Upgrade KVB stock to ‘buy’ on RoA recovery visibility

We upgrade our rating on Karur Vysya Bank (KVB) to ‘buy’ on improving visibility on RoA recovery, continuity of strategic initiatives even after management change and favourable risk-reward. We see a retracement of valuation to 1x (~15% lower than 5 year average multiple) on likely ~60bps RoA improvement over FY21E-FY22E to 0.9%. Key rationale, overall collections at ~95% as on October 29, with better collection in commercial segment than peers, speaks for KVB’s superior customer profile; calibrated growth during FY17-FY20 (5% loan CAGR) to ensure lower legacy stress and strong PCR at 64% would keep credit cost low; strong liability franchise, adequate capital (tier-1 @ 16.4%) and completion of corporate book realignment will help revive credit growth quicker than peers; and revamped digital platform and business processes are likely to enable quality growth ahead.

Adequate capital (Tier-1 @ 16.4%) and strong liability franchise to support loan growth revival. During the past couple of years, KVB has been actively fine-tuning its portfolio mix by, reducing corporate exposure, building robust infrastructure to expand its retail portfolio, and setting up separate corporate and business banking units to sharpen the focus on both these segments. KVB also launched ‘NEO Banking’ – ‘phygital’ alternate distribution channel with focus on acquiring new-to-bank customers in commercial and corporate segments. Further, strong Tier-1 at 16.4%, granular retail liability base and completion of corporate book realignment (chart 10) would help KVB shore up credit growth quicker than peers.

Better collections and strong PCR @ 64% to ensure credit cost moderation from FY22E onwards. While we expect interim spike in slippages owing to Covid over H2FY21E, calibrated growth over past two years and recent collection trends suggest that incremental stressed asset formation would be within manageable limits and is unlikely to dent balance sheet quality meaningfully.

Further, current PCR @ 64% is likely to restrict credit cost, only to incremental slippages and negligible legacy provisions. The same gives us comfort to lower our credit cost assumption for FY22E to 1.7% vs 2.2% in FY21E (still higher than the 10-year historical average of 1.4%). Bringing the culture of ‘ownership’. KVB will roll out new performance-linked ESOP policy (starting Mar’21), covering ~90% of its workforce. ESOP vesting period will be 1-3 years depending upon retirement year and number of years serviced.