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MFI Stress Peaks; Looking to Accelerate Growth in Credit Cards and PL

Est. Vs. Actual for Q1FY26: NII – INLINE; PPOP – BEAT; PAT – MISS Changes in Estimates post Q1FY26 FY26E/27E/FY28E (%): NII -3.8/-2.6/-3.3; PPOP -4.9/-2.8/-4.5; PAT -8.0/-2.4/-4.3

Recommendation Rationale

• MFI Stress Peaks; Credit Costs to Taper Gradually: The stress in the MFI has peaked, and slippages in this segment are expected to gradually taper from H2 onwards. Similarly, the asset quality challenges in the Personal Loans (PL) and Credit Card (CC) segments have stabilised. The bank is witnessing emerging stress in the retail CV segment. Consequently, the bank has tightened its underwriting policies. The management expects the stress in the retail CV segment to subside over the next couple of quarters. In the business banking and SME portfolio, KMB is currently not witnessing any signs of stress emerging. With the slippages in the unsecured portfolio having peaked out and the incremental stress formation across most segments (ex-Retail CV) remaining benign, KMB expects credit costs to taper sequentially. We pencil-in credit costs of 80 bps (+/-5bps) over FY26-28E.

• Growth Momentum to be Healthy; Calibrated Improvement in Unsecured Mix: The management has reiterated its guidance of growing the advances at 1.5-2x of nominal GDP growth. With Asset quality challenges in the unsecured portfolio now behind, the bank will look to resume growth in the PL, CC and MFI segments. While the MFI portfolio contribution to the portfolio will remain capped at 3-4%, KMB believe PL and CC remain key growth drivers. With the embargo now lifted, KMB will look to pursue accelerated growth in the CC portfolio, supported by new product launches (2 new products launched with a focus on the affluent customer segment). So far, the uptick in credit cards has been slower than expectations; however, the bank is confident that growth will accelerate over the coming quarters. The bank continues to aspire to scale the unsecured portfolio to ~15% of the overall book over the medium term vs ~9.7% in Q1FY26. Another focus area for the bank would be the mid-market segment, wherein KMB will look to accelerate growth. We expect KMB to deliver a healthy ~17% CAGR credit growth over FY25-28E.

Sector Outlook: Positive Company Outlook: With the embargo being lifted, KMB will look to pursue growth in the unsecured segments, though steadily. Resumption of growth in the higher-yielding segment, CRR cut, and the rate cut action on deposits, reflected in CoF, should help KMB’s margins to recover from H2FY26 onwards. Near-term pressure on NIMs will persist, with Q2 possibly marking the bottom in terms of NIMs. Asset quality challenges seem to be waning away, with fresh stress accretion trending downwards in the unsecured portfolios and secured portfolio (ex-retail CVs) asset quality holding up well. Thus, credit costs are expected to taper from H2FY26 onwards. The bank could continue to incur opex towards new product roll-out, branding campaigns, and tech enhancement, keeping opex ratios in a tight range. We expect KMB to deliver steady RoAs of 2.1-2.2% over FY27-28E. Current Valuation: 2.5x FY27E ABV; Earlier Valuation: 2.5x FY27E ABV Current TP: Rs 2,500/share; Earlier TP: Rs 2,525/share Recommendation: We maintain our BUY recommendation on the stock. Alternative BUY Ideas from our coverage: HDFC Bank (TP – Rs 2,300); ICICI Bank (TP – Rs 1,650)

Financial Performance:

? Operational Performance:

KMB’s advances grew by 14/4% YoY/QoQ. The mix of the unsecured book declined to 9.7% vs 11.6/10.5% YoY/QoQ. Deposits growth was healthy at 15/3% YoY/QoQ, led by TD (+20/7% YoY/QoQ), while CASA Deposits growth was muted (+8/- 2 YoY/QoQ). CASA Ratio declined to 40.9% vs 43% QoQ. LDR stood at 86.7% vs 87.2/85.5% YoY/QoQ.

