Valuation and Outlook. Growth (%) PAT (Rs cr)

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1 Feb-18 May-18 Aug-18 Nov-18 Feb-19 4 Recommendation Hold CMP Rs. 67 Target Price Rs. 90 Sector Stock Details Banking BSE Code NSE Code Bloomberg Code KARURVYSYA KVB IN Market Cap (Rs Cr) Rs. 5,355 Free Float (%) 97.9% 52- week H/L (Rs) 101/63 Avg. volume (BSE+NSE) Face Value (Rs) 2 Div per share (FY 18) 0.60 Shares o/s (Crs) 72.7 Relative Performance 1Mth 3Mth 1Yr KVB -27% -17% -34% Sensex -25% -20% -40% Shareholding Pattern Dec 18 Promoters Holding 2.1% Institutional (Incl. FII) 40.9% Public & others 57.0% Jehan Bhadha ( ) Research Analyst jehankersi.bhadha@nirmalbang.com Dnyanada Vaidya ( ) Research Associate dnyanada.vaidya@nirmalbang.com Year NII (Rs cr) Growth (%) PBP (Rs cr) Elevated slippages and credit costs in SME and Corporate book to persist in FY20E KVB reported a muted quarter on the asset quality front; with profits plummeting on the back of significantly higher provisions Advances stood at Rs. 47,766 Cr vs Rs. 44,836 Cr in a growth of 7% YoY. Retail loans exhibited a robust growth of 25% YoY contributing 19% to the overall advances. The bank chose to grow the Agri, SME and corporate book cautiously, with each contributing 17%, 35% and 28% resp. We expect loan growth of 14% CAGR over FY19-21E. NIMs were higher 3 bps QoQ at 3.60%. They were at 3.76% YoY resulting in NII growth of just 3% YoY. NIMs are expected to inch higher in coming quarters, with cost of funds coming down. Total income also grew by 7% YoY supported by 16% growth in non-interest income. Opex growth stood at 14% YoY. Cost/income ratio showed an improvement sequentially improving by 267 bps; however increased by 300 bps YoY to 49.4%. Employee expenses increased by 29% YoY due to higher provisions for employee retirement benefit; while other expenses increased by 3% YoY. PPP remained flat at Rs. 425 Cr YoY. Provisions during the quarter stood at Rs. 400 Cr vs Rs. 325 Cr in and Rs. 213 cr in. The quarterly provisioning rate was higher mainly on account of provisioning on the IL&FS exposure of Rs. 314 Cr. Credit cost for the quarter remained elevated at 3.5% vs 1.8% QoQ and 3.1% YoY. Credit costs are expected to remain elevated in FY20 on the back of expectations of an increase in slippages and an increase in an calculated PCR from current levels of ~43% to levels of ~60% over next one to two years. The bank reported Net Profit of Rs. 21 Cr vs Rs. 72 Cr in (-70% YoY) and Rs. 84 Cr in. Valuation and Outlook Sharpening focus on the retail and SME segments while building revenue as well as profit momentum (loan/pat CAGR of 14%/85%, respectively, over FY19-21E) and transformation into a granular and higher RoE business combined with cheap valuations at 1.2x FY21 ABV provides decent scope for re-rating. However, continued elevated stress in the corporate & SME book should result in the bank recognizing this pending stress which would mean elevated credit costs for FY20E. We thus revise our rating to Hold on the stock with a price target of Rs. 90, based on 1.5x FY21E ABV (33% discount to CUB). PAT (Rs cr) Growth (%) EPS (Rs) PE (x) Adj BVPS (Rs) FY18 2,298 11% 1, % % FY19E 2,410 5% 1, % % FY20E 2,656 10% 2, % % FY21E 3,030 14% 2, % % P/ABV (x) RoE (%) 1 P a g e

