Punjab National Bank (PNB IN, INR 76, Buy)

Punjab National Bank’s (PNB) Q4FY16 profitability was hit by continued disappointment on asset quality. Slippages spiked to INR235bn (24% versus run-rate of <6% in past 6 quarters) with GNPLs touching 12.9%. This resulted in slower revenue momentum (NII fell >27% YoY) with NIMs taking a knock due to higher interest income reversal. Loan growth, at ~10% (albeit slower than trend), was better than peers with focus on granularity (small ticket size loans >57% of loans). Given weak RoE profile and elevated stress PNB is not preferred pick. But, considering valuations of 0.5x FY18E book after factoring in potential stress, focus on granularity & healthy liability franchise (CASA > 40%), we maintain ‘BUY’.

Stress formation dealt a nasty blow, outlook cautious
Slippages spiked to INR235bn (crossing 20% mark), taking GNPLs to 12.9% (versus 8.5% in Q3FY16). While part of it was attributable to RBI’s asset quality review, even adjusted for that slippages were on higher side. A large part of stress emanated from restructured book (>40% of slippages), with overall stress pool (NNPLs plus restructured) coming in at 13.5% (14.4% in Q3FY16). Sector-wise iron & steel, chemical and other infra sectors were main contributors to stress. While management guided for lower incremental stress going ahead, SMA-II accounts of INR110bn (~3% of book) and high exposure to stressed segments (I&S and power), keeps us guarded.

Revenue traction sluggish; lower opex cushions profitability
High asset quality stress also took a toll on revenue momentum (NII fell >30% QoQ) with NIMs dipping owing to higher interest income reversal (NIMs down >90bps QoQ). However, lower opex (down >16% YoY, gains on pension assets of ~INR4bn) and higher recovery from written-off accounts (core fee was softer) cushioned the impact.

Outlook and valuations: Asset quality vital; maintain ‘BUY’
PNB’s performance was marred by dismal asset quality, leading to loss in FY16. Incorporating lower NIMs and lower growth, we lower FY17/18E EPS by 10%/9%. While the bank has relatively higher dilution risk at weak multiple, government’s assurance of capital support to leading PSU banks will cushion impact. Given weak RoE profile and elevated stress, PNB is not a preferred pick. But, valuations of 0.5x FY18E book after factoring in potential stress, focus on granularity and healthy liability franchise, we maintain ‘BUY/SP’ with TP of INR120.