Punjab National Bank's Q2FY20 results (Underperformer) - Asset qualityremains a challenge.

Q2FY20 result highlights

• PNB’s PAT of Rs5bn was better than our and street estimate of a loss of Rs15bn. The beat was on account of the bank not moving to the new tax rate. PAT declined 111% yoy and 50% qoq. Operating performance was weaker than expected with weak loan growth and a sharp increase in slippage.  Further the bank has deferred provisions of Rs22.8bn. If the bank had taken these provisions in 2Q, it would have reported a loss.
• The bank wrote off only Rs6.5bn of the total provision of Rs25.8bn that had to made because Bhushan Power has been classified as fraud. The remaining Rs19.3bn has been deferred. In addition the bank has deferred provisions of Rs3.5bn pertaining to earlier quarters.
• Gross loans remained flat yoy and qoq. Domestic loans grew 2% (slower than 7% in 1Q) while overseas loans declined 29%. Retail loans remain the key driver growing 19%.
• On a beaten down base, NIM improved 3 bps qoq to 2.39% aided by capital infusion by the government. NII grew 7% yoy and 3% qoq
• Total non-interest income grew strongly at 33% yoy and 10% qoq. Core fee income was subdued growing 4.5% yoy and declining qoq (because most account related charges are booked in 1Q) but recovery in written off accounts and trading gains were high and drove the growth in non-interest income.
• Operating expenses grew 4% yoy and 9% qoq.
• Core PPOP grew 14% yoy.
• Slippage rose sharply to Rs81.2bn from Rs54bn qoq, the highest in the last five quarters. The slippage ratio remained uncomfortably high at 7.5%. GNPAs rose  3% qoq to 16.8% in 2Q compared to16.5% in 1Q. GNPLs for PNB are amongst the highest in the sector.
• Credit cost rose sharply by 45% qoq to 3% of loans from 2% in 1Q. PCR declined from 61% to 59%.
• CET 1 improved from 6.4% to 10.9% following the government’s capital infusion. The government has infused Rs161bn into PNB through a preferential allotment. The infusion is currently shown as share application money. The infusion price is Rs75.4 versus CMP of Rs65. The infusion will result in a dilution of 46%.

Valuation and view

PNB’s asset quality continues to remain volatile. While slippage moderated in 1Q, it rose sharply in 2Q. Loan growth and profitability also remain weak.  In the run up to the merger of United and OBC with PNB, loan growth will continue to deteriorate and credit cost will likely rise. As such we expect profitability to remain weak for the standalone and merged entity. We maintain Underperformer and cut TP to Rs55.