PNB: 2Q11 Results: Asset Quality Concerns Mask Strong NIMs:: Citi

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Punjab National Bank (PNBK.BO)
2Q11 Results: Asset Quality Concerns Mask Strong NIMs
 2Q11 profits up 16% yoy; 4% below our estimates — 2Q11 was a mixed quarter
for PNB – there were positives: a) strong loan growth (+28% yoy), b) NIM
expansion (+11bps qoq) and c) healthy fee income growth (+15% yoy). However,
these were largely overshadowed by: a) higher operating expenses (+15% qoq,
and mostly recurring), and b) continued high pace of asset deterioration.
 P&L: NIMs expand further, fees better, but expenses rise sharply — PNB’s NIMs
expanded 11bps QoQ to 406bps; high and we believe has peaked (expect gradual
moderation). Core fee income growth has picked up again (+15%yoy), still below
credit growth but is expected to stabilize at these levels. PNB’s operating costs
went up sharply (+38% yoy), largely on account of structurally higher and
recurring employee costs (pension and gratuity expenses remained flat).
 Balance sheet: Growth is good, but quality holds key — PNB’s loan growth at 28%
yoy remained strong and well above industry levels. Deposit growth has lagged
credit growth (better recently as management picks up short term funding), but
overall funding mix has been maintained so far (41% CASA). Key concern
however, remains on asset quality – delinquencies remain high (over 2.2%,
though appears to be stabilizing), coverage levels continue to drop (down to 77%
now) and its high restructured portfolio (6.5% of loans) provides little comfort.
 Raising target price to Rs1275, but maintain Sell (3M) — We raise our EVA based
target price to Rs1,275, tweak earnings and roll forward benchmark valuations to
FY12E (1.7x P/BV). We believe PNB has a strong balance sheet (funding mix) and
its return profile is looking more sustainable than before (key risks: incomplete
transition to automated NPL recognition and peak NIMs). The stock has however,
remained an outperformer (+16% vs Sensex in 3 months), and given its still peak
valuations, we would wait for a correction before considering turning positive again.