Ladies and gentlemen, good day, and welcome to City Union Bank Q2 FY '23-'24 Earnings Conference Call hosted by AMBIT Capital. Please note that this conference is being recorded. I now hand the conference over to Mr. Prabal Gandhi from AMBIT Capital. Thank you, and over to you, sir.

Thank you, Saber. On behalf of AMBIT Capital, I once again welcome you all for City Union Bank's Second Quarter Earnings Call. From the management side, we have Dr. N. Kamakodi, MD and CEO; and Mr. J. Sadagopan, CFO. Without further ado, I'll hand over the call to Dr. Kamakodi for his opening remarks, post which we can open the floor for Q&A. Thank you, and over to you.

Good evening, everyone. Dr. Kamakodi here. Welcome to all of you for this call to discuss the unaudited financial results of City Union Bank for the second quarter and the first half year ended 30th September 2023. The Board approved the results today, and I assume you all have received the copies of the results and the presentation. During the March '23 and June '23 calls, we shared some of the expectations for the financial year '23-'24. We are aiming for a 12 to 15% growth for the financial year '24, which should be skewed towards the year-end. We hope to close the financial year '24 with an ROA of 1.3%, for which NPA recovery will be a major contributing factor. In the absence of treasury profit opportunities in the increasing interest rate scenario, the cost-to-income ratio will be in the range of 42 to 45%. We expect some pressure on the NIM, at current levels plus or minus 10 basis points. Things are happening almost as expected and even getting better in certain aspects. We have seen about INR 1,280 crores or a 3% credit growth during the second quarter of 2024. The soft launch of the digital process for the MSME lending below INR 3 crores has started. The project executed by the Newgen Software team and coordinated by BCG is on track. We hope to achieve the numbers we shared with you during the year-end, particularly for credit disbursement and growth as we move forward. We closed the second quarter of the financial year '24 with a profit after tax of INR 281 crores compared to INR 276 crores in the second quarter of the financial year '23. In fact, we had the highest profit after tax of INR 276 crores in the second quarter last year. After that, we had some moderation in the subsequent three quarters. This quarter, we achieved INR 281 crores profit as we had already shared with you all. The ROA for the second quarter of financial year '23-'24 is 1.69% compared to 1.4% in the first quarter of financial year '24 and the same ROA was 1.46% for the whole year of financial year '23. We typically used to have above 1.5% during the pre-COVID years. In the financial year '20, we had a 1% ROA which reversed over and above that as we accounted for COVID provisions. We saw a sequential increase to 1.15%, 1.3%, and 1.4% in the subsequent years. In this quarter, we have a 1.69% ROA. We closed the first half of financial year '24 with a profit after tax of INR 508 crores and hope to cross a 4-digit profit after tax figure for the full year of financial year '24 for the first time. Whatever profit we have discussed in the current quarter is the highest ever profit that the bank has declared in its 120 years of progress. We hope to achieve this figure despite having headwinds in operating profit, mainly due to the positive contribution from the credit cost. Our slippage ratio for Q2 is down to 2.06%, almost equal to the pre-COVID level. Our absolute slippage number for Q2 FY '24 is INR 225 crores, while the total recoveries made is INR 299 crores, comprising INR 230 crores from live NPA accounts and INR 61 crores from recoveries from technically written-off accounts. For the first time in recent history, live recovery has surpassed live slippage, and we expect this trend to continue moving forward. The net NPA has come down below the INR 1,000 crore mark after many quarters. The overall SMA 2 numbers to the total advances as of 30th September 2023 stands at 2.05%, down from 2.43% in the first quarter of financial year '24. We also wish to inform you that the RBI inspection for the position as of 31st March 2023 was completed, and there is no requirement for any disclosure concerning divergence and asset classification or provisioning as per the guidelines given in the results. Last year, in the third and fourth quarters, we had some issues that pulled down profitability. But now, this year is over and we don't have to make any disclosures as per the extended deadline. In summary, we are now in a phase where NPA slippages have significantly reduced and NPA recoveries have started to surpass the slippages. Consequently, we will see a substantial reduction in credit costs and the NPA returning to pre-COVID levels, which will reduce the provisions required substantially and take care of the profit after tax. The soft launch of digital lending products has commenced, which is expected to help us achieve improved credit growth in the second half, as we discussed in earlier calls, to reach double-digit credit growth for the whole year. Both projects are executed by the Newgen Software team, and coordination is done by BCG, and the entire project is on track, helping us to succeed in achieving better growth as we move forward. ROAs are back to over 1.5%, which used to be our benchmark, and net interest margin is also within the range we shared earlier. For the current quarter, it currently stands at 3.74%. Despite headwinds in growth, we should be closing the financial year '24 with a four-digit PAT, a substantial reduction in net NPA, and ROA around the long-term average of 1.3% plus. Overall, except growth, if you remember, pre-COVID, we had positive progress in all parameters like growth, net interest margin, ROA, etc., with some setbacks after the onset of COVID, particularly on slippage ratios and moderation in growth. We have taken our foot off the growth pedal since financial year 2020. We continued our growth with the gold loan, but due to certain regulatory observations, we had to stop the agri-gold loan KCC product. This has become a headwind to our growth, but the growth in other core sectors has started to show some progress, which we expect to improve particularly with the arrival of our digital lending platform. Overall, things are aligning with our long-term progress, and the progress is visible. We expect to show PAT growth by saving credit costs this year. Once growth picks up as we can see, all parameters should return to our long-term benchmarks that we had set over time. Overall, things are settling well, and we hope for further improvements as we move forward. With these opening remarks, I open the floor for questions and discussion.

