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Lacklustre growth, weak core earnings and elevated stress

* Despite muted credit growth, lower margins and higher opex, Union Bank reported a beat in PAT at Rs15.2bn (est. Rs11.6bn), mainly due to the one-off recovery from DHFL (Rs16.5bn). Asset quality was a mixed bag, with reported GNPA down 96bps qoq to 12.6%, but the restructuring book inched up by 70bps qoq to 3.4% of loans.

* The bank has reduced its FY22 credit growth guidance to 6-8% from 8-10%, given the challenges in the corporate segment. However, in our view, this is also slightly optimistic. Given continued slow growth, we believe that NIMs will remain sub-par, impacting core profitability.

* We remain concerned about elevated stress, including from its otherwise higher SME book. The bank expects recoveries and upgrades of Rs60bn in H2, and is looking to transfer Rs120bn worth of loans to NARCL, including fraud accounts of Rs40bn, by Mar’22.

* We raise TP (Dec’22) to Rs40 from Rs34, factoring in earnings upgrade and valuing the bank at 0.5x Dec’23E ABV. Maintain Sell/UW in EAP, mainly due to sub-par asset-quality profile, growth/return ratios and capital position, which will necessitate continuous equity dilution.

Growth remains anemic; margins slip qoq:

Overall credit growth remained weak at 0.3% yoy due to a continued decline in Corporate (down 9% yoy). RAM grew by 8.5% yoy. The corporate segment continued to be impacted by lower WC utilization/TL sanctions despite a strong pipeline in sight, which management believes will remain under pressure due to the very low interest rates and competition. However, management has optimistically guided for 6-8% credit growth for FY22, mainly driven by Retail and Agri, with backend support from MSME. In Q2, CASA remained healthy at 37%. However, despite lower CoF, lower growth and interest reversals impacted NIM, which declined by 13bps qoq to 2.9%. Management expects NIMs to sustain in the range of 2.9-3%.

Asset-quality risks persist:

Fresh slippages were elevated at 4.7% of loans, mainly from corporate (53%) and MSME (23%). However, higher recovery/write-offs led to a 96bps qoq improvement in the GNPA ratio to 12.6%. The overall restructuring pool for the bank has inched up to Rs214bn, 3.7% of loans (2.4% in Q1), with major contribution from Retail (45%) and Corporate (30%).Specific PCR fell by 213bps qoq to 66.6%. On the other hand, the overall SMA 2 ratio declined to 2.3% from 3.7% in Q1. Management expects recoveries and upgrades of Rs60bn in H2, leading to a total of Rs160bn, or 2.7% of loans, for FY22. This, coupled with the transfer of Rs80bn of identified accounts and Rs40bn worth of fraud accounts to NARCL (200bps of loans), should further bring down corporate/overall NPA. For FY22, management expects credit cost and delinquencies to be 2% and 2.5%, respectively.

Outlook and valuations: 

We raise FY22-24E EPS by 12-15%, factoring in higher other income and some moderation in LLP. However, we maintain our Sell rating/UW in EAP, mainly due to its relatively weak asset-quality profile, sub-par growth/return ratios and capital position, which necessitate continuous equity dilution. Key upside risks: one-off gains from stake sales in the insurance business and slower-than-expected NPA formation.

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