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TableofContents

PotentialriseinGDPandcutinratesapleasantmixforbanks ........................................................ 3

UpgradestotheFY09,FY10GDPforecastbyuptoc3% ....................................................................3

wascoupledwiththec2.4xexpansionintheP/BofCNXPSBK .........................................................3

Currentforecast

builds

1.6%

rise

in

GDP

over

FY15

FY16 .....................................................................4

Lessscopeforriseinthereporateasgapwith1yrGsecyieldfalls ...................................................4

WhileCPItargetforJan15issettobeachieved................................................................................5

foodinflationmaykeeptheinterestrateshighinCY14 ...................................................................5

RatescutmaybebackendedinFY15...................................................................................................6

StressonassetqualityintensebutincrementalNPLtrendingdown................................................ 7

IncrementalNPLofPSUbanksareondownwardtrajectory.............................................................7

andstressedassetsvirtuallystableforthelastsevenquarters ........................................................7

WeassumemoderationintheincrementalNPLinFY16fFY17f .......................................................8

butsubduedloangrowthlikelytodelaytherecoveryinNPLratios .................................................8

NIMexpansionmayrevivecorerevenuesoverFY15fFY17f .......................................................... 10

OurFY15fPATforecastforPSUbanksismarginallybelowconsensus ...............................................10

PSUbanks

PAT

growth

forecast

to

exceed

new

banks

for

FY15

FY16 ...............................................10

Fallinrates,moderationinslippagetosupportNIMexpansion ........................................................11

EdgeinSBdepositshasslippedfornewprivatebanks.......................................................................12

Retailpartlyoffsetthelargeslowdowninthecorporateloans ..........................................................13

PSUbanksseerevivalinretailloangrowthaheadoffewnewbanks.................................................14

NII/assets,fallinprovisionstodriveRoAexpansionofPSUbanks.....................................................14

FallinthevaluationgapbetweenPSBsandnewbankscouldsustain............................................ 16

RallyinCY14ontheheelsoflargestunderperformancein10years..................................................16

Evenaftertherally,P/BofCNXPSBKc15%belowthe5yearmean ...................................................17

Reforms,reboundinassetqualitycouldfurthershrinkvaluationgap ...............................................17

LargerpotentialupsideinPSUbanksoverthe12months ............................................................. 19

DCFassumereturntonormalRoAoversemiexplicitperiodforPSBs ...............................................19

Potentialupside

of

up

to

21%

for

PSU

banks

over

12

months............................................................19

Riskfactors ..........................................................................................................................................20

Annexure:StockselectionwithinPSUbanksbasedonthefilters ......................................................21

Companies

BankofBaroda.24

HDFCBank 31

ICICIBank39

PunjabNationalBank47

StateBank

of

India..53

AxisBank......60

IndusIndBank.67

BankofIndia75

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PotentialriseinGDPandcutinratesapleasantmixforbanks

Large upgrade to GDP, by upto 3% during FY09FY10 was accompanied by c2.4x expansion in the P/B of PSU banks.

CurrentconsensusforecastfactorsrevivalinGDPby1.6%to6.3%inFY16,with20bpupgradetotheFY16GDPforecast

in the last3 months. PSU banks couldbe a larger beneficiary of GDP revival due to larger exposure to the corporate

sectorcomparedtothenewprivatebanks.There is lessscopeforfurtherrise inthereporateasgapwith1yrGsec

yield has contracted. In recent monetary policy, RBI indicated the peaking of interest rates. CPI and WPI have

moderated and stay close to the comfort zone of RBI. While high food inflation is likely to keep the interest rates

elevatedinCY14,potentialcutinFY16coupledwiththeuptrendinGDPislikelytosustaintherecentexpansioninP/B.

UpgradestotheFY09,FY10GDPforecastbyuptoc3%

The reported GDP (revised estimate) for FY09FY10 was significantly higher than the consensus

forecast.WeassumealagofthirteenmonthsfortheGDPtobereportedasfinalrevisedestimatefrom

thefiscalend.ThemonthlytimeseriesforecastfortherealGDPgrowthforFY09wasupgradedfrom

4% in Mar09 to 7% in Jul09. The reported revised GDP was closer, at 6.7%. Similarly, FY10 GDP was

upgradedfrom6.3%inOct09to8.2%inMar10.

wascoupledwiththec2.4xexpansionintheP/BofCNXPSBK

ThedurationoflargeGDPupgradeswascoupledwithlargeexpansionintheP/BofPSUbanks.TheP/B

ofCNXPSBKincreasedfrom0.69xattheendofMar09andpeakedat1.65xinOct10.

Uptoc3.5%fallintheFY11FY13GDPforecastcoupledwiththefallinP/BForFY11,fromthepeakof9.0%inJan11,GDPforecastdeclinedto7.75%inMar11.ThereportedGDP

was1.4%higherat8.91%.TherewaslargedowngradetotheGDPforecastforFY12from8.7%inJun11

to5.2%inMar13.However,thereportedGDPwashigherat6.69%.FY13GDPat4.7%wasabout2.2%

lower than the forecast in Jul12. The P/B of CNXPSBK declined from 1.33x in Jan11 to 0.56x at end

Feb14.

