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Union Bank of India’s June quarter metrics had enough reason to vindicate the 11% increase in its share price since April. The public sector lender’s operating performance improved with both core interest income and non-interest income growing at a healthy pace sequentially.

The bank reported a 29.8% sequential increase in its core interest income even though its loan book contracted. That is because the bank’s margins rose, helped by low cost of funds and an increase in yield on advances. The support to margins in the coming quarters with interest rates expected to remain low is a key strength for public sector banks. For Union Bank, the mix of loans in incremental disbursements has lifted its yield too.

Meanwhile, the second wave has impacted both growth and asset quality in an expected way. Loan book shrank 1% sequentially and was flat from a year ago. Loans to small businesses declined 4% sequentially and this portfolio has been the most troubled one for the bank despite the government guarantee scheme. Defaults from small businesses have surged in the wake of the second wave. Micro, small and medium enterprises (MSME) segment contributed 41% to fresh slippages which surged to 7050 crore during the June quarter. The management said that cash flows of small businesses were impacted resulting in a rise in delinquencies. But the lender is confident that incremental stress from this segment would be less. “We are confident that eclgs facilities will help bring stress down," said Rajkiran Rai, managing director of the bank in a media call on Thursday. Rai is also hopeful that recoveries would offset any pain that emerges from the overall loan book of the bank.

Despite the gross bad loan ratio still being elevated at 13% of the loan book, investors have been willing to give the lender the benefit of doubt. This is reflected in the roughly 6% increase in the share price since the release of the results on Thursday noon.

Two factors contribute to this comfort. One is the high provisioning done by the bank with coverage ratio being 69%. The big mover of the asset quality needle in the coming quarters is expected to be the newly minted bad bank. The National Asset Reconstruction Company Ltd (NARCL) will enable banks to offload their bad assets, thus freeing up capital. Union Bank aims to transfer 7700 crore as a first batch. The lender has indicated a total recovery of 13000 crore this year which would bring down its stressed asset pool.

Analysts point out that upgrades have also risen off late which augurs well for asset quality. “We expect slippages to moderate, mainly from 2HFY22. We project credit cost at 2.3%/1.9% in FY22E/FY23," wrote those at Motilal Oswal Financial Services Ltd in a note.

That said, until Union Bank brings down its bad loan pile to a reasonable level, valuations may remain under pressure. Despite the 17% gain since January, the stock trades at a discount to its estimated book value for FY22.

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