Stock Recommendation | DCB Bank - BUY - Target price : 185

Overall gross and net NPLs were stable qoq at 1.8% and 0.7% of loans. Slippage at 1.8%of loans have been broadly stable in recent quarters and the gross NPLs reported in the LAP portfolio are lower than the industry average, which gives greater comfort to the underwriting standards of the bank. Most of the underlying trends in other product segment are not showing any major negative deviations. The impact of GST appears to be negligible.

We value DCB at 1.8X book and 14X September FY2020E EPS (TP at ₹185 from ₹180 earlier) for RoEs at 12-13% in the short term but ~25% CAGR in earnings over FY2018-20E.

Margin pressure remains as lending yields are still moving downwards

Calculated NIM dropped 10 bps qoq (down 50 bps yoy) led by decline in yields while cost of funds has remained stable qoq. Cost of deposits increased by 10 bps yoy to 6.6%. Yield on advances decreased 15 bps qoq to 11% (down ~40 bps yoy). MCLR rates increased by 65 bps in 2QFY19. Increase in competition from other players in the retail space and gradual shift in product mix to include more of low-yielding mortgage and CV loans have led to yield compression yoy.

We maintain a negative outlook on NIM in the absence of any change in product mix though directionally we are less negative than before. Competition, especially from NBFCs, has slackened in the past month and we do expect this to result in an improvement in pricing power for the existing players.

We expect NIM to drop by ~50 bps from FY2018-21E. NIM continues to drop from peak levels of 4%. Pressure on NIM would result from – (1) shift in loan mix to include more retail assets like vehicle and mortgage loans where competition from other banks and NBFCs is relatively high, (2) stable rather than any improvement in CASA ratio in medium term and (3) focus on building retail deposit franchise (currently at 75% of deposits; up 100 bps qoq) in the medium term may result in deposit costs being relatively inelastic in comparison to the loan yields.

Asset quality stable qoq; NPLs in the LAP portfolio stable qoq

Headline gross NPL ratio remained stable at 1.8% of loans in 2QFY19 whereas net NPL ratio was flat qoq at 0.7%. On absolute basis GNPL increased ~2.3% qoq. Reported provision coverage ratio (including technical write-off) inched upwards by 80 bps qoq to 77%. The bank maintains relatively high coverage ratio compared to its peers.

Slippages saw marginal improvement for the quarter at 1.8% of loans. Recoveries and upgrades remain strong at 1.3% in 2QFY19 (1.3% in 1QFY19 and 1.2% in 2QFY18). This hint at directional shift in asset mix focusing on consumers whose tendency of default is high but chances of recovering bad loans are also high as compared to corporate NPLs. Impact of GST has been negligible as the asset quality continues to hold up well in all segments, including MSME.

NPLs in the core mortgage portfolio remained high but stable qoq at 1.7%. Corporate GNPL inched up by 30 bps qoq to 2.8%, a trend similar to previous quarters. CV/CE loan GNPL saw significant improvement in 2QFY19 (down 40 bps qoq and 200 bps yoy). This segment continued to see drop in GNPL over the past few quarters. SME GNPL was flat qoq at 1.4%. We build in 1.6%-2% slippages and 60-70 bps credit cost over FY2019-21E.

Loan growth maintains momentum at ~27% yoy

Loan growth was strong at 27% yoy in 2QFY19. Loan growth has maintained robust pace over the past four quarters recording >25% yoy growth. The sharp spike in loans was led by CV and SME segments. Corporate loan growth maintained an upward trajectory growing 12% yoy though it is not a key focus area for the bank. CV/CE loans jumped 1.5X yoy (up 15% qoq) in 2QFY19. This has been driven by positive sentiment in the sector and a gradual increase in focus of the bank towards increasing retail asset mix. Mortgage loan growth remains healthy at 21% yoy, broadly similar to that observed over the past few quarters. SME/MSME growth saw a spike at 27% yoy. This segment remains a major area for growth going ahead. However, corporate loan growth momentum declined to 12% yoy growth (48% in 1QFY19). This point towards the shifting focus of management towards retail segments and management has guided for restricting the corporate book growth at around ~15% in the medium term.

We expect overall loan growth to remain above the industry average, closer to ~24% CAGR from FY2018-21E. However, there might be a shift in product mix with increasing share of CV and SMSE loans while mortgage loans may see a slight dip.

CASA ratio remains stable at ~24% CASA ratio was stable qoq at ~24% in 2QFY19 (down 160 bps yoy). While growth in total deposits was strong at 27% yoy, it was relatively modest at 19% yoy for CASA reflecting the increased focus on term deposits to improve overall branch productivity. Retail deposits comprise about 75% of total deposits (up 30 bps qoq).

We expect similar CASA growth going ahead. Our forecast is 21% CAGR growth in total deposits and 23% CAGR growth in CASA from FY2018-21E.

Focus on cost efficiencies continues; cost-income ratio improves Cost-to-income ratio decreased ~140 bps qoq to 59% (similar decline yoy) in 2QFY19. Costincome ratio has remained high in the range of 55-60% over the past two years as the bank had aggressively opened branches. Operating expenses growth at 10% yoy was lower than that observed over the past few quarters as the bank has changed assumption regarding change in useful life of the assets. Employee expenses grew 20% yoy as the bank is probably increasing its capacity within each branch to reflect increase in business opportunity. The bank has slowed down branch expansion and is focusing on improving productivity of existing branches in order to gain cost efficiencies.

We expect cost-income ratio of ~53-58% in FY2019-21E. We forecast around ~13% CAGR in operating cost in FY2018-21E as we build in about 100 additional branches till FY2021E compared to 120 new additions during FY2016-18. Higher pressure on NIM is slowly emerging as key headwind for improvement in cost-income ratio. The bank would need to cut back operating expenses growth in FY2019 to achieve its medium term RoEs of 12% for 4QFY19E.

Other highlights for the quarter

▶ Non-interest income remained stable qoq at `740 mn (up 13% yoy). Fee income increased 16% yoy while sharp drop in treasury gains continue to be driven down by increase in mark to market losses. We forecast ~20% CAGR growth in non-interest income in FY2018-21E led by sharp growth in fee income.

▶ Capital adequacy ratio stood at 15.6% with tier-1 at 12%. Growth in RWA at 18% yoy was slightly lower than advances growth at 27% yoy in 2QFY19.

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