Exhibit1:GDPgrowthforecastand1yearforwardP/BofCNXPSBK

2

4

6

8

10

Oct07 Oct08 Oct09 Sep10 Sep11 Sep12 Aug13 Aug14

0.0

0.5

1.0

1.5

2.0

P/B(CNXPSBK,RHS) FY08 FY09FY10 FY11 FY12FY13

Source:Bloomberg,IL&FSInstitutionalEquities

RBIindicatespositivebiastowardsFY15centralestimateof5.5%

ThecurrentforecastforrealGDPgrowthforFY14,FY15andFY16isbetween4.7%and6.3%,withina

narrowrangeof1.6%.FY16GDPhasbeenupgradedby20bpsinceMay14.RBI,initsAnnualMonetary

policyApril2014had statedthatcontingentupon thedesired inflationoutcome,realGDPgrowth is

projected topick upfroma little below 5% in201314 to a rangeof5 to 6% in201415albeit with

downside risks to the central estimate of 5.5% However, in its latest Bimonthly monetary policy

there was a positive bias towards the GDP guidance prospectsfor reinvigoration of growth have

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improvedmodestly.Thefirmingupofexportgrowthshouldsupportmanufacturingandservicesector

activity.Iftherecentpickupinindustrialactivityissustainedinanenvironmentconducivetotherevival

ofinvestmentandunlockingofstalledprojects,withongoingfiscalconsolidationreleasingresourcesfor

private enterprise, external demandpicking up and international crudeprices stabilising, the central

estimate of real GDP growth of 5.5% within a likely range of 5 to 6% that was set out in theApril

projectionfor201415canbesustained.

Currentforecastbuilds1.6%riseinGDPoverFY15FY16

FY16GDPhasbeenupgradedby20bpsinceMay14Exhibit2:GDPgrowthforecastand1yearforwardP/BofCNXPSBK

2

4

6

8

10

Jul12 Nov12 Feb13 May13 Aug13 Nov13 Feb14 May14 Aug14

0.0

0.5

1.0

1.5

2.0

P/B(CNXPSBK,RHS) FY14 FY15 FY16


PSUbankscouldbelargerbeneficiaryoftherevivalinGDPWe believe the impending uptrend in GDP is likely to sustain the gradual expansion in valuation of

banks. PSU banks could be a larger beneficiary of GDP revival due to their larger exposure to the

corporatesector

compared

to

the

new

private

banks.

The

P/B

of

CNXPSBK,

despite

sharp

rise

in

CY14,

at0.85xon02Sep14staysbelowthe5yearmean.

Lessscopeforriseinthereporateasgapwith1yrGsecyieldfalls

OneyearGsecyieldcloselytrackstherepo innormaltimeswithformerbeingthe lead indicatorfor

thereporate.ThedeclineinthegapbetweenoneyearGsecyieldandreporatewithfallinthespread

closeto5yearmeanof39bpleaveslessscopeforanysignificantriseinthereporate.

Exhibit3:1yrGsecandReporate

3.5

5.0

6.5

8.0

9.5

11.0

Mar06 Dec07 Aug09 Apr11 Dec12 Aug14

1yrGsec (%) Reporate(%)

Source:IIL&FSInstitutionalEquities

Exhibit4: Spreadbetween1yrGsecandRepo

2.8

1.4

0.0

1.4

2.8

4.2

Mar06 Dec07 Aug09 Apr11 Dec12 Aug14

Spread(1yrGse cand Repo)5yrs mean

Source:IL&FSInstitutionalEquities

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Exhibit5:CPI(%)

15%

5%

5%

15%

25%

J an1 2 J un12 Nov12 Apr1 3 Se p13 Fe b14 J ul14

5%

7%

9%

11%

13%

CPI (yoy,RHS) CPI(mom,annualised)


Exhibit6:FoodsegmentinCPI(%)

30%

14%

2%

18%

34%

J an1 2 J un1 2 Nov1 2 Apr 13 Se p1 3 Fe b1 4 J ul 14

5%

8%

11%

14%

17%

Food(33.8,yoy,RHS) Food(mom,annualised)


WhileCPItargetforJan15issettobeachieved

According to theUrijitPatel Committeeto revise andstrengthenthe monetary policyframeworkin

view of the elevated level of current CPI inflation and hardened inflation expectations, supply

constraintsandweakoutputperformance,thetransitionpathtothetargetzoneshouldbegraduated

tobringingdowninflationfromthecurrentlevelof10%to8%overaperiodnotexceedingthenext12

monthsand 6% over aperiodnot exceeding thenext 24 monthperiod beforeformallyadopting the

recommendedtargetof4percentinflationwithabandof+/ 2%..CPI(combined)hasdeclinedfrom

9.87%inDec13to7.42%inJul14.

foodinflationmaykeeptheinterestrateshighinCY14

While we may see rise in retail inflation driven largely by food, in the nearterm due to inadequate

rainfall, CPI may moderate towards the end of FY15. In the latest Annual Monetary Policy, RBI has

statedthe

risks

to

achieving

the

inflation

of

8%

by

Jan15

such

as

less

than

normal

monsoon

due

to

possibleelninoeffects,uncertaintyonthesettingofMSPforagricommoditiesandthesettingofother

administered prices, especially of fuel, fertilizer and electricity; the outlook for fiscal policy; geo

politicaldevelopmentsandtheir impacton internationalcommodityprices.However,therewillalso

beadownwardpullonCPIinflationexertedbybaseeffectsofhighinflationduringJunNov13.