2 Quarterly Results Particulars (Rs. Cr) Comments Interest Earned Interest Expended Net Interest Income Growth 12% 12% 9% 11% 8% 4% 3% NIMs 3.76% 3.81% 3.76% 3.86% 3.65% 3.57% 3.60% NIMs have stabilized and should inch higher in coming quarter. Other Income % of total income 30% 29% 29% 25% 30% 23% 31% Total Income Growth 20% 10% 14% 5% 8% -4% 7% Employee exp Other op exp Total op exp Growth -10% -9% -12% 22% 16% 10% 14% Cost to income ratio 42.0% 45.6% 46.4% 43.7% 45.2% 52.1% 49.4% Higher on account of higher recoveries on w/off a/cs of Rs. 36Cr vs Rs. 5Cr in Opex growth stood at 14% YoY. Cost/income ratio showed an improvement sequentially improving by 267 bps to 49.4%. Employee expenses increased by 29% YoY due to higher provisions for employee retirement benefit; while other expenses increased by 3% YoY. Profit before prov Provisions Growth 249% 170% 244% 81% 81% -34% 23% Credit Cost 2.28% 3.07% 3.12% 3.61% 3.75% 1.85% 3.46% Profit before tax Tax Profit after tax Growth 1% -40% -38% -77% -69% 11% -70% No. of shares EPS Advances 42,401 44,237 44,836 45,973 47,886 48,140 47,766 Growth 8% 12% 17% 11% 13% 9% 7% CASA Ratio 29.2% 27.6% 28.1% 29.1% 30.0% 29.5% 29.8% CAR 11.7% 12.2% 13.9% 14.4% 14.1% 0.1% 0.1% Slippages Slippage Ratio 3.0% 3.9% 6.4% 5.5% 6.6% 1.6% 7.4% Gross NPA 4.3% 4.8% 5.9% 6.6% 7.4% 7.7% 8.5% Net NPA 2.9% 3.2% 3.9% 4.2% 4.4% 4.4% 5.0% PCR (Calculated) 34.0% 34.1% 36.2% 38.2% 41.4% 44.7% 43.4% ROA 1.0% 0.5% 0.4% 0.3% 0.3% 0.5% 0.3% ROE 11.7% 5.8% 4.6% 3.2% 2.9% 5.3% 1.3% Source: Company data, Nirmal Bang Retail Research The quarterly provisioning rate was higher mainly on account of provisioning on the IL&FS exposure of Rs. 314 Cr. Credit cost for the quarter remained elevated at 3.5% vs 1.8% QoQ and 3.1% YoY. Retail loans exhibited a robust growth of 25% YoY contributing 19% to the overall advances. The bank chose to grow the Agri, SME and corporate book cautiously, with each contributing 17%, 35% and 28% resp. GNPAs have inched up mainly due to the IL&FS exposure slipping to NPA during the quarter. The bank contiues to witness stress on its SME book which has also resulted in higher slippages.however, the retail and the agri book continue to remain pristine. 2 P a g e

3 Key Conference-call highlights and our takeaways Asset Quality Gross NPAs came at Rs Cr vs QoQ Rs Cr at 8.5% vs QoQ 7.7% Gross slippages were at Rs. 888 Cr (7.4%) an all-time high vs QoQ Rs. 190 Cr (1.6%) & YoY Rs. 713 Cr (6.4%). Corporate gross slippages formed Rs. 484 Cr comprising of - the entire IL&FS exposure (2 entities) worth Rs. 314 Cr; one watchlist asset of Rs. 130 Cr and one restructured asset worth Rs. 40 Cr. Provisioning on IL&FS slippage has been done at 50%. SME gross slippages stood at Rs. 158 Cr. There are signs of stress visible in the SME segment and particularly in the timber industry. Earlier the bank permitted customers to pay between 0-90 dpd with a relaxed approach; however now the bank is discontinuing this practice. Over next 5 quarters, the bank has guided for following outcomes on asset quality a) Corporate book gross slippages should be at Rs. 750 Cr; SME gross slippages at Rs. 1,000 Cr; Retail & Agri gross slippages at Rs. 100 Cr totaling to gross slippages of Rs b) Total Recovery & Upgradation of Rs. 750 Cr. c) Thus, Net Slippages of Rs. 1,100 Cr. d) On a conservative side; management has guided for a net slippages in the range of Rs. 1,100 Cr to Rs. 1,300 Cr (will be front loaded). e) This translates to a net slippage ratio of 1.8% which is not far away from the 1.5% ratio that the bank had been guiding since few quarters now. (Previous guidance was 1.5% net slippage ratio with annual absolute amount of Rs. 750 Cr). f) Calculated PCR for KVB stands at 43% which it intends to increase to ~60%. Thus credit cost would continue to be elevated in FY20E. g) Over next 5 quarters, KVB expects provisioning of ~Rs. 1,300 Cr. 3 P a g e

