IndusInd Banks' first-quarter fiscal 2016 results met our expectations, with earnings per share of INR 10 on track to meet our full-year estimate of INR 44 per share. While loan growth of 23% was modestly behind our 25% forecast for 2016, the slated merger of Royal Bank of Scotland's diamond and jewellery business in India should help bridge the gap. Deposit growth (up 22%) was strong despite the bank bringing down deposit rates for small savings balances, demonstrating it has developed sticky relationship with its liability customers, supporting our narrow economic moat rating.
Shares of IndusInd Bank remain fairly valued, trading 10% above our unchanged INR 842 per share fair value estimate. The stock price reacted positively to return on equity crossing the 20% threshold. We see returns moving up further from here on, as the bank realizes the benefits of scale through further expansion of its branches, while bringing down the cost-to-income ratio to below the 45% level in the coming two years. Our outlook on net interest margins remains rosy at a forecast of 4% for the year, as we believe the fixed interest rate vehicle book will aid margin expansion in a falling interest rate environment. However, the merger of the jewellery loan book may cause some deviations from our forecast. With performance of the bank hinged on the broader macroeconomic environment and bad debts in the system, we maintain our high uncertainty rating on the stock.
Overall, we remain positive that gross non-performing loans as a percentage of average loans will trend lower than 1% for the bank, as has been the case during the past several years, and repeated this quarter as well. This confirms that the bank is a good underwriter of loans, and a standard steward of shareholder capital. Its recent capital raises at prices above book value will be minimally dilutive, providing the bank an adequate run rate to grow at our 25% average earnings growth forecast over a five-year period.