Exhibit7:YoychangeinWPIanditssegments

0.5%

3.5%

7.5%

11.5%

15.5%

Apr12 Jul12 Oct12Jan13Apr13 Jul13 Oct13Jan14Apr14 Jul14

WPI Food(24.3)Fuel(inc.crude,15.8) Manufactured(exc.food,55)


Exhibit8:Mom(annualized)changeinWPIsegments

60%

30%

0%

30%

60%

Apr12 Jul12 Oct12 Jan13 Apr13 Jul13 Oct13 Jan14 Apr14 Jul14

Food(24.3) Fuel(inc.crude,15.8)

Manufactured(exc.food,55)


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RatescutmaybebackendedinFY15

Nearterm rise in food Inflation may lead to the upward pressure on inflation. Hence, despite the

moderation in WPI and CPI, the interest rate cut may be backended in FY15 after the impact from

factorssuchasmonsoonsandbaseeffectplaysout.

FallinWPIfortwoconsecutivemonthsinJun14Jul14

WPI

surged

to

6.01%

in

May14

after

the

decline

in

Apr14

to

5.2%

and

staying

below

5.7%

in

the

precedingfourconsecutivemonths.However,therehasbeenadeclineinthetwoconsecutivemonths

of Jun14Jul14. The Food segment24.3% weight in the Wholesale Price Index (WPI) has remained

closerto7%forfivemonths.Themomchange(annualised),revealsthesteeprise infoodprices in

May14andJul14andmaykeeptheWPIhighinthenearterm.

Exhibit9:Reporate,1yearGsecyield,CPI(%)andWPIinflation(%)

4

6

8

10

12

Jan12 Mar12May12 Jul12 Sep12 Nov12 Jan13 Mar13May13 Jul13 Sep13 Nov13 Jan14 Mar14May14 Jul14

4

6

8

10

12

Reporate 1yrGsec yield

CPI(yoy,RHS) WPI(yoy,RHS)

Source:Company,AvendusResearch

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StressonassetqualityintensebutincrementalNPLtrendingdown

The intense stress on the asset quality of PSU banks is visible in nearly the decade high stressed assets and low

provisioncoverage.However,thepaceofnetadditiontostressedassetismoderating.Thefourquartermovingaverage

forincrementalNPLratiodeclinedduringthelastfourquartersby0.56bp.Thisisinsharpcontrasttothoseinthenew

privatebanks,whichhadanincreaseof10bpduringJun13Jun14.WhilethestressislikelytostayinFY15f,weassume

an improvement in incrementalNPLduringFY15fFY17f,byupto0.72%.However,therecovery inNPLratiosandNPL

provisionsmaybedelayedduetosubduedloangrowthandburdenduetosharpfallinthePCR;thePCRofthefifteen

largestPSUbanksdeclinedfrom61.7%attheendofSep08to42.4%attheendofJun14.

IncrementalNPLofPSUbanksareondownwardtrajectory

The incremental NPL (change in outstanding gross NPL over four quarters as percentage of starting

loans)of15PSUbanksdeclinedforthethirdconsecutivequarterinMar14,thisbeingthefirstdecline

forthreeconsecutivequarters innineteenquarters.Mar14beingcyclicallybetterquarter,therewas

riseinJun14quarterbutstayedwellbelowthepeak. TheincrementalNPLmayhavepeakedat0.72%

inJun13quarterbeforedecliningthereafter.ThedeclinewaslargelydrivenbySBI,BOB,CanaraBank,

AndhraBank, Central Bankand IDBIBank.Large writeoffandsale to ARCs partlycontributed to the

declinein

net

additions

in

the

last

few

quarters.

Newprivatebankshadthereverse,risingtrendfor5consecutivequartersThetrendinincrementalNPLfornewprivatebankshasbeenmovinginthedirectionoppositetothat

ofthePSUbanks.Therehasbeenaconsistentrise intheratio inthe lastfivequartersfrom0.12% in

theDec12quarterto0.34%intheMar14quarterbeforemoderatingintheJun14quarter.Theincrease

hasbeendrivenbyICICIBank,KotakMahindraBankandYesBank.HDFCBankandIndusIndBankhad

thereversetrendwithinnewbankswithdeclineintheirincrementalNPLratiooverpastfivequarters.