4 Other Highlights a) Loan growth for the quarter stood at 7% (Loan book of Rs. 47,766 Cr). Retail +25%, SME +9%, Agri +7% and Corporate -6%. b) Loan growth guidance: Retail will continue to grow at ~30%, SME & Agri growth will pick up to high teens and corporate growth will be in low-mid single digits. Overall loan growth guidance given by the management is of 15% for FY20E. c) As per management, opex should grow at 8-10% going forward and expenses relating to new systems will reduce from now. KVB shut 8 branches during the quarter and now has 782 branches. It also shut down a bunch of ATMs which were incurring losses. d) KVB took a write off of Rs. 434 Cr in this quarter via cash sale to ARC (no Security Receipts involved). The cash recovered was Rs. 140 Cr. 4 pillars that will drive the bank in the long term a) The bank has gained competitive advantage by adopting a comprehensive digital initiative which is fully embedded into the system. Digital initiatives have been fully embedded in SME as well. b) KVB is focusing on risk management and established a new team a few quarters back. Corporate book has shrunk 6% YoY due to this. KVB is now using external benchmarks, ratings and scorecards to ensure that quality of the book improves substantially. c) In terms of operational control, KVB has transitioned from decentralized to centralized processes. This shall free up branches so that they focus more on sales activities. d) KVB is targeting profitable growth by enhancing the product suite. Commercial credit card has gone live. The bank is targeting ~10,000 cards by end of Q4. Newly digitized risk based pricing will help expand overall yields and NIMs. 4 P a g e

5 View and Valuation Despite KVBs stellar performance in its core segment of Retail & SME over a decade back, its decision to aggressively grow the corporate book over FY07-12 and the subsequent stress due to defaults in the corporate book landed the bank in trouble. Since FY14, KVB has shifted its focus back towards Retail & SME. The new CEO & MD, Mr. Seshadri s extensive experience & expertise in Retail & SME shall aid KVB in improving efficiency and accelerate the pace of retailization of its loan book. The slippage and credit cost guidance given by the management during the quarter is higher than their previous guidance. To that extent we revise our estimates down and now expect FY20E to remain subdued. Although our long term thesis remains intact for KVB, any meaningful improvement in the bank s return ratios can only be expected from FY21E onwards. Sharpening focus on the retail and SME segments while building revenue as well as profit momentum (loan/pat CAGR of 14%/85%, respectively, over FY19-21E) and transformation into a granular and higher RoE business combined with cheap valuations at 1.2x FY21 ABV provides decent scope for re-rating. However, continued elevated stress in the corporate and SME book should translate to the bank recognizing this pending stress which would mean elevated credit costs for FY20E. We thus revise our rating to Hold on the stock with a price target of Rs. 90, based on 1.5x FY21E ABV (33% discount to CUB). Dupont ROE FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY21E NII 2.7% 2.6% 2.8% 3.2% 3.4% 3.6% 3.5% 3.6% 3.7% Other Income 1.1% 1.1% 1.1% 1.3% 1.3% 1.4% 1.4% 1.5% 1.5% Total Income 3.8% 3.8% 3.9% 4.4% 4.7% 5.0% 4.9% 5.2% 5.2% Opex 1.8% 2.1% 2.1% 2.1% 2.1% 2.2% 2.4% 2.4% 2.4% PPP 2.0% 1.7% 1.8% 2.3% 2.6% 2.8% 2.6% 2.8% 2.8% Provisions 0.3% 0.9% 0.9% 0.7% 1.1% 2.0% 2.1% 1.4% 1.4% PBT 1.7% 0.8% 0.9% 1.6% 1.5% 0.8% 0.5% 1.3% 1.5% Tax Rate 24% 2% -7% 38% 31% 31% 31% 31% 31% ROA 1.3% 0.8% 0.9% 1.0% 1.0% 0.5% 0.4% 0.9% 1.0% Leverage ROE 16.7% 12.1% 11.8% 12.9% 12.6% 6.1% 3.9% 10.0% 11.4% 5 P a g e

