Kotak Mahindra Bank's Q3FY18 results (Neutral) - Strong and in line

Q3FY18 result highlights

• KMB’s standalone PAT of Rs10.5bn was better than our expectation and grew 20% yoy and 6% qoq.
• Asset quality remained robust. Gross NPAs declined 2.6% qoq. SMA-2 loans continue to be immaterial at 0.2% of loans.
• Loans grew 23% yoy and 4% qoq. The sequential growth slowed to 4% from 7% as growth in business banking failed to pick up and growth in corporate banking slowed. Loan growth was strong in CVs, small business / personal loans and mortgage loans. Retail loans grew 27% yoy and 7% qoq while corporate loans grew 21% yoy and 3% qoq. At the current run rate, Kotak’s loans will likely grow 22% yoy in FY18 which is higher than the guided 20%.
• CASA deposits grew 34% yoy and 7% qoq. Savings deposits grew 52% yoy while current deposits grew 7% yoy. NIM declined 13 bps qoq to 4.2%. NII grew 17% yoy and 3.5% qoq. Growth in non-interest income was strong at 14% yoy and 9% qoq. Core fees grew 14% yoy and 2% qoq.
• Operating expenses grew 13% yoy and 5% qoq. Cost to income declined 141 bps yoy and 21 bps qoq to ?%. Opex would have been lower had it not been for ‘811’ expenses.
• Non-banking/non-lending subsidiaries reported strong earnings growth. The profit of life insurance, AMC, investment banking and broking combined grew strongly at over 80% yoy. The profit of the standalone bank grew 20% yoy. Consolidated PAT grew 28% yoy.

Valuation and view

We believe Kotak’s earnings will be better than the sector’s as Kotak does not face corporate stress seen in other banks. But we believe Kotak needs to deliver consistently on higher loan growth and fees to justify its rich valuations.  We believe at current levels the stock is fairly valued. Management sees a pickup in credit cycle and believes financial services are in a sweet spot right now despite rising rates. With demonetization led liquidity receding, banks will have an edge over other financiers in incremental lending given that banks rely on retail deposits which are more stable versus wholesale funding of other financiers which becomes volatile and expensive when liquidity becomes tight. Banks have had to move to a higher LCR of 90% effective January 1, 2018 which banks started preparing for in 3QFY18. This has resulted in margin pressure for the system. Any leeway from RBI on allowing a higher proportion of SLR that can be counted towards LCR could help improve margins.