Exhibit10:IncrementalNPL(4qtrsmovingaverage)

0.0%

0.2%

0.4%

0.6%

0.8%

Dec09 Jun10 Dec10 Jun11 Dec11 Jun12 Dec12 Jun13 Dec13 Jun14

Newprivatebanks PSUbanks

Source:Company,IL&FSInstitutionalEquities

andstressedassetsvirtuallystableforthelastsevenquarters

The stressed asset (Gross NPL and restructured loans) of the group of fifteen largest PSU Banks has

remainedclosetoc11% inthe last eightquarters.Restructured loanofagroupofthefifteen largest

PSUbankshasremainedwithinarangeof6.5%to7.5%inthelasttenquarters.Afterneardoublingin

FY13to6.5%of loans,therestructured loansaspercentageof loanshas largelystabilized.Thegross

NPLratiohasalsoremainedwithinaverynarrowrangeof4.3% 4.5% inthelastfourquarters.After

sharpriseby80bpand67bpinFY12andFY13,respectively,thepaceofrisehassloweddowninFY14.

Thetotalstressedassetshavedeclinedinthepastthreequartersfrom11.7%attheendofJun13to

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Exhibit11:Stressedassets(%)

0.0

4.0

8.0

12.0

Jun10 Dec10 Jun11 Dec11 Jun12 Dec12 Jun13 Dec13 Jun14

0%

150%

300%

450%

RatioofPSU/New(RHS)

PSU

New


Exhibit12:PCR(%,excludingwriteoff)

30

50

70

90

Jun10 Dec10 Jun11 Dec11 Jun12 Dec12 Jun13 Dec13 Jun14

Newprivatebanks PSUBanks


11.2% at the end of Jun14. While the has been partly driven by sale of asset by banks to ARCs, the

stressedassts

as

remained

virtually

stable

and

within

a

very

narrow

range

of

10.6%

11.5%

in

the

last

eightquarters.

WeassumemoderationintheincrementalNPLinFY16fFY17f

We assume the incremental NPL in FY15f to stay close to the average during FY13FY14 for the PSU

banksunderourcoverage.ThesignificantimprovementintheassetqualityislikelyinFY16fFY17f.For

thePSUbanksunderourcoverage(SBIN,BOB,BOI,PNB),weassumedeclineinincrementalNPLover

FY15fFY16fbyupto0.72bp.However,despitethe improvement in assetquality,wedonotexpect

theincrementalNPLratiotofalltothepreFY12level.Forthenewbanks,weassumetheincremental

NPLtoremainlargelystablewithupto5bpriseassumedforICICIBCandIIBduetolargeincremental

restructuringintherecentquartersanddelayedrecoveryintheCVcycle.

Exhibit13:IncrementalNPL(%)

0.0%

0.4%

0.8%

1.2%

1.6%

2.0%

SBI(s) PNB BOB BOI

FY10FY12 FY13FY1 4 FY1 5f FY1 6FFY17f


Exhibit14:IncrementalNPL(%)

0.0%

0.3%

0.6%

0.9%

1.2%

1.5%

1.8%

ICICIBC AXSB HDFCB IIB

FY10FY12 FY13FY1 4 FY1 5f FY1 6FFY17f


butsubduedloangrowthlikelytodelaytherecoveryinNPLratios

Whiletheremaybefall inthepaceofnetadditiontogrossNPLs,therebound intheNPLratiosand

NPL provisions may be delayed. Moderation in loan growth may partly keep the gross NPL ratio at

higher level. For the PSU banks under our coverage, we estimate the rise in gross NPL ratios. Loan

growthoverFY15FY17isassumedtogrowthintherangeof15%18%,constrainedduetolargecapital

requirementsevenifthereisarecoveryintheinvestmentcycle.

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Exhibit15:GrossNPLratio

0.0%

1.5%

3.0%

4.5%

6.0%

7.5%

SBI(s) PNB BOB BOI

FY10FY1 2 FY1 3FY14 FY15f FY16FFY17f


Exhibit16:GrossNPLratio

0.0%

1.5%

3.0%

4.5%

6.0%

7.5%


FY10FY1 2 FY1 3FY1 4 FY15f FY16FFY17f


LowPCRiskeeptheprovisioningburdenhighThePCR(excludingwriteoff)ofthefifteenlargestPSUbanks(referexhibit19)declinedfrom61.7%at

theendofSep08to42.4attheendofJun14.SBI,BOBandIDBIbankarebestplacedamongPSUbanks

withtheir

PCR

being

close

to

50%.

Exhibit17:PCR(%)

0

20

40

60

80

SBI(s) PNB BOB BOI



Exhibit18: PCR(%)

0

20

40

60

80




Except SBI, we do not forecast the NPL provisions/ loans to decline to preFY13 level. Even with an

improvementtheprovisioningburdenislikelytostayhighduetopossibleincreaseintheprovisionson

restructuredloansandverylowcoverageratio.