6 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Q3FY17 Q4FY17 Story in Charts Loan Book Mix Credit Cost remains elevated % 18% 17% 30% Corporate SME Retail % 3.1% 3.1% 3.6% 3.7% 1.8% 3.5% 5.0% 4.0% 3.0% 2.0% 1.0% 35% Agri Provisions (Rs Cr) Credit Cost Muted Advances Growth Share of Corporate advances declines to 28% % 5% 2% 5% 8% 12% 17% 13% 11% 9% 7% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 100% 80% 60% 40% 20% 0% 34% 33% 32% 33% 32% 31% 31% 30% 28% Advances Growth Corporate Retail+SME+Agri Corporate Net Slippages SME Net Slippages % 7.6% 16.1% 14.3% 7.2% 0.9% 7.3% 20.0% 16.0% 12.0% 8.0% 4.0% 0.0% % 0.9% 1.5% 1.6% 5.8% 2.4% 2.1% 8.0% 6.0% 4.0% 2.0% 0.0% Corporate Net Slippages (Rs. Cr) Corporate Net Slippage Ratio SME Net Slippages (Rs. Cr) SME Net Slippage Ratio 6 P a g e

7 Financials P&L (Rs. Crs) FY17 FY18 FY19E FY20E FY21E Bal. Sheet (Rs. Crs) FY17 FY18 FY19E FY20E FY21E Interest earned 5,622 5,700 5,886 6,411 7,289 Equity capital Interest expended 3,549 3,402 3,476 3,756 4,258 Reserves & surplus 4,914 6,119 6,308 6,866 7,544 NII 2,074 2,298 2,410 2,656 3,030 Net worth 5,036 6,264 6,468 7,026 7,703 Non interest income ,125 1,260 Deposits 53,700 56,890 60,127 67,392 77,073 Total income 2,856 3,198 3,358 3,781 4,290 (of which CASA) 14,889 16,577 18,074 20,754 24,112 Growth 15% 12% 5% 13% 13% Borrowings 1,696 2,382 1,000 1,200 1,450 Operating expenses 1,285 1,421 1,604 1,760 1,949 Other liab and prov 1,376 1,393 1,418 1,443 1,468 Growth 8% 11% 13% 10% 11% Total liabilities 56,772 60,665 62,545 70,035 79,991 Staff costs Total liab and equity 61,808 66,929 69,012 77,062 87,694 Other Op Exp ,033 Cash and bank bal 1,555 1, Profit before prov 1,571 1,777 1,755 2,021 2,342 Bal. with RBI 2,790 2,960 3,006 3,370 3,854 Growth 21% 13% -1% 15% 16% Investments 14,857 15,803 15,199 16,497 18,288 Provisions 687 1,274 1,396 1,040 1,117 Net Advances 40,908 44,800 48,611 54,698 62,742 Growth 85% 85% 10% -25% 7% Growth 5% 10% 9% 13% 15% Profit before tax ,224 Other assets 1,697 2,029 2,171 2,323 2,485 Taxes Total assets 61,808 66,929 69,012 77,062 87,694 Net profit Growth 7% -43% -29% 173% 25% Asset Quality FY17 FY18 FY19E FY20E FY21E GNPA 1,484 3,016 4,198 5,078 6,058 Key Ratios FY17 FY18 FY19E FY20E FY21E GNPA ratio 6.6% 8.4% 9.0% 9.4% 9.4% Yield on Advances 11.3% 10.3% 9.7% 9.8% 9.9% NNPA 1,033 1,863 2,296 2,686 3,048 Yield on Tot Assets 9.6% 9.1% 8.9% 9.1% 9.1% NNPA ratio 2.5% 4.2% 4.7% 4.9% 4.9% Cost of Borrowings 6.5% 5.9% 5.8% 5.8% 5.8% PCR (Calculated) 30% 38% 45% 47% 50% Spread 4.82% 4.39% 3.96% 4.03% 4.09% Credit Cost 1.7% 2.9% 2.9% 2.0% 1.9% NIM 3.70% 3.80% 3.62% 3.71% 3.75% Balance Sheet Ratios FY17 FY18 FY19E FY20E FY21E Profitability Ratios FY17 FY18 FY19E FY20E FY21E CD Ratio 76.2% 78.7% 80.8% 81.2% 81.4% Cost / Income Ratio 45.0% 44.4% 47.7% 46.5% 45.4% CASA 27.7% 29.1% 30.1% 30.8% 31.3% ROE 12.0% 6.1% 3.9% 10.0% 11.4% CAR 12.5% 14.4% 14.5% 14.0% 13.4% ROA 1.00% 0.54% 0.36% 0.92% 1.02% Tier % 13.9% 14.0% 13.5% 12.9% Per Share Data FY17 FY18 FY19E FY20E FY21E Valuation Ratios FY17 FY18 FY19E FY20E FY21E EPS P/E BVPS P/BV Adjusted BVPS P/ABV Source: Company data, NBRR 7 P a g e

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