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State Bank of India's Q3FY18 results (Downgrade to Neutral) – Divergence leads to loss, impairs CET1

Q3FY18 results highlights

• SBI reported a pre-tax loss of Rs71bn for 3Q18. At the post tax level the loss was lower at Rs25bn due to fresh DTA. We expected the bank to post profit of RS17bn. The loss was driven by higher than expected loan loss provisions, provision of Rs7bn towards the new wage agreement, a sharp decline in trading gains and MTM loss of Rs40bn.
• There was a sharp deterioration in asset quality with a sharp increase in slippages from Rs106bn to Rs268bn qoq. Of the total slippage, Rs218bn was from the corporate segment of which Rs160bn was on account of divergence. Corporate slippage rose sharply from Rs45bn to Rs218bn qoq while retail slippage declined qoq. The sharp rise in corporate slippages was on account of divergence with RBI for FY17. The bank had a total divergence of Rs232bn for FY17 of which Rs28bn was recognized as NPLs in 1Q .Of the remaining divergence of Rs204bn, an account of Rs44bn (JSPL) was not shown as slippage because it was upgraded and downgraded during the quarter and the remaining Rs160bn was shown as slippage in 3Q. In addition to divergence, there were other corporate slippages of Rs58bn. Of the total corporate slippage 89% was from the disclosed stress pool.
• Consolidated loan growth remains weak at 1% yoy and qoq. Global NIM improved to 2.45% from 2.43% qoq despite high slippages. Surprisingly interest reversal in 3Q at Rs19bn is lower than ~Rs22bn in the last 2 quarters.
• RBI asked the bank to reverse Rs112bn of revaluation reserve as it related to leased property. Consequently Tier 1 declined by 45bn. The government has allocated Rs88bn of equity to SBI. Revaluation (45bn) and quarterly loss (25bn) have depleted CET1 by Rs69bn in 3Q18. So most of the new infusion has been consumed.

Valuation and view

We cut earnings to factor in 3Q loss. Management guides to RoA of 0.6% in FY19 and 1% in FY20E backed by a pick-up in margins from NCLT resolutions and lower bad loan provisions. We build in RoA of 0.5% for FY19 and 0.8% for FY20E. RoE will remain below CoE through our forecast period. The bank plans to raise capital of Rs200bn in FY19. We cut our TP to Rs310 as we cut the target multiple for the core bank to 0.8x from 1.1x earlier.  At our TP the stock rates a Neutral. Risks from the existing stress pool, higher bond losses, uncertainty of haircuts on non-steel NCLT cases and intense pricing competition will continue to weigh negatively on the stock