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Union Bank of India's Q2FY20 results (Neutral) - Slippages rise, guidance downgraded

Q2FY20 Results 

• Union reported a loss of Rs12bn versus our estimate of Rs4bn. We had factored in a loss due to a DTA mark-down. While the bank has not adopted the new tax scheme and therefore not remeasured DTA, it still reported a big loss due to divergence provisioning of Rs16bn. The bank’s divergence with RBI on provisioning was on two accounts where RBI asked for the security cover to be marked down to zero and two accounts where RBI asked for back dating NPLs. Slippages rose sharply qoq. 
• Net loans grew 2% yoy while gross loans grew 3%. Retail loans grew 16% yoy, MSME and agri grew 4% each while corporate loans declined 3%. While loan growth was subdued partly because of lack of capital, NIMs improved 23 bps qoq to 2.35%. The bank deducted interest on AT1 bond from reserves rather than debiting it to the income statement because it reported a loss. The interest saving resulted in a 7 bps increase in NIMs. The remaining 16bps came from better yield on loans as the bank enjoyed pricing power (in the absence of NBFCs) and lower cost of funds. NII grew 17% yoy and 15% qoq. 
• Slippage rose qoq from Rs31bn to Rs42bn and remains uncomfortably high at 5.3% of lagged loans. Agri slippage rose 11% qoq, retail slippage rose 54% qoq while corporate slippage rose sharply by 131% qoq. The GNPA ratio rose marginally qoq to 15.24%. Agri NPLs are 11% while MSME NPLs are 13.4% of MSME loans. NPLs in the Mudra scheme are 12%, higher than 9% qoq.
• In addition to NPLs, Union has standard stress loans of 2.8% of total loans amounting to Rs80bn. The bank also has security receipts of Rs9.2bn.
• Non-interest income ex-trading grew 4% yoy and 16% qoq. Core PPOP grew 15% yoy.
• Credit cost rose sharply to 4.3% from 1.9% qoq led by divergence related provisions. The bank also made 15% standard provision on DHFL which was standard in 2Q but has slipped in 3Q.
• CET1 improved to 11.46% from 7.87% qoq due to capital infusion

Valuation and view  

With high standard stress at 2.8% of loans, weak earnings and downward revision to guidance, we do not see positive triggers for the stock. We maintain Neutral given cheap valuations. Management has revised slippage guidance to 4.5% for FY20 from 3.5% (as DHFL slipped in 3Q) and credit cost guidance to 3% from 2%. Mgmt expects recovery of Rs35bn from Essar Steel, Bhushan Power and Alok and total recoveries of 90bn in 2H. We cut TP to Rs55 from Rs60 as we build in a loss for FY20