Kotak -Lending business robust; weaker-than-expected capital market business ::Credit Suisse,

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Kotak ------------------------------------------------------------------------------------ Maintain NEUTRAL
Lending business robust; weaker-than-expected capital market business


● Kotak's 1Q net profit (Rs4.2 bn; +27% YoY) was slightly ahead of our
estimate, mainly due to higher non-interest income from the bank.
Lending business growth and asset quality continued to be robust,
while margins were down 30 bp QoQ (vs 20 bp estimated drop).
● Loan growth was strong at 36% YoY, driven by both retail and
corporate divisions and the company is targeting to grow by 30%
in FY12 (vs 39% in FY11). Adjusted margins were down 30 bp
QoQ due to deposit re-pricing and management expects current
NIMs to be sustained in FY12. Asset quality continued to be
strong with a low credit cost of 0.3% (gross NPLs were down 120
bp YoY to 1.6%).
● The share of capital market business dropped further to only 10%
of profit in 1Q11 (vs 22% in FY11, peak of 61% in FY08) and the
medium-term outlook appears unattractive as well.
● We expect FY12-13 EPS growth to moderate to 10-20% (with
moderating NIMs, higher credit costs, weak capital market
business). We reduce our FY12-13E EPS marginally, by 2%, as
we build slightly lower NIMs. With 15% FY12-13E RoE, at 18x
FY13E EPS, we maintain our NEUTRAL rating.
Lending business – Robust growth and asset quality
Lending business growth and asset quality continued to be robust
while margin drop was slightly higher than our estimate. Loan growth
was robust at 36% YoY (8% QoQ in 1Q), driven by both retail
(mortgage, CV, auto) and corporate divisions. Management has
guided for FY12 loan growth of 30% and our forecast is at 30% (vs
39% in FY11). Adjusted NIMs were down 30 bp QoQ to 5.3%
(reported NIMs are at 5.0% due to an accounting change in
recognising the processing charges) during the quarter driven by repricing
of deposits. We expect margins to be sustained at the current
levels in FY12. Deposit growth was healthy at 32% YoY (8% QoQ) but
share of CASA deposits fell 100 bp YoY to 27%. The bank is targeting
to expand to 500 branches by CY13 (from 323 branches currently).
Asset quality continued to be robust with gross NPLs declining further
to +1.6% (including NPAs acquired from other banks) – down 120 bp
YoY (coverage excluding writeoffs is at 66%). Credit costs were a low
0.3% during the quarter (well below the normalised credit costs of 1.2-
1.3%). Kotak continues to be very well capitalised with Tier 1 of 16%
(consolidated group excluding 1Q12 profits) .


Capital markets business weaker than expected
The capital market business’ performance was weaker than expected
(down 54% QoQ and 55% YoY) with investment banking, international
subsidiaries and securities witnessing a sharp sequential drop in
profit. Share of capital market business to profit fell to 10% (vs 22% in
FY11 and 61% in FY08). Management believes the medium-term
outlook for these businesses does not look attractive with increasing
fragmentation and declining margins. Total premium for the life
insurance business was down 8% YoY and it reported profit of Rs460
mn (vs a loss of Rs69 mn in 1Q11).


We value Kotak at Rs444, based on our sum-of-the-parts analysis.
We value the standalone bank and Kotak Prime (car financing
business) at 2.5x FY13E book value (Rs366 per share) and other
subsidiaries at Rs79/share (securities/investment banking at
Rs20/share – 12x FY13E EPS; AMC at Rs22/share – 4.0% of FY13E
AUM; and life insurance at Rs19/share).