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  • Stock Recommendation | J&K Bank - BUY - Target price : 90

    Publish date: OCTOBER 17, 2018

    Impairment ratios decline further. J&K Bank reported another quarter of improvement with earnings growth of 31% yoy led by 29% yoy decline in provisions. Gross NPLs and net NPLs declined 80 bps qoq while restructured loans declined 70 bps qoq (largely led by repayments). Barring their exposure to IL&FS, overall performance continues to show improvement. We are building in higher provisions of ₹5 bn to factor this risk. Valuations are attractive. BUY with revised TP of ₹90 (from ₹100 earlier).

    J&K Bank reported a strong quarter with healthy performance on all metrics. (1) Earnings grew 31% yoy led by ~30% decline in provisions (35% yoy decline in loan-loss provisions). (2) NIM was flat qoq at 3.7% and loans grew 24% yoy (within J&K at 21% yoy and outside J&K at 15% yoy). Asset quality showed further improvement with gross and net NPLs declining 80 bps qoq to 9% and 3.9% of loans, respectively. Restructured loans declined 70 bps to 6.2% of loans. Provision coverage stands comfortable at 70% (including write-off) and 60% (excluding write-off), one of the highest among peers.
    As we have highlighted in the past, restructuring of loans within J&K state is showing a different delinquency profile as compared to that which was done outside and primarily to the corporate segment. While the bulk of the corporate loans eventually slipped into NPLs, the experience is so far different within the state with repayments and closures driving the reduction. From the peak book, ~10% has slipped into NPLs. This trend is giving more comfort as the provisions required would be lower than initially expected.
    We do believe that the bank has exposure to IL&FS group across its various subsidiaries. While we don’t have an exact number, our initial reading suggests that the exposure could be ~1.5% of the loan book. We are building in higher provisions in our estimates of ~80 bps in our models currently assuming that this would have to be provided at some point in time.
    We maintain our BUY rating on the bank with a revised TP of ₹90 (from ₹100 earlier) valuing the bank at 1X book and 8X September 2020E EPS. Given its area of business and strong liability franchise, the bank has the ability to generate superior NIMs, which can help sustain additional credit costs, if any. Pace of capital consumption is worrying but we have seen support from the state in the past. As concerns on restructuring of loans recede, which we are witnessing currently, we see a possible expansion in valuation multiples.

    Gross NPLs decline 280 bps qoq; slippages decline sharply to 1.7% of loans
    GNPL ratio dropped 280 bps qoq to 9.0% of loans along with reduction in slippages by 370 bps qoq to 1.7% in 2QFY19. It does appear that slippages from restructured loans were negligible and no large corporate slippages reported this quarter as we are closer to the end of the weakness in the corporate NPL cycle.
    Restructured loans declined 70 bps qoq to 6.2% of loans with nearly all of these loans coming from within the state of J&K. There have been some more disbursements to the restructured loan portfolio, which could be due to drawdown of existing unutilized credit lines of customers. The portfolio within the state has seen a steady repayment and limited stress so far giving comfort that the risk is probably not as worse as it was initially perceived given the performance of restructured loans in general for the sector.
    One of the key positives of the bank is the high coverage ratio it maintains. Reported PCR (including write-offs) stood at ~70%, highest among its peers. Outstanding SDR, S4A and 5/25 dispensations dropped 10 bps qoq to 0.5% (S4A and 5/25 was flat qoq). We forecast GNPL to drop to 6% of loans by FY2021E driven by sharp drop in slippages going forward (2.6% in FY2019E and 1.5% in FY2020E).

    Loan growth accelerates to ~24% driven by strong performance in home state
    Overall gross advances increased 24% yoy primarily on account strong loan growth within J&K. Loan growth outside J&K was relatively modest at 15% yoy primarily driven by corporate loan book growth at 14% yoy. The share of gross loans outside J&K remained stable at 47%. Overall growth in retail loans was strong at 30% yoy, a trend similar to previous quarters. The growth in retail loans has been strong in home state at 31% yoy while that outside J&K grew 15% yoy. The share of retail loans has increased to ~23% of loan mix. Growth in corporate loans was relatively slower at 12% yoy. SME and agriculture loan growth was robust at 29% yoy and 14% yoy, respectively.
    We forecast 15% CAGR in net advances from FY2018-2021E as the management remains positive on growth in advances within the state.

    Reported NIM remains stable at 3.7%
    Reported NIM remained stable at 3.7% on the back of improvement in lending yields offset by increased cost of funds and drop in investment yields. Reported yield on loans increased 50 bps qoq to 9% on the back of lower interest reversals. There was no relief from cost of deposits, which increased 8 bps qoq to 4.9%.
    We expect lending yields to marginally inch up going ahead due to better pricing power. J&K Bank, however, maintains a strong CD ratio, which provides some comfort to the NIM profile. Growth in CASA going and drop GNPL will provide slight comfort to NIM. We forecast NIM (calculated) to drop ~10 bps to 3.5% in FY2019E.
    CASA ratio stable qoq to 49%
    CASA increased 13% yoy and the ratio was stable qoq at 49%. CASA ratio within J&K was strong at ~54%. Growth in CA maintains momentum at 30% yoy and SA growth rate also picked pace in 2QFY19 recording a 9% yoy increase.
    Growth in SA within J&K was modest at 10% yoy in (up 3% qoq). The growth in outside J&K remained muted qoq but recorded a modest increase of 8% yoy. We forecast a modest 12% CAGR in CASA from FY2018-2021E stable CASA ratio of ~50% CASA ratio over the same period.

    Other highlights for the quarter
    ▶ Non-interest income showed a modest increase of 6% yoy on the back of loss of `260 mn in treasury income. Growth in fee income was high at 18% yoy. Insurance distribution income grew 3% yoy.
    ▶ Cost-income ratio was high at 62% yoy in 2QFY19 driven by sharp rise in employee expenses at 19% yoy in 2QFY19. Operating expenses increased 21% yoy in 2QFY19. Cost-to-income ratio has been high in the range of 55-65% over the past few quarters. We forecast cost to income ratio to moderate to ~56% by FY2021E from 59% in FY2018 driven by modest 9% CAGR in operating expenses from FY2018-2021E.
    ▶ CAR decreased 40 bps qoq to 12% with tier-I ratio at 10.2%. Given the pace of growth in balance sheet and current CET-1, we do believe that the bank would either need to slow down its balance sheet growth and/or improve profitability if it is not able to raise capital. The bank has got support from the state government in the past which in our view is a source of comfort if the capital consumption continues at the current levels though it is negative for the minority shareholders as the capital infusion would be below reported book value.

    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.

    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.

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