? Financial Performance: NII grew by 6% YoY/ flat QoQ, driven by healthy advances growth; however, NIM contracted sharply by 32 bps QoQ and stood at 4.65%. Non-interest income grew by 5/-3% YoY/QoQ, led by slower fee income growth (flat YoY/-14% QoQ). Treasury gain stood at Rs 2 Bn vs Rs 0.2 Bn QoQ. The impact of lower-than-expected non-interest income growth was offset by controlled Opex growth. Opex growth was at 6/-4% YoY/QoQ. C-I Ratio stood at 46.2% vs 46.2/47.7% YoY/QoQ. PPOP grew by 6/2% YoY/QoQ. Provisions were up 109/33% YoY/QoQ, a miss vs. our expectations. Credit costs (calc.) stood at 107bps vs 58/83bps YoY/QoQ. PAT de-grew by 8% QoQ.

? Asset quality:

Slippages inched up QoQ, with the slippage ratio at 1.7% vs 1.4% each YoY/QoQ. Slippages were higher in the MFI pool, retail CV segment, and due to seasonal rural slippages. GNPA/NNPA stood marginally higher at 1.48/0.34% vs 1.42/0.31% QoQ. The write-offs during Q1 stood at Rs 7.6 Bn vs Rs 8.5 Bn QoQ.

Key Takeaways

Focus on deposit granularity:

KMB continues to focus on SA Accounts, Activ Money and Retail TDs to drive deposit growth, while aiming at containing CoF. In Q1, the bank delivered a strong 23% YoY growth in ActivMoney, supported by the resumption of customer acquisition with a revamped superior product through the 811 channel. The Kotak811 channel will remain a key enabler to drive healthy liability franchise growth. In the CA accounts, the bank saw improved traction in the NTB in the self-employed segment. KMB's focus on LAP, SME, and business banking verticals should enable healthy CA deposit accretion. We expect deposit growth will mirror credit growth, enabling the bank to maintain a steady LDR between 85-86%.

NIMs to Bottom-out in Q2; Improved Unsecured Share to Support NIMs:

KMB’s margins contracted sharply by 32 bps QoQ owing to (1) Repo rate cuts weighing on yields, (2) Slower growth and lower mix of these better-yielding unsecured products in the portfolio mix, and (3) the day convention. The repo rate cut in Jun’25 is yet to reflect on the yields, and thus margins will continue to remain under pressure in Q2. However, the SA rate action (reduction of ~75 bps) should reflect in Q2, partially supporting NIMs. However, the impact of TD repricing would be visible from H2 onwards. Thus, from Q3 onwards, KMB's margins should find support from the (1) Impact of CRR cut, (2) Improving growth in the unsecured segments and an improving mix in the overall portfolio, and (3) Downward repricing of deposits. We expect FY26 margins to remain lower at ~4.7%, before improving to ~4.9-5% over FY27-28E, driven by aforementioned factors.

Outlook

We expect KMB to deliver healthy Advances/NII/Earnings growth of 17/16/11%* (*incl one-time gain from stake sale in KGI in FY25) CAGR over FY25-28E. We believe KMB remains well-positioned to improve its margins in a rate cut environment supported by accelerating growth in the higher-yielding unsecured segment, coupled with rate cut actions on deposits. However, near-term headwinds on NIMs and credit costs could be visible. We trim our NII estimates by 2-3% to factor in the impact on NIMs and the near-term headwinds, with the full impact visible in Q2. Even as the bank continues to invest in the franchise, scaling up of the unsecured products and tech, opex growth is likely to be in line with business growth. Gauging near-term challenges on credit costs and pencilling in the impact on margins, we reduce our Earnings estimates by ~8% for FY26E and by 2-4% over FY27-28E. We expect healthy RoA/RoE delivery of 2-2.2%/12-14% over FY26-28E.

Valuation & Recommendation

We value the bank’s core book at 2.5x FY27E ABV (vs current valuation of 2.3x FY27E ABV on core book) and assign a value of Rs 635 to the subsidiaries, thereby arriving at a target price of Rs 2,500/share. The TP implies an upside of 18% from the CMP. We maintain our BUY recommendation on the stock.

Key Risks to Our Estimates and TP

• The key risk to our estimates remains a slowdown in overall credit momentum, which could potentially derail earnings momentum for the bank.

• Management focusing on growing the unsecured portfolio would support margins, but may come at the cost of challenges to asset quality

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