Tuesday, October 13, 2009


Stepping up the pace of growth

Rise in CD ratio and dip in cost of funds to boost NIMs H2FY10 onwards Karnataka Bank’s (KBL) NIMs are set to expand on the back of increase in the credit-deposit (CD) ratio and decline in cost of funds. We expect NIMs, which bottomed in H1FY10, to increase from below 1% to over 2% by FY10E as: (i) strong disbursement growth will propel the CD ratio from 55% currently to 70% by FY11E; and (ii) re-pricing of high cost deposits will drive down cost of funds from Q2FY10 by ~50bps by FY11E.

High credit growth trajectory of 25% plus likely over FY09-11E KBL had adopted a conservative stance on advances through FY09, growing them at 11% Y-o-Y and steadily reducing lending to sensitive sectors. Management, however, intends to move to a strong credit growth trajectory of ~25% CAGR over FY09-11E via the following roadmap: (1) lend in consortium that enables faster and quicker disbursements; (2) follow the hub-and-spoke model which enables faster turnaround time and better pricing; and (3) increase advances to the agriculture segment and fulfill priority sector commitments. The bank already has a strong sanction pipeline which will enable it to achieve targets for the year.

Strong operating efficiency and comfortable provisioning coverage The bank has enjoyed high operating efficiency reflected in low opex/assets (at 1.7%) compared to the industry and it is likely to further decline by 15-20bps to 1.5% by FY11E on back of strong balance sheet growth and modest expansion in branches and staff costs. Asset quality has witnessed improvement since FY04, with slippages seeing a secular down trend declining to 1.5% by FY09. KBL’s provision coverage stands comfortable at >70%, one of the best in the industry.

Outlook and valuations: Attractively priced; re-initiate with “BUY” We believe KBL is an attractively priced bank compared to its peers at 0.9x FY11E book and 6.9x FY11E earnings, delivering sustainable RoEs of around 16-18%. Given its extensive reach in South India and the non-promoter holding structure, we believe KBL offers an attractive franchisee for potential new entrants in the banking system. All these make a strong case for the stock to re-rate to peer
group valuation. Hence, we re-initiate coverage on the stock with a “BUY” recommendation and rate it ’Sector Outperformer’ on relative return basis.

To see full report: KARNATAKA BANK