South Indian Bank. Institutional Equities. 1QFY19 Result Update. Performance Troughs, Pessimism Peaks BUY. 23 July 2018

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1 1QFY19 Result Update Institutional Equities South Indian Bank 23 July 2018 Reuters: SIBK.BO; Bloomberg: SIB IN Performance Troughs, Pessimism Peaks South Indian Bank (SBL) reported 1QFY19 results with the key strategic takeaways being: (1) SBL applied the concept of inherent weakness conservatively leading to total slippages of Rs 6.06bn but management has guided for Rs 6-7bn slippages over the remainder of FY19 (2) Core fee income growth was tepid due to the absence of PSLC income (~Rs 200mn in 1QFY18) (3) Hit from (a) gratuity revision (Rs 204.5mn) and (b) MTM loss (Rs 343mn) that remained unamortized as of 4QFY18 were, conservatively, fully absorbed (4) NIM contracted ~10 bps QoQ and ~20 bps YoY to 2.6% but management guided for NIM reversion to 2.8% in ~6 months on the back of MCLR resets. (See comprehensive conference call takeaways on page 2; see initiating coverage report here). Per se, on the results front, SIBL posted NII growth of 7.3% YoY at Rs4,943mn, PPOP decline of 28.9% YoY at Rs2,696mn and PAT decline of 77.3% YoY at Rs230mn. We have revised our estimates for FY19/FY20 and have retained Buy rating on SBL, revising our target price to Rs26 (from Rs30 earlier) and valuing the stock at 0.75x FY20E P/BV. SBL applied the concept of inherent weakness conservatively leading to total slippages of Rs 6.06bn: One social infra account (Rs 1.05bn), two cashew sector accounts (Rs 1.17bn) and an EPC account (Rs 0.22bn) slipped upon conservative application of the concept of inherent weakness. As things stand, there is no account standard at SBL that is NPA at another bank. There were no slippages from large syndicated / consortium corporate accounts. However, total corporate slippages were Rs 3.08bn mainly from smaller non-consortium accounts. Slippages from SME segment spiked to Rs 2.26bn and were the primary negative surprise. Of these, ~Rs 1bn were from accounts that had previously been accorded RBI 180-day dispensation for MSMEs. None of the sub-investment grade corporate accounts (18.3% of corporate book on internal rating) are in default. Management guided for total slippages of Rs 6-7bn over the remainder of FY19 and credit costs of ~100 bps for the full year FY19. Core fee income growth was tepid due to the absence of PSLC income: Core fee income grew 8.3% YoY to Rs 910mn. Last year, about Rs 800bn of PSLC fee income was garnered, of which about a fourth was booked in 1QFY18. This was absent in 1QFY19. Business development officers have now been deployed effectively at branches and will start to perform with some lag on the liabilities and cross-sell front. Some incipient signs of improved performance is visible with SA growth of ~6% QoQ. Accelerated amortization of gratuity and MTM hit further compressed bottomline, NIM compression is transient: While SBL had availed respective RBI dispensations for spreading gratuity revision and MTM hits in 4QFY18, they, conservatively, chose to fully absorb the unamortized quantums of Rs 204.5mn and Rs 343 mn during the quarter. MCLR resets over the next ~6 months will aid NIM reversion to ~2.8%. Majority of loans are on 1-year MCLR and recent MCLR hike amounts to 25 bps. NIM compression on account of interest reversals was 9 bps. Valuation and outlook: We have revised our NII estimates by -3.2%/-1.1%, PPOP estimates by -6.4%/- 4.9% and PAT estimates by -15.4%/-8.3% for FY19/FY20, respectively. We have retained Buy rating on SBL, revising our target price on it to Rs26 (from Rs30 earlier) and valuing the stock at 0.75x FY20E P/BV. NBIE Values your patronage- Vote for The Team in the Asia Money poll Click Here BUY Sector: Banking CMP: Rs18 Target Price: Rs26 Upside: 41% Shivaji Thapliyal Research Analyst shivaji.thapliyal@nirmalbang.com Key Data Current Shares O/S (mn) 1,809.5 Mkt Cap (Rsbn/US$mn) 33.3/ Wk H / L (Rs) 35/18 Daily Vol. (3M NSE Avg.) 11,030,740 Price Performance (%) 1 M 6 M 1 Yr South Indian Bank (21.5) (43.0) (35.9) Nifty Index Source: Bloomberg Y/E March (Rsmn) 1QFY19 1QFY18 4QFY18 YoY (%) QoQ (%) Interest income 16,539 14,907 15, Interest expenses 11,597 10,300 10, Net interest income 4,943 4,607 4, NIM (%) (20bps) (13 bps) Non-interest income 1,459 2,193 1,787 (33.5) (18.3) Operating income 6,402 6,800 6,709 (5.9) (4.6) Staff costs 2,111 1,670 1, Other operating expenses 1,594 1,336 1, (4.3) Total operating expenses 3,705 3,005 3, Cost-to-income (%) ,369bps 422bps Pre-provision profit 2,696 3,795 3,109 (28.9) (13.3) Provisions 2,315 2,243 1, PBT 381 1,552 1,623 (75.4) (76.5) Tax (71.9) (68.7) -Effective tax rate bps 987bps PAT 230 1,015 1,141 (77.3) (79.8) EPS (Rs) (77.4) (79.8) BV (Rs) Deposits 7,24,880 6,57,910 7,20, Advances 5,54,440 4,64,980 5,45,