Exhibit19:NPLprovisions/loans(%)

0.0

0.3

0.6

0.9

1.2

1.5

SBI(s) PNB BOB BOI



Exhibit20:NPLprovisions/loans(%)

0.0

0.3

0.6

0.9

1.2

1.5




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NIMexpansionmayrevivecorerevenuesoverFY15fFY17f

Current earnings expectation for PSU banks for FY15FY16 is above that for the new banks with FY16f PAT growth

forecastbeingupgradedbyc6%inthelast12months.WiththegradualmoderationintheadditiontoNPLs,thesharp

dropinyieldonloansislikelytogetarrested,benefittingthemargins.ThesignificantleadinSBdepositsproportionof

thenewprivatebanksoverPSUbankshasdeclinedoverthelasttwoyears.TheyoySBdepositsgrowthofPSUbanks

declinedfrom20%28%inFY11to13%18%inFY14PSUbanksundercoverage.Theslowdownhasbeenlargerforthe

newprivatebanksfrom21%60%to17%41.WeforecastanexpansionintheRoAofupto25bpoverFY15fFY17ffor

thefourlargePSUbanksunderourcoverage.EasingofpressureoncorerevenuesanddeclineinNPLprovisionsasnet

additiontogrossNPLrecedes,islikelytodrivetheRoAexpansion.

OurFY15fPATforecastforPSUbanksismarginallybelowconsensus

Exhibit21:ConsensusandourforecastforthePSUbanksinourcoverage

(INRmn) Ourforecast Consensus Variationwithconsensus

FY15f FY16f FY17f FY15f FY16f FY17f FY15f FY16f FY17f

SBI 184,586 239,780 306,884 179,017 220,181 267,885 3% 9% 15%

PNB 41,708 55,299 70,475 48,187 59,623 74,838 13% 7% 6%

BOB

52,863 62,397 75,354 53,799 64,907 76,731

2%

4%

2%

BOI 32,439 41,996 48,804 32,870 41,335 53,601 1% 2% 9%

Total 311,596 399,471 501,517 313,872 386,045 473,055 1% 3% 6%


Exhibit22:Consensusandourforecastforthenewbanksinourcoverage

(INRmn) Ourforecast Consensus Variationwithconsensus

FY15f FY16f FY17f FY15f FY16f FY17f FY15f FY16f FY17f

AXSB 70,821 84,574 100,323 71,874 85,548 103,537 1% 1% 3%

HDFCB 108,103 134,265 162,107 104,166 128,848 160,184 4% 4% 1%

ICICIBC 114,874 133,235 153,153 112,047 132,073 157,042 3% 1% 2%

IIB 17,409 21,611 26,880 17,692 22,196 27,901 2% 3% 4%

Total

311,207 373,685 442,463 305,779 368,666 448,665

2%

1%

1%Source:Company,IL&FSInstitutionalEquities

PSUbanksPATgrowthforecasttoexceednewbanksforFY15FY16

Exhibit23:YoyPATgrowth(CNXPSBK)

20

10

0

10

20

30

May13 Aug13 Oct13 Dec13 Feb14 Apr14 Jun14 Aug14

FY14 FY15f FY16f


Exhibit24:YoyPATgrowth(Newprivatebanks)

20

10

0

10

20

30

May13 Aug13 Oct13 Dec13 Fe b14 Apr14 Jun14 Aug14

FY14 FY15f FY16f


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PATgrowthforecastbytheconsensusforFY15FY16forPSUbanks isabovethatforthenewprivate

banks.FY15fPATgrowthforecasthasbeenupgradedfortheCNXPSBK,withanincreasefrom19.4%in

Sep13 to 25.1% in Sep14. The consistent upgrade has been on the lowbase and downgrade inFY14

PATgrowth.FY16fPATgrowthforecasthasalsoseenanupwardtrajectory.Newbankshaveastable

PATgrowthforecastforFY15FFY16f, inthenarrowrangeof18%20%.Whilethereexistarisktothe

earningsofPSUbanksposedbyhigherNPLprovisions,itisforecasttostaywellabovethatinFY14.

Fallinrates,moderationinslippagetosupportNIMexpansion

Withthegradualpickup in loansandmoderation intheadditiontoNPLs,thesharpdrop inyieldon

loansforthePSUbanksislikelytogetarrested. WeforecastgradualrecoveryinNIMofthePSUbanks.

SBINislikelytoseelargestexpansioninNIMduetotheirstrongliabilityfranchise.

New banks had large NIM expansion over the last two years and we estimate it to have peaked for

mostofthem.HighCASA,strongtilttowardshighyieldingretailloanspartlycontributedtotherising

NIMofthenewbanks.

Exhibit25:NIM(calculatedfortheyear,%)

1.8

2.3

2.8

3.3

3.8

Mar10 Mar12 Mar14 Mar16f

SBI(s) PNB BOB BOI


Exhibit26: NIM(calculatedfortheyear,%)

1.8

2.3

2.8

3.3

3.8

4.3

4.8




Exhibit27:Yieldonloans(%)

7

8

9

10

11


SBI(S) PNB BOB BOI


Exhibit28: Costofdeposits

4

5

6

7

8


SBI(S) PNB BOB BOI


NIMdeclineofPSUbanksinlasteightquartersweredrivenbyhostoffactorsTherewaslargedeclineinNIMofthePSUbanksduringFY13FY14withthecontractioninfourlargest

PSU banks byupto 60bp over last two years, largest being for SBI and BOB. High cost of funds, low

yieldsduetothe inabilitytopassonratehikefollowing lackofloandemandand interestreversalon

accountofhighslippageledtothesharpcontractionintheNIMofPSUbanks.

