PNB - Evaluate asset quality performance v/s muted expectations - Prabhudas Lilladher

PNB reported a beat in Q3FY13, driven by a surprise jump in recoveries/upgrades. Operating metrics continue to remain weak and so did delinquencies. However, the key positive was ~40% recoveries/upgrades of Rs76bn of H1FY13 slippages, indicating that PNB may have possibly been more conservative in recognizing NPAs. We maintain our view that credit costs will continue to remain high for PNB but despite deterioration in asset quality, PNB will be able to maintain ROAs of +1-1.1% and ROEs of +16.5. Hence, valuations at <1x FY14 is undemanding. Retain PNB as a contrarian PSU bank; ?BUY? with a PT of Rs1025/share (1.1x FY14 book).

Delinquencies high but recoveries/upgrades indicate conservative recognition: PNB reported high gross slippages of Rs29bn (4% annualized) and also ~Rs37bn of restructuring highlighting continued stress in PNB's book. With management now completely focused on recoveries, overall upgrades/recoveries jumped to ~Rs30bn, of which, ~90% was upgrades from H1FY13 slippages, indicating that PNB has been conservative in recognizing NPAs. Management indicated that recovery trends in Jan-13 remained very strong and could surprise positively even in Q4FY13. Though we remain concerned on high slippages, asset quality trends indicate that management could have been more conservative in NPA recognition and net delinquency numbers could surprise positively v/s muted expectations.

Operating metrics very weak; base rate cut will not help: (1) Margin performance was weak with Q3FY13 NII including Rs800m of interest write-back adjusted for which margin contraction was ~10bps QoQ. With an aggressive 25bps base rate cut and likely easing rate cycle, we see further pressure on margins (2) With management focusing on recoveries, loan growth has come off drastically (1% YTD) and most part of the incremental credit is going to risky sectors (3) Core fee income growth has also come-off with 9% YoY contraction reported and management expects further challenges to persist in the near term.

Near-term P&L Drivers: Positives (1) Recovery/upgrade trends remain positive and could lead to a surprise on net delinquencies (2) AFS duration increased over the last two quarters - To aid in high treasury income. Negatives (1) Expect margins to further dip - Aggressive rate cut + easing rate cycle ahead (2) Core fees continue to disappoint and (3) Credit costs will remain high on ageing NPAs + higher provisions on restructuring.

Source : Equity Bulls

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