.96bn (est. Rs0.55bn) mainly due to higher treasury income. We believe that subdue growth and ensuing interest reversals on NPA could weigh on NIMs/core earnings.

* Proforma GNPA stood high at 3.7%, while the restructured pool stood at Rs6.9bn (2.7% of loans). This coupled with continued sub-par collection efficiencies across portfolios (mainly CV) indicates inherent asset quality risk. DCB has increased the provisioning buffer to Rs2.3bn (0.9% of loans), but still remains sub-par in view of elevated stress.

* DCB guides for double-digit credit growth in FY22/23 and optimistically lower LLP in FY23 at ~50bps, leading to >1% RoA. We believe that the asset quality risk will persist in FY22/FY23, with elevated restructuring, and thus build in higher LLP (180bps/140bps) and lower RoA of 0.8%/1% in FY22/FY23.

* We maintain Sell/UW in EAP with a TP of Rs95 (based on 0.8x FY23E ABV), given the sub-par growth trajectory for small banks, traditionally weak liability profile, higher asset quality risk and subdued return ratios. Current MD’s term is up for renewal in Apr’21 and it will be a key event to watch out for.

Growth remains sub-par as inherent asset quality risk comes to fore: Credit growth remains subdued (down 1% yoy) due to a slowdown in the retail/SME business. However, the bank has seen sharp re-acceleration in its corporate book in Q3, reversing the conscious downtrend for many quarters. Under ECLGS, the bank has disbursed Rs6bn so far (out of Rs21bn sanctioned). Incrementally, DCB intends to focus on business loans (LAP), home loans, gold loans, KCC, tractor loans and short-term corporate loans in the near- to mediumterm and guides for high-teens growth in FY22-23. Deposits dip 3% yoy as DCB consciously sheds high-cost bulk deposits and instead is focusing on RTDs/CASA. NIM remains flat qoq at 3.7%, but we believe that ensuing interest reversals on NPA could weigh on NIMs.

Asset quality pain to accentuate further: Reported GNPA improved 30bps qoq to 1.96% due to continued SC stay on NPA tagging, while proforma GNPA is much higher at 3.7%. As a cautious stance, the bank improved specific PCR by 620bps qoq to 70% and made a contingent provision of Rs861mn during Q3, leading to a cumulative buffer of Rs2.3bn (0.9% of loan book), which we believe is still sub-par. In addition, it carries a floating provision of Rs1bn. DCB expects the next 4 quarters to be a bit challenging and guides for elevated stress once the SC stay is lifted with restructuring touching a higher band of 5%, and thus intends to provide adequately going ahead. In our view, the restructuring (3-5%) and potential relapse could lead to higher tail-end risk in FY22/FY23, and thus build in higher LLP over FY21-23E (140/180bs).

Retain Sell: We expect the bank’s RoA/RoE trajectory to remain sub-par around 0.8-1%/9- 11% given moderate growth and higher LLP. Retain Sell/UW in EAP with a TP of Rs95 based on 0.8x FY23 ABV. Key risks to our call include lower NPA formation than expected, and better operating leverage leading to higher RoAs.

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