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Exhibit29:Loan/depositsratioofallbanks

240%

20%

200%

420%

640%

860%

1080%

J un0 8 J ul 09 J ul 10 J ul 11 Aug1 2 Aug1 3 Aug1 4

70.0%

71.5%

73.0%

74.5%

76.0%

77.5%

79.0%

Incr.loans /deposits Loans/deposits(RHS)


Exhibit30: Loangrpwthanddepositsgrowth

6%

11%

16%

21%

26%

31%

36%

Jun08 Jul09 Jul10 Jul11 Aug12 Aug13 Aug14

Loangrowth Depositgrowth


Normalizationofloan/depositratiomayhavelimitedimpactonPSUbanks

Theloan/deposit

ratio

of

banks

saw

significant

rise

from

70%

at

the

end

of

CY09

to

c78%

at

the

end

of

Mar14.However,ithasdeclinedsinceMar14to76.1%.TheimpactonNIMduetofallinloandeposit

ratio may be limited for PSU banks. However, several new private banks replaced deposit with

borrowingsinFY14tomanagetheircostoffunds.Thetrendmayreverseandputneartermpressure

ontheirNIM.

EdgeinSBdepositsgrowthhasslippedfornewprivatebanks

The significant lead in SB deposits proportion of the new private banks over PSU banks has declined

over the last two years. Also, there has been rise in the SB deposits proportion of PSU banks in the

recent years, partly driven by low accretion of term deposits following sharp slowdown in corporate

loans.

Exhibit31:

SBdeposits

proportion

at

the

end

of

Mar14

0%

8%

16%

24%

32%

40%

SBI(s) PNB BOB BOI ICICIBC AXSB HDFCB IIB


Declineininflation,interestratesmayarrestthedeclineinSBdepositsgrowthTheyoySBdepositsgrowthdeclinedfrom15%30%inFY10toc15%inFY14formostPSUbanks.The

slowdownhasbeen largerforthenewprivatebankswiththeirSBdepositsgrowthalignedtothatof

thePSUbanksfrom30%45% inFY10toc15%,exceptforIIB. Wedonotexpectsignificantrevival in

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growthandproportion inFY15f.Fall in inflation,decline in interestratesmaybebackended inFY15

andthisislikelytoleadtothereboundinSBdepositsinFY16.

Exhibit32:SBdepositsgrowth

0%

10%

20%

30%

40%

50%

60%


SBI(s) PNB BOB BOI


Exhibit33:SBdepositsgrowth

0%

10%

20%

30%

40%

50%

60%




Retailpartly

offset

the

large

slowdown

in

the

corporate

loans

LargecorporateloanshadsteadydeclineintheircontributiontoloangrowthExhibit34: Contributiontononfoodcreditgrowth

0%

15%

30%

45%

60%

Micro&s ma ll Me di um Large

FY12 FY13 FY14


Exhibit35:Contributiontononfoodcreditgrowth

5%

0%

5%

10%

15%

20%

Power Tele com Roa ds Othe rInfra

FY12 FY13 FY14


CREandhousingloanscontributiontoloangrowthroseoverFY12FY14

Exhibit36:Contributiontononfoodcredit

0.0%

2.5%

5.0%

7.5%

10.0%

CRE Trade

FY12 FY13 FY14


Exhibit37:Contributiontononfoodcredit

1%

3%

7%

11%

15%

Consumer Housing Vehicle

FY12 FY13 FY14


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Thesharp slowdown in the corporate segment ledto the fall in thecontribution of large industry to

incremental nonfood loan growth, from 50.8% in FY12 to 42.1% in FY14. The small and midsize

industryresumedtheirgrowthaftertheperiodofconsolidationduringFY12FY13.Industrywas45.3%

of nonfood loans at the end of Mar14, large industry being 36.7% of total nonfood loans. The

decelerationincorporatesegmentwaspartlyoffsetbyfewsegmentswithinretail.Housingloanshada

steady rise in their contribution to nonfood loan growth from 8.2% in FY12 to 12.1% in FY14.

Commercialrealestate(CRE)hashadincreaseintheirmomentuminthelastthreeyears.

PSUbanksseerevivalinretailloangrowthaheadoffewnewbanks

TheretailloangrowthofPSUbankshadareboundinFY14,largelydrivenbyhousingloans.PNB,BOB

andBOIreportedretailloangrowthinFY14higherthanthatforHDFCBank,IndusIndBankandsimilar

to ICICI Bank. The sharp slowdown in retail loans of new private banks was largely driven by the

slowdowninthevehicle loansegmentandis likelytoreviveforward.However,PSUbankshavebeen

morecompetitiveintheretailsegmentandcouldsustaintheuptrend.

Exhibit38:Retailloangrowth

0%

10%

20%

30%

40%

50%

Mar11 Mar12 Mar13 Mar14

SBI(s) PNB BOB BOI


Exhibit39:Retailloangrowth

0%

10%

20%

30%

40%

50%

Mar11 Mar12 Mar13 Mar14



NII/assets,fallinprovisionstodriveRoAexpansionofPSUbanks

Weforecast

an

expansion

in

the

RoA

of

up

to

24

bp

over

FY15fFY17f

for

the

four

large

PSU

banks

under our coverage universe. While the pressure on core revenues may ease for most PSU banks,

declineinNPLprovisionsasthenetadditiontogrossNPLrecedes,islikelytodrivetheRoAexpansion.

