Karnataka Bank Q1 FY27 growth accelerates as margins and asset quality improve

Investment View and Valuation

Anand Rathi Research maintained its BUY rating on Karnataka Bank following a healthy Q1 FY27 performance, supported by stronger margins, improved profitability and better asset quality. The broker expects return on assets to remain above 1 per cent through FY27E and FY28E, aided by stable net interest margins, healthy balance-sheet growth, controlled slippages and a manageable transition to the expected credit loss (ECL) framework.

Anand Rathi values Karnataka Bank at 0.9 times FY28E price-to-book value and sets a 12-month target price of Rs 364.

Q1 FY27 Financial Performance

Karnataka Bank reported strong year-on-year growth in Q1 FY27, although pre-provision operating profit declined sequentially and operating expenses increased.

Non-interest income declined sequentially because of muted fee income. Operating expenses increased, with staff costs rising because of higher retirement-benefit provisioning linked to yield movements. As a result, the cost-to-income ratio increased by 467 basis points sequentially to 55.1 per cent.

Margins and Profitability

Net interest margin expanded by 13 basis points quarter on quarter to 3.2 per cent. Anand Rathi attributed the improvement to a 22-basis-point sequential reduction in cost of funds and a 188-basis-point improvement in the loan-to-deposit ratio. These benefits were partly offset by a 10-basis-point fall in yields on advances.

The broker expects margins to remain broadly stable as Karnataka Bank shifts its asset mix towards higher-yielding segments while deposit costs remain stable. Q1 FY27 return on assets improved by 2 basis points sequentially to 1.29 per cent. Management is targeting return on assets of 1.35 per cent to 1.4 per cent over time.

Credit Growth and Balance-Sheet Strategy

Credit growth accelerated to 17 per cent year on year in Q1 FY27 from 6.9 per cent in Q4 FY26. Corporate advances grew 25.2 per cent year on year, while retail advances increased 17.8 per cent.

Management reiterated its guidance for 15 per cent to 20 per cent loan growth in FY27E, led by retail, agriculture and micro, small and medium enterprises (RAM) and mid-corporate lending. Karnataka Bank intends to run down its lower-yielding IBPC portfolio and redeploy capital towards higher-yielding assets. Deposits increased 6.9 per cent year on year to Rs 1,103,964 million in Q1 FY27.

Asset Quality and ECL Transition

Asset quality improved during Q1 FY27. Gross non-performing assets declined by 20 basis points sequentially to 2.58 per cent, aided by lower slippages and steady recoveries and upgrades.

Management attributed the increase in the SMA-II and overall SMA pools mainly to quarter-end disruptions caused by multiple holidays. About 76 per cent of incremental SMA additions was regularised after the quarter end. Management expects the transition to the ECL framework to be manageable because of Karnataka Bank's comfortable capital position.

Earnings Estimate Revisions

Following the quarter, Anand Rathi raised its FY27E and FY28E estimates.

Key Risks

• Lower-than-expected credit growth.
• Higher slippages from the agriculture and MSME books.