IndusInd Bank's Q2FY19 results (Outperformer) - Strong PPOP growth but IL&FS remains an overhang

Q2FY19 result highlights

• PAT of Rs9.2bn was substantially lower than the consensus estimate of Rs10.98bn due to a provision of Rs2.8bn on IL&FS. Growth in PAT was the lowest in many quarters at 5% yoy (decline of 11% qoq). Excluding this provision, PAT growth would have been in line.
• Operating profit was broadly in line. Stronger than expected loan growth and lower than expected opex were the key positives which were offset by substantially lower trading gains and lower NIMs. Core PPOP grew 30% yoy and 7% qoq.
• Loan growth was exceptionally strong at 33% yoy and 8% qoq. Corporate loan growth of 35% yoy / 10% qoq outpaced retail loan growth of 29% yoy / 6% qoq. A portion of the corporate loans acquired this quarter will be sold down in the subsequent quarters especially in real estate and EPC. Loan growth in these sectors will cool off as sell downs happen. Within retail loans, vehicle loans grew the most. Vehicle disbursals grew 40% yoy with CV disbursals of 44% yoy. 
• Yield on loans rose sharply by 29bps qoq to 11.44%. However cost of funds rose faster leading to a decline of 8bps qoq in NIMs to 3.84%. YoY NIMs have come off by 16bps.
• Core fees grew 20% yoy and 5% qoq led by general banking fees and third party distribution. Investment banking fees grew 15% yoy and 2% qoq. Trading gains crashed falling to Rs990M versus Rs1,370M qoq and Rs1,750M yoy. Overall non-interest income grew 11% yoy and 1% qoq.
• Operating expenses remained low for a third quarter in succession growing 11% yoy and 1% qoq. The lower than expected growth in opex was due to productivity gains.
• We believe IIB has an exposure of Rs24bn to IL&FS though management did not quantify. The exposure is broadly to two entities 1) Chenani Nashri Tunnel 2) IL&FS parent. Mgmt believes that there will be no haircuts on the first because the project is rated AAA (SO). The second exposure to the parent was taken very recently (3 months ago) and is rated D. This exposure was given as liquidity funding - akin to a bridge loan till IL&FS could complete its rights issue. But after the disbursal, IL&FS was downgraded and the rights issue has been delayed. Management believes that as soon as rights or a liquidity infusion happens, IIB will be repaid. Based on management's judgement of haircut and with auditors consent, the bank has provided Rs2.8bn on IL&FS though it was a standard asset at end September and no provisions were required.

Valuation and view

Our new TP is Rs1935 based on 3.7x PBV FY20E versus our old TP of Rs2,250 based on 3.9x.  We are cutting earnings to factor in the higher provision.  For calculating our TP we are building in a 25% haircut on IL&FS (we believe there will be haircuts for all lenders given the complications). We maintain OP. We believe IIB will continue to report strong core growth but IL&FS will remain an overhang in the short term as asset sales will take time to materialize.