WhileourforecastassumesafallinincrementalNPLsandNPLprovisionsafterFY14,theprovisionsare

estimatedhigherthanthepreFY13leveltorecoverthePCRratio.

Exhibit40:DupontofPSUbanksundercoverage

SBIN PNB BOB BOI

Change Change Change Change

FY14 FY12FY14 FY15fFY17f FY14 FY12FY14 FY15fFY17f FY14 FY12FY14 FY15fFY17f FY14 FY12FY14 FY15fFY17f

Netinterestincome 2.93 0.08 0.24 3.14 0.36 0.14 1.98 0.78 0.13 2.11 0.44 0.19

Feebasedincome 0.86 0.28 0.01 0.61 0.11 0.05 0.41 0.07 0.00 0.42 0.13 0.01

Otherincome

0.24

0.00

0.02

0.28

0.07

0.07

0.33

0.07

0.00

0.42

0.11

0.10

Operatingrevenue 4.04 0.21 0.22 4.03 0.54 0.12 2.72 0.92 0.14 2.95 0.46 0.10

Operatingexpenses 2.13 0.11 0.04 1.81 0.07 0.12 1.18 0.27 0.06 1.31 0.35 0.06

Operatingprofit 1.91 0.31 0.18 2.21 0.47 0.00 1.54 0.65 0.08 1.64 0.11 0.05

Loanlossprovisions 0.85 0.11 0.13 0.88 0.28 0.13 0.49 0.15 0.03 0.77 0.43 0.03

Provisionforinvest. 0.03 0.02 0.00 0.15 0.11 0.12 0.03 0.03 0.01 0.01 0.03 0.00

Otherprovisions 0.07 0.05 0.01 0.27 0.17 0.11 0.11 0.03 0.02 0.16 0.06 0.07

Tax 0.31 0.27 0.10 0.26 0.37 0.11 0.16 0.28 0.09 0.16 0.17 0.08

Netprofit 0.65 0.08 0.20 0.65 0.66 0.25 0.75 0.58 0.04 0.53 0.28 0.07


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WeforecastpeakingoftheRoAformostnewprivatebanksContrary to the trend in PSU banks, we believe the RoA of new private banks could have peaked in

FY14 and is likely to see marginal moderation. The peaking of NII/assets, largely stable NPL

provision/assetsislikelytoresultinthemarginalcontractionintheirRoA.Declineinthehighyielding

retailloanproportion,fallintheyieldonloansintheneartermwithfallininterestratesislikelytoput

pressureontheyields.NPLprovisionhasalowbaseandevenwiththedeclineinincrementalNPL,we

donotseesignificantdeclineinNPLprovisions/assetsoverFY15fFY17f.

Exhibit41:DuPontofnewprivatebanks

AXSB ICICIBC HDFCB IIB

Change Change Change Change

FY14 FY12FY14 FY15fFY17f FY14 FY12FY14 FY15fFY17f FY14 FY12FY14 FY15fFY17f FY14 FY12FY14 FY15fFY17f

Netinterestincome 3.30 0.20 0.02 2.91 0.58 0.01 4.14 0.07 0.14 3.61 0.21 0.08

Feebasedincome 1.65 0.20 0.07 1.44 0.23 0.14 1.60 0.21 0.08 2.23 1.21 0.15

Otherincome 0.39 0.06 0.05 0.41 0.35 0.07 0.18 0.25 0.05 0.13 0.62 0.01

Operatingrevenue 5.35 0.06 0.04 4.75 0.70 0.08 5.92 0.03 0.16 5.96 0.80 0.24

Operatingexpenses 2.18 0.07 0.01 1.82 0.12 0.04 2.70 0.16 0.03 2.73 0.24 0.20

Operatingprofit 3.17 0.14 0.05 2.93 0.58 0.04 3.22 0.13 0.19 3.24 0.57 0.05

Loanlossprovisions 0.36 0.09 0.01 0.35 0.17 0.00 0.37 0.06 0.07 0.39 0.01 0.01

Provisionfor

invest.

0.03

0.07

0.04

0.01

0.04

0.01

0.07

0.07

0.07

0.11

0.09

0.11

Otherprovisions 0.25 0.15 0.00 0.10 0.08 0.02 0.06 0.40 0.01 0.08 0.00 0.01

Tax 0.87 0.04 0.01 0.73 0.32 0.02 0.96 0.21 0.02 0.90 0.15 0.00

Netprofit 1.72 0.12 0.01 1.73 0.40 0.05 1.90 0.33 0.19 1.76 0.33 0.06


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Evenaftertherally,P/BofCNXPSBKc15%belowthe5yearmean

TherallyinPSUbankshasliftedtheP/BofCNXPSBKto0.85xon02Sep14,closetotheirfiveyearmean

of1.0x.TheP/BofPSUbanksmayhavebottomedoutatthedecadelowvaluationof0.49xon3Sep13

andhasbeenseeinggradualrecoverythereafter.TherapidbouncesinceFeb14haslifteditsP/Bclose

to15%belowthefiveyearmean.DespitelargeoutperformancetoNiftyof12%inCY14(ytd),theP/B

isstillbelowthe5yearmeanandwellbelowthepeakinFeb08andNov10.

