IndusInd Bank's Q3FY18 results (Outperformer) - In line and strong earnings, divergence may remain a short term overhang

Q3FY18 result highlights

• IIB’s PAT of Rs9.4bn grew 25% yoy in 3Q18 and was in line with our estimates. Strong growth in savings and a pick-up in CV financing were the key positive highlights. While growth in interest income lagged loan growth due to competitive pressure on yields, cost of funds also improved led by a strong rise in savings deposits leaving NIMs unchanged sequentially. The bank disclosed that they have not received even the preliminary divergence report from RBI, so no divergence was disclosed this quarter. Divergence will remain an overhang for the stock till disclosed in 4Q.
• Loan growth was strong at 25.1% yoy and 4.4% qoq. On a sequential basis, retail growth at 7.4 % qoq is faster than corporate growth of 2.3%, due to strong growth in CVs and tractors.
• Yields on loans declined due to competitive pressure on CV and LAP, and improving rating profile of corporate loans. However cost of funds also declined due to strong growth in savings leaving NIMs unchanged.  Management explained that even with competitive pressures NIMS will remains stable due to a rising proportion of retail loans in the overall mix and a strong growth in savings which will keep funding cost low.
• Sustained strong growth in CASA especially savings deposits was the key positive highlight. Savings deposits grew strongly at 68% yoy and 5% qoq driven by strong growth in government savings, maturity of existing branches and higher rate on savings deposits. The CASA ratio of 42.9% has already crossed management’s target of 40% by FY20. Management now expects CASA ratio to improve to 45% by 2020.
• Core fees grew 22% yoy and 6% qoq. The biggest contributor was distribution fees (41% yoy and 8% qoq) which is a positive effect of higher mutual fund and insurance sales following demonetisation. Trading gains declined 17% qoq.
• Asset quality remained stable with slippages at 1.6% of lagged loans versus 2% in 1Q. Gross NPLs rose 11% qoq. Both corporate and retail NPls rose 11% qoq in absolute terms.
• CET1 improved 26 bps qoq because of an improvement in the rating profile of the loan portfolio.  The bank disclosed its SMA2 portfolio for the first time. SMA2 loans are ~Rs10bn and account for less than 1% of loans.  While the bank does not have its divergence report, the CEO explained that should they have divergence it will be of a technical nature only, given that the SMA2 portfolio is insignificant.

Valuation and view

We expect IndusInd to outperform the sector given its strong retail lending franchise, strong capitalisation in a weak sector, low NPLs, low rate risk and inorganic growth. However, divergence will remain a short term overhang. The bank is evaluating opportunities to get into asset management and insurance. For long gestation business, IIB prefers inorganic growth.  Our TP for IIB is Rs2100. We have factored in the BhaFin merger in our earnings estimates and target price. The bank has received approval from the Competition Commission for the merger and is now awaiting RBI nod.