2 Comprehensive Conference Call Takeaways Growth drivers in the advances portfolio were mortgages- 66%, MSME- 21%, agri- 14.2% and auto loans- 31% on a YoY basis. NIM compressed this quarter on account of increased deposit rates and interest reversals contributed 9 bps to NIM compression. The management recently hiked MCLR rates by 25 bps this quarter. Resets will take place over 6 months. The management has guided for NIM to improve to ~2.8% in about 6 months. Management has guided for 1% credit cost for the full year. Slippages in this quarter mainly comprised of Rs.3080mn from corporate segment, Rs.2260mn from MSME, retail & others contributed Rs.610mn and agri Rs.110mn. Corporate slippage comprised of one large account of Rs.1050mn, two cashew accounts worth Rs.1170mn and one EPC account of Rs.220mn. The management stated that they applied the principle of inherent weakness of the fundamentals of the business rather than recovery history in order to evaluate accounts for stress recognition. The management stated that the large corporate book has stabilised as such. There were no corporate slippages from large syndicated/ consortium accounts which were a cause of worry in the past due to lower recovery rates. Break-up of slippages from MSME segment was as follows: Rs590mn trading firms, Rs380mn textile, Rs.360mn food processing, Rs.180mn professional services, Rs.170mn engineering, Rs.150mn metal products, Rs.110mn leather products, Rs.100mn contractors and Rs.130mn from other manufacturing industries. The management has now revised its guidance for slippages for the pending 3 quarters cumulatively to Rs mn. The management is expecting recovery to be not less than Rs. 5000mn in FY19 on account of strong recovery initiatives and platform in place. ~Rs.1000mn worth of MSME slippages which took advantage of RBI dispensation in the previous quarter were classified as NPAs this quarter. The outstanding MSME loans still availing such dispensation is ~Rs.500mn. SIB does not maintain a watchlist on MSME loans. The management stated that the credit appraisal mechanism has been centralized in all segments except for gold loans. SIB has created a centralized credit committee based sanctioning system whereas this was earlier under the control of individual regional heads. The management stated that there s no widespread slippage pressure on the MSME segment as such. There has been some GST transitioning pressure on MSMEs. Within Kerala, there have been issues in the cashew and marine segments. The management stated that there has been very selective sanction with respect to Kerala cashew exposure in the last 3 years. SIB is ensuring reasonable prospective stability with the SME segment through credit underwriting, processing and monitoring. The management is confident of stably growing ~20% YoY in this segment. As per SIB s internal rating of corporate borrower profile, ~18% of the total corporate loan book is below BBB grade vis-a-vis ~9% as per external rating. The management stated none of the below BBB accounts are part of outstanding NPAs. The management also stated that none of these sub-investment accounts are in default. Gross SR book stood at Rs.13110mn with an accumulated provision of Rs.2650mn. SIB provided Rs.40mn in this quarter on SR book. Some of these accounts were RBI indentified NCLT accounts. As resolution occurs, more comfort will come on this front. 2 South Indian Bank

3 SIB has classified all accounts associated with DCCO issues as NPAs. The bank experienced reasonable traction on SA front with a QoQ growth of ~6%. The deployment of business development officers is relatively recent and the full impact of the same will be felt with a lag. The bank s loan book exposure to NCLT Lists 1 and 2 are to 2 accounts worth Rs.3360mn. Provisions on this exposure is ~50%. The management stated that the share of NPAs in MSME is broadly in line with geographical branch distribution. About 45% of the total MSME slippages were from Kerala in this quarter. SIB s focus on adequate security aims to have collateral comprising of immovable assets such as land, building etc beyond primary security such as receivables etc. The management stated that the board has not arrived at a decision on the capital raising front. They also stated that they still have some room to raise Tier 2 capital. The management stated that the LGD on slipped assets will not be high, particularly for MSME business, given that SIB has minimal unsecured business and strong collateral. The management stated that there is no account which is classified as NPA in other banks, is performing with SIB. SIB checks CRILC data to know if accounts are stressed at other banks. GNPA reductions comprised Rs.130mn of cash recoveries and Rs.240mn of upgrades. There were no write-offs during the quarter. Exhibit 1: Financial summary Y/E March (Rsmn) FY16 FY17 FY18 FY19E FY20E Net interest income 15,097 16,754 19,655 24,673 31,985 Pre-provision profit 8,794 12,146 14,808 16,113 21,192 PAT 3,333 3,925 3,349 4,714 7,611 EPS (Rs) ABV (Rs) P/E (x) P/ABV (x) GNPAs (%) NNPAs (%) RoA (%) RoE (%) Exhibit 2: Actual performance versus our estimates (Rsmn) 1QFY19 1QFY18 4QFY18 YoY (%) QoQ (%) 1QFY19E Devi. (%) Net interest income 4,943 4,607 4, ,796 (15) Pre-provision profit 2,696 3,795 3,109 (29) (13) 3,917 (31) PAT 230 1,015 1,141 (77) (80) 267 (14) Exhibit 3: Change in our estimates Revised estimate Earlier estimate % Revision FY19E FY20E FY19E FY20E FY19E FY20E Net interest income (Rsmn) 24,673 31,985 25,479 32,332 (3.2) (1.1) NIM (%) (6bps) 5bps Operating profit (Rsmn) 16,113 21,192 17,220 22,290 (6.4) (4.9) Profit after tax (Rsmn) 4,714 7,611 5,570 8,302 (15.4) (8.3) 3 South Indian Bank

4 Jul-13 Dec-13 May-14 Oct-14 Mar-15 Aug-15 Jan-16 Institutional Equities Jun-16 Nov-16 Apr-17 Sep-17 Feb-18 Jul-18 Exhibit 4: One-year forward P/BV (x) P/BVPS Mean +1 SD -1 SD +2 SD -2 SD 4 South Indian Bank

5 Financials Exhibit 5: Income statement Y/E March (Rsmn) FY16 FY17 FY18 FY19E FY20E Interest income 55,572 58,471 61,928 74,972 92,369 Interest expenses 40,475 41,716 42,273 50,300 60,383 Net interest income 15,097 16,754 19,655 24,673 31,985 Fee income Other Income 4,656 6,606 7,816 6,107 7,345 Net revenues 20,272 23,910 28,028 31,500 40,276 Operating expenses 11,478 11,764 13,220 15,387 19,083 -Employee expenses 6,923 6,765 7,132 8,185 9,635 -Other expenses 4,556 4,999 6,088 7,202 9,448 Pre-provision profit 8,794 12,146 14,808 16,113 21,192 Provisions 3,696 6,144 9,809 8,970 9,661 -Loan loss provision 3,911 6,201 7,008 7,836 8,643 -Provision for investment ,090 1,134 1,018 -Other provisions PBT 5,097 6,002 4,999 7,143 11,532 Tax 1,764 2,077 1,650 2,429 3,921 PAT 3,333 3,925 3,349 4,714 7,611 Exhibit 7: Balance sheet Y/E March (Rsmn) FY16 FY17 FY18 FY19E FY20E Equity Capital 1,350 1,803 1,809 1,899 1,899 Reserves & Surplus 37,106 46,682 50,623 57,141 63,843 Shareholder's Funds 38,456 48,485 52,432 59,040 65,742 Deposits 5,57,207 6,61,175 7,20,296 8,51,247 10,24,102 -Current deposits 19,831 27,526 30,576 37,455 49,157 -Saving deposits 1,04,758 1,29,938 1,40,841 1,74,506 2,30,423 -Term deposit 4,32,618 5,03,712 5,48,879 6,39,286 7,44,522 Borrowings 26,150 19,578 40,434 58,567 71,042 Other liabilities 12,936 13,884 13,697 30,875 50,167 Total liabilities 6,34,749 7,43,122 8,26,859 9,99,729 12,11,053 Cash/Equivalent 32,745 38,877 42,210 55,654 67,898 Advances 4,10,857 4,63,895 5,45,629 6,54,755 7,98,801 Investments 1,47,439 1,94,297 1,83,631 2,23,535 2,66,160 Fixed Assets 4,870 6,561 6,808 7,489 8,237 Other assets 38,837 39,492 48,581 58,297 69,956 Total assets 6,34,749 7,43,122 8,26,859 9,99,729 12,11,053 Exhibit 6: Key ratios Y/E March FY16 FY17 FY18 FY19E FY20E Growth (%) NII growth Pre-provision profit growth (0.4) PAT growth (14.7) Business (%) Deposit growth Advance growth Business growth CD CASA Operating efficiency (%) Cost-to-income Cost-to-assets Productivity (Rsmn) Business per branch 1, , , , ,994.4 Business per employee Profit per branch Profit per employee Spreads (%) Yield on advances Yield on investments Cost of deposits Yield on assets Cost of funds NIMs Capital adequacy (%) Tier I Tier II Total CAR Asset quality (%) Gross NPAs Net NPAs Specific provision coverage Slippage Credit cost Return (%) RoE RoA RoRWA Per share EPS BV ABV Valuation (x) P/E P/BV P/ABV South Indian Bank

6 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18 Jun-18 Jul-18 Institutional Equities Rating track Date Rating Market price (Rs) Target price (Rs) 26 March 2018 Buy May 2018 Buy July 2018 Buy Rating track graph Not Covered Covered 6 South Indian Bank

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