Newprivatebanksc11%abovetheir5yearmeanof2.28xHowever,newprivatebankssawtheirvaluationrise11%abovetheir5yearmean(2.28x)to2.54xon

02Sep14butbelowthepeakof2.99xinNov10.

Exhibit44:OneyearforwardP/BofCNXPSBKandnewprivatebanks

0

1

2

3

4

Apr04 May05 Jul06 Sep07 Nov08 Jan10 Mar11 May12 Jun13 Aug14

CNXPSBK NPVT

Avg(Sep09Sep14)

Avg(Sep09Sep14)


Reforms,reboundinassetqualitymayfurthershrinkvaluationgap

ThereportbyDrP.J.Nayaktoreviewthegovernanceofboardsofbanks inIndiaentailsmeasuresto

improve

the

structural

framework

of

the

PSU

banks.

The

committee

has

recommended

the

new

governance structure including reduction of the government shareholding in banks to avoid capital

support from government. Other key recommendations include: elimination of constrains which are

applicableonlytothePSUbankssuchasdualregulation,shorttenorsofCMDsandEDs,compensation

constrains,externalvigilanceenforcement and applicabilitytoRTIAct. Whilereformscouldbealong

drawnprocess,the introductionofsomeoftheseproposalsandgradualturnaround intheNPLcycle

maysustainthecontractioninthevaluationgapwithnewbanksclosertothelongtermmeanoverthe

next12years.

DiscountofPSUtonewbanksbottomedmuchearlierthantherallyin2014Theimprovedoutlookfortheeconomyfollowingthestableelectionoutcomeanddepressedvaluation

ledtothelargeoutperformanceofPSUbankstothenewprivatebanksinMay14Jun14.Drivenbythe

sharp

rise

in

NPLs

and

concern

over

the

capital

constrain,

the

discount

of

PSU

to

new

banks

hadincreasedtoadecadehighof 78%.Ithascontractedthereafterto 71%on02Sep14butstayshigher

thanthe5yearaverageof 63%.TheoutperformanceofthePSUbanksmayextendfurtherovernext

12months.

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Exhibit45: DiscountofCNXPSBKtonewprivatebanksinP/B

80%

70%

60%

50%

40%

30%

20%

Apr04 May05 Jul06 Sep07 Nov08 Dec09 Feb11 Apr12 Jun13 Aug14

DiscountofPSUbanksoverNPVT

Avg(Aug09Aug14)

28Oct13,78%

Avg(Apr04Aug14)


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19

LargerpotentialupsideinPSUbanksoverthe12months

WehavevaluedbanksusingacombinationofDCF,P/EandP/B.OurthreestageDCFusesexplicitforecastsuntilFY17,

followedby10yearsofsemiexplicitforecasts.Wehavecappedleverageratioforthesemiexplicitperiodat18xforthe

PSUbanksandlinkedtheloangrowthtothetargetasset/equity.Hence,thesemiexplicitgrowthforthePSUbanksis

assumedtobeintherangeof6%14%.WereinitiatecoverageonBankofIndia,BankofBaroda,PunjabNationalBank

StateBankofIndia,AxisBank,HDFCBank,ICICIBankandIndusIndBank.TheestimatedpotentialupsideinPSUbanks

exceedsthereturninnewbanksoverthe12monthsperiod.ThepotentialupsideinPSUbanksisupto21%.Weprefer

banksthatarebettercapitalizedandaresuperiorinassetquality.OurmostpreferredpickamongPSUbanksisBankof

BarodaandICICIBankamongnewprivatebanks.

DCFassumereturntonormalRoAoversemiexplicitperiodforPSBs

We have valued banks using a combination of DCF, P/E and P/B. Our threestage DCF uses explicit

forecastsuntilFY17,followedby10yearsofsemiexplicitforecasts,wherewelinkloangrowthtothe

leverageratioandassumedividendpayoutof20%.Thefinalstageof12yearsassumesconvergenceof

RoEandCoE(assumedtobe14%).TheRoAisassumedtoconvergetothe10yearaverageforthePSU

banksand1.2%forthenewprivatebanksattheendofthesemiexplicitperiod.

WehaveestimatedthemeanP/EandP/Bforthefiveyearperiodended02Sep14.Weapplytheseto

ourone

year

forward

EPS

and

adjusted

book

value

forecast

to

arrive

at

our

P/E

and

P/B

based

fair

value.Ourtargetpriceisaweightedaverage,whereweassignaweightof30%toourDCFvalueand

35%eachtoourP/EandP/Bvalues.

CaponleverageratioduringsemiexplicitperiodimplieslowergrowthWehavecappedleverageratioforthesemiexplicitperiodat18xforthePSUbanksandlinkedtheloan

growthtothetargetasset/equity.Hence,thesemiexplicitgrowthforthePