City Union Bank (CUBK IN) - Q4FY23 Result Update - Earnings quality being tested

We trim NIM by 18 bps to 3.5% and reduce multiple from 1.8x to 1.4x due to growth/pricing pressures emanating from higher competition. Downgrade from ‘BUY’ to ‘ACCUMULATE’ and rolling forward to Mar’25 our TP is Rs160 (earlier Rs190). CUB saw a weak quarter as core PPoP missed PLe by 8.5% due lower NII/NIM. However, asset quality was the silver lining as GNPA/OTR reduced by 25/117bps QoQ. For FY24E, bank guided for 12-15% loan growth that would be back-ended while it expects reported NIM to decline YoY from 3.9% to 3.7%. Intent is to keep RoA at 1.5% driven by higher recoveries and moderating provisions. CUB has tied up with BCG to help in risk assessment, pricing, portfolio modelling and digital lending. SME credit model of CUB is challenged due to competitive intensity as yields fell by 13bps YoY in FY23 compared to 100bps rise for private banks although asset quality is expected to improve over FY23-25E and valuation is favourable at 1.2x on FY25E ABV.

•  Miss on earnings due to weaker NII/NIM: NII was a miss at Rs5.14bn (PLe Rs5.7bn), due to lower NIM as loan growth was in-line. Credit growth was +6.7% YoY while deposit growth was 9.9% YoY. NIM was lower at 3.52% (PLe 3.88%) mainly due to lower yields. Other income was largely in-line at Rs1.95bn with slightly better fees and treasury. Opex was lower at Rs2.9bn (PLe Rs3.1bn) due to employee cost. Core PPoP at Rs3.95bn missed PLe by 8.5% due to weaker NII; while PPoP was Rs4.2bn. GNPA fell by 25bps QoQ to 4.37% led by lesser net slippages. Provisions were a tad more at Rs1.6bn (PLe Rs1.4bn) due to higher gross slippages. PAT was Rs2.2bn (PLe Rs2.4bn).

• Loan growth for FY24E guided at 12-15%; to be back ended: Growth slowed down in H2FY23 mainly due to regulatory inspections, RBI divergence and tightening of approval rates from 50% to 25%. Bank guided 12-15% loan growth for FY24E, which could be back-ended (in H2FY24) while growth for H1FY24E would remain muted due to fine tuning of internal processes and sorting of regulatory issues. The bank has tied up with BCG to help in risk measurement, pricing, modelling of portfolio and upgradation of digital lending. Arrangement is business related and there would be no change in organization structure. Gold loans’ share is 25% and idea is to pursue gold loans in case MSME is not doing well or liquidity is in surplus; gold share should normalize to 12-15%.

• NIM to decline; stable asset quality: While yields for private banks increased by 100bps YoY in FY23, reported yields for CUB declined by 13bps YoY owing to competitive intensity and higher slippages. Moreover, ~90% of assets are repriced compared to 50% of deposits suggesting that in FY24E deposit cost would rise faster than yields. Management guided that NIM for FY24E would be ~3.7% (vs 3.9% in FY23). Hence we trim our NIM guidance for FY24/25E by 18bps to 3.5%. Asset quality was better as GNPA declined by 25bps QoQ due to higher recoveries while OTR reduced from 4.0% to 2.9%. Bank expects net slippage ratio for FY24E to moderate as recoveries would improve.