Earnings Report /
Sri Lanka

Commercial Bank Of Ceylon: Credit growth still weak; more impairments in H2

    Kavinda Perera
    Kavinda Perera

    Head of Research

    Asia Securities
    19 August 2019
    Published by

    Our TP for COMB increases to LKR 110.00/share (+9.9% TSR) and COMBX to LKR 96.00 (+10.2% TSR) on overall market re-rating. COMB’s Q2 CY 19 PAT beat our estimates and came in at LKR 3.4bn with an EPS of LKR 3.36, on higher FX gains, but impairment charges of LKR 3.6bn were higher than our forecasts. The loan book contracted by 0.4% qoq, while NPL ratio increased to 4.86% reflecting the industry trend. We see further upside to NPLs and impairments in H2 with the still weak economic conditions. The low growth environment reduces the pressure on capital raising, and we believe early next year is a likely timeline for a rights issue. Once announced, we expect the prices would drop initially but will trade back to our TP in 12 months.

    Impairments double sequentially; we expect further pick-up in H2

    Impairment charges of LKR 3.6bn in Q2 CY 19 increased 62.1% YoY and 91.5% QoQ, with the cost of risk surging to 163bps. Despite the loan book contracting, the bank booked in higher impairments, which came mainly from the weakening economic environment (collective impairments) rather than any significant individual exposure. The bank’s provision coverage remains at a low of c80.0% as of Q2 CY 19, and rising NPLs would lead to higher provisioning in H2 CY 19.

    Loan book contracts further, while asset quality continues to deteriorate

    The loan book contracted for the second consecutive quarter, marking a 0.4% qoq drop. While the weak credit demand is largely driven by corporates, management indicated that SME business has seen some pick up. With our sector thesis that H2 CY 19 would see recovery of private sector credit, we cut our CY 19e forecast to 0.9% yoy. Gross NPL ratio saw a 72bps increase qoq to 4.86% and remains in line with the industry average of 4.8%. NPL stock too has increased to LKR 43.2bn (+16.9% qoq) and the contracting loan book worsened the ratio. With slow credit growth, we expect NPLs could reach 6.0% in CY 19e.

    NIMs marginally lower, but expected to stabilise through CY 19

    Bank’s reported NIMs saw a marginal drop (-8bps qoq) in Q2 CY 19driven by the high NPL book and contraction in credit. While the deposit rate cap and cut in SRR would reduce cost of funds for the banks, we believe that the lower credit growth and drop in AWPLR would lead to a drop in lending rates, neutralising the positive impact to a large degree. We expect NIMs to remain flat through CY 19e but highlight downside risk if credit growth drops below our estimate and/or NPLs pick up further.

    We raise our TP to LKR 110.00 for COMB and LKR 96.00 for COMBX

    COMB trades at 0.9x CY19E BV while COMBX trades at 0.8x after seeing a pick up due to the overall market rerating. Although COMB would need to raise equity capital, with the slow loan growth this year, we do not see major pressure to carry out a rights issue. Our base case assumes that COMB would likely carry out the issue early next year, after allowing the share price to recover further. With this, within the next 12 months, we believe that the share price would see a correction for the rights dilution and would trade back up. Accordingly, we set our TP for COMB to LKR 110.00 (+3.8% upside; +9.9% TSR) and for COMBX at LKR 96.00 (+3.2% upside; +10.2% TSR). Maintain Hold.