The first question is from Rohan Mandora from Equirus Securities.

Congrats on the improved set of numbers. Sir, firstly, in terms of the upgrades that we have seen this quarter, could you share some insights on which segments they are coming from and when the accounts slipped?

Yes. In fact, we had discussed this during our last call. Basically, we had a process where whenever an account upgrades before the release of the quarterly numbers, we take that into our collections. However, recently there were observations during inspections, which impacted this process, and we have also provided numbers regarding account upgrades. It is all around, across the sectors, with the largest one being upgradation of about INR 19 crores from a resort that started seeing improvements in collections. The second has come from a contractor for the Government of Tamil Nadu, who received payments that were pending. The third was from the fishing sector, where recoveries led to account upgrades. The composition of the upgraded accounts spans various sectors, and there is no specific sector standing out. This is mainly due to delayed receivables from sectors like government, which, upon payment, resulted in these accounts being upgraded.

And sir, secondly, regarding the PCR. Despite having contained provisioning for this quarter, we did not see an increase in PCR, which is showing around 50-51%. Will we remain comfortable at this level? Or will we see some increases in PCR levels over the next two years? Also, what was the credit cost guidance for FY '24?

Yes. We have explained multiple times in earlier calls that our average recovery for the portfolio is such that if INR 100 slips, we recover about INR 65 to 70. So anything around INR 35 to 40 provision is not required based on our track record due to the available collateral and its liquidation. We keep provisions based on our requirements. The 70% coverage ratio is something that was sought repeatedly, and we feel we can improve it to 70%. We don’t expect any major significant improvement in the coverage ratio because we believe we don’t need to increase it due to our existing collateral. This coverage ratio is largely in line with the recoveries arriving. Our primary focus is getting to net NPA levels and not specifically on the coverage ratio. We had a net NPA of less than 2% pre-COVID. We plan to return to that number and perhaps lower net NPA as we move forward, which will improve the coverage ratio over time as a byproduct.

Got it, sir. And do we have any specific number for credit cost guidance for this year?

As we have seen, when recoveries exceed slippages, the incremental net provisions required will decrease. Based on this, we can adjust our targets accordingly regarding net NPA levels to approach pre-COVID metrics.

And sir, lastly, we've seen an increase in yield this quarter. Could you point to the benefits from interest reversals? Were there any other reasons for the increase in yields on advances?

There was an incremental pass-on of rates towards the middle to the end of the first quarter. The full effect was seen only in the quarter following that.

The next question is from Nilesh Jethani from Bank of India Mutual Funds.

My first question is on a macro level. Many peers are discussing the stress they face in the MSME sector. What is our outlook on this?

We observe two divergent trends in the market. On one hand, many have come out of the issues faced during COVID, and nearly all MSMEs surviving are performing well with good cash flows. Asset quality issues have largely subsided, and things are on track. On the other hand, we are not seeing the expected growth in this segment, unlike previous cycles. We're awaiting a recovery in the investment cycle and capacity expansions. The current bulk investments are primarily in renewable energy sectors such as solar.

Understood. Internally, considering the credit and NPA cycle, at what levels of NPA, specifically GNPA, NNPA, or credit cost, will we press the pedal for growth?

Our slippage ratio pre-COVID typically ranged between 2% to 2.5% of closing advances. For the financial year '21 and '22, this increased to around 3% to 3.5%. Our peak gross NPA in this cycle did not exceed about 5.7%, while net NPA was around 3.5%. While many peers were cleaning their books years ago, we had challenges during the COVID period that impacted recoveries. Currently, our visibility on SMA numbers is encouraging and suggests substantial improvement in stress levels. If INR 100 slips, we typically recover around INR 60 to 70. Due to this, we believe incremental provisions required just for securing losses can be less than 40%. With live recoveries now exceeding slippages, we foresee a reduction in incremental provision ratios.

So, does this indicate we can push for growth if these numbers improve? Will we also increase growth efforts?

Yes, we have already started positioning ourselves for growth. As previously shared, we anticipate growth skewed toward the second half. We achieved about 2% to 3% quarterly growth in this quarter. The introduction of digital lending processes, for which soft launches have begun, is critical. Our growth expectations are based on aggressive efforts underway to achieve our targets.

The next question is from the line of Anand Dama from Emkay Global.

Sir, my question is on the margins. Earlier you mentioned RBI had an observation on the MCLR. Any updates on that?

We have written to RBI and are awaiting their response. We stopped recognizing income due to their observations on products that usually generate interest. Some yield transfer has occurred, leading to a marginal improvement in yield. Our current credit-deposit ratio is also below pre-COVID levels, affecting us slightly. Our overall average NIM should remain stable, within 10 basis points of our existing levels.

Is it possible to share the unrecognized interest income?

In the last quarter, it was about INR 20 crores to INR 30 crores.

So in the first and second quarters, no additions to that unrecognized interest, right?

No. This product typically concludes within a year, and we ceased recognizing that income as it was flagged.

We've heard Uday Kotak has secured a Board position. In previous discussions, would you consider a Board position post-retirement from your MD and CEO role?

I mentioned in earlier calls that the Board has appointed a subcommittee exploring potential candidates. There's an upper limit of 4 months for this transition. The goal is a smooth handover to a successor. We are actively working on this process.

So, you could consider a Board position once you retire as MD and CEO?

There are still 2 years left in my term. We should wait for things to settle before I provide a clear answer.

Your perspective on maintaining PCR seems aligned with other banks revising theirs. Shouldn't we consider increasing our PCR to build a buffer?

Our focus has been on the net NPA, which should automatically improve the coverage ratio as we work towards achievable net NPA targets. Our strategy is to reach pre-COVID levels by the year’s end. We anticipate steady provisioning will manage this as recoveries continue to exceed slippages.

Do your guidance figures of 8% to 10% loan growth for the full year still stand?

Yes, it still stands, and we are working toward that.

The next question is from Neel Mehta from Investec.

My first question is about the employee cost. What led to the 20% Q-o-Q increase?

The annual increment period starts on July 1, leading to a sequential increase. Year-on-year, it reflects a 6% increase for the first half.

Understood. As for recoveries, do we net them off from provisions when we recognize credit costs, or do we book them as other income in our P&L?

If the account is entirely written off, it's considered income. If it's a live account that has been upgraded or collected from, it shifts from one account to another.

If it's a live account that hasn't been fully written off, would you recognize it net of credit cost?

Yes, any losses we incur will be deducted from the provisions made, and the remaining will move to other accounts.

What would be our LCR level for this quarter?

Typically, it sits around 200%, which is standard for us and will be available on our website soon.

The next question is from Rakesh Kumar from B&K Securities.

Very strong performance this quarter. Could you provide updates on the BCG project? How is progress going, and when do you plan to finish the exercise?

As I mentioned, the actual software is developed by Newgen, while BCG handles support and coordination. The soft launch of the MSME loans under INR 3 crores is already on. It will be used for select branches for the next 10-15 days. After addressing any bugs, by the second half of November, it should be available to all branches. Other products are in the soft launch phase as well, and we expect everything to be operational by the end of Q3. The progress so far is promising, and we're closely monitoring it.

Post-transition, we expect a significant improvement in turnaround time, especially for MSME customers?

Yes, that is the expectation, and it's the primary purpose of this entire initiative. We anticipate seeing positive results in the second half.

The next question is from Jai Mundhra from ICICI Securities.

Congratulations on a solid quarter. To clarify, the LOS implementation across all products should finish by early January next year, right?

Yes, that's the target. By the third quarter results in late January, at least 50-60% of our products should be in full production, with the remaining in soft launch or generating results.

Will the LOS implementation affect our usual growth trajectories, particularly the pattern we typically see across quarters?

We don't expect major changes in our usual pattern. The main anticipation is that the turnaround time will improve significantly, allowing us to process things more effectively. Possible improvements may not be immediately visible in financials but could contribute to lower slippage ratios in the long run.

On the yield front, you mentioned better pricing due to bargaining power. However, it seems MCLR has reduced over recent quarters. Can you explain how this balances out?

I did not imply that. I indicated there was one interest rate transmission towards the end of the first quarter, which fully affected the second quarter. Rate hikes have been transmitted. We missed some previous transmissions which impacted last year's rates; we've adjusted that now.

In this quarter, yields were better due to stronger card rates, better pricing power, or a combination of both?

There was overall rate transmission towards the end of the first quarter, resulting in the increase in yield. You can interpret it as better bargaining power contributing positively to overall yield.

This quarter marked our first negative net slippages. How does this impact NIM? Will there be a significant effect, or do you expect more adjustments?

The impact is minor, only about INR 30 crores to 40 crores, and we don't anticipate it to be significant or influential in that regard.

This quarter has seen negative net slippages, while gross slippages are declining. Other banks are running at negative net slippages; how does this reflect on our recovery process? Is there an underlying advantage for sustaining this trend?

Particularly when analyzing peer banks, many faced severe slippages years ago. Many, especially larger banks, went through cleaning cycles long before us. Our slippage spike occurred during the COVID period, consequently delaying recoveries. Cumulatively, given that we observe positive recovery, our slippage reductions reflect an important transition, although we are perhaps about one to two years behind more prominent players.

Is our confidence in sustaining negative net slippages ongoing?

Yes, as long as we have a pool of NPAs available for recovery, we can sustain this trend for the next couple of years. Once that pool diminishes significantly, challenges may arise.

The next question is from Aravind R. from Sundaram Alternates.

Can we expect any further rate increases in the future?

We don't anticipate any more hikes moving forward. Even with a 25% probability, if there is anything pending, it will likely be just a 25 basis points increase. The greater probability suggests no further hikes in the immediate future.

So, credit costs could remain low in the second half, similar to what we observed in the second quarter—am I right?

Yes, that is correct.

As there are no further questions from participants, I now hand the conference over to the management for closing comments.

Yes. Thank you all for attending this call. As you've observed, we've entered a phase with reduced slippages, increasing recoveries, and significantly decreased credit costs. We anticipate this trend continuing for several quarters. Our ROA and efficiency metrics approach, even exceed, our long-term averages. The only aspect yet to achieve is growth, for which we see some initial signs. We expect that digitization and the introduction of the LOS will improve efficiency, paving the way for double-digit growth of advances in the second half. Overall, it appears things are returning to normalcy, and we anticipate further improvements and better numbers moving forward. Thank you once again for your participation.

Thank you very much. On behalf of AMBIT Capital, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.