Union Bank of India's Q4FY18 results (Upgrade to Neutral) - Loss widens, profitability likely to remain weak

Q4FY18 results highlights

• Union reported a higher than expected loss of Rs26bn in 4Q driven by a sharp rise in slippage triggered by the RBI circular. Also the bank has not used RBI dispensation on MTM losses, gratuity and NCLT provisions. Loss for the full year is Rs52bn. 
• Slippage of Rs100bn was substantially higher than Rs42bn qoq. Corporate slippage was Rs79bn of which Rs69bn is from SDR/S4A/restructured. MSME slippages also rose sharply from Rs3.7bn to Rs11.2bn qoq. While the bank has now streamlined the MSME lending process, these slippages were from vintage loans including the Mudra scheme. Stress loans account for 21% of total loans versus 19% qoq.
• Net loans grew 1% yoy and declined 2% qoq. While retail loans grew strongly at 23% yoy / 7% qoq, growth in other segments was modest as the bank followed a capital-lite lending strategy. MSME loans grew only 2% yoy as the bank focussed on strengthening the lending infrastructure to ensure that the quality of new loans is good.
• NIM fell 33bps qoq. NII declined 8% yoy and 14% qoq. The bank debited interest of Rs0.92bn towards AT1 bonds from reserves otherwise NII would have declined more sharply. Non-interest income grew strongly at 70% qoq (3% yoy) with core fees growing 56% qoq. Core fees include Rs4.5bn of tax refunds excluding which growth would be lower at 5% qoq
• Credit cost rose sharply to 7.8% of loans from 3.5% qoq. The bank has 62% provisioning on NCLT 1 and 58% on IBC2. The bank also made MTM provisions of Rs11.5bn. The entire MTM los was taken upfront though RBI has allowed amortization.

Valuation and view:

Management guided to slippage of 3% in FY19 (~Rs95bn) with Rs60bn likely to be corporate of which Rs50bn will be from thermal power. These power accounts are currently fully standard. Management has guided to credit cost of 2%. While mgmt. has guided to GNPAs reducing to below 12% from 16% currently our estimate of GNPA for FY19 is higher at 14% as we have built in lower recoveries. We expect profitability to remain weak with RoA of 0.2% for FY19 and 0.5% for FY20E. The stock has corrected sharply and has limited downside but with weak profitability, high duration of 4.6 years on AFS, a high stock of stress loans and low capital we do not see upside either. We cut our TP sharply on weak profitability but upgrade to Neutral on price correction. Our TP of Rs90 is based on 0.36x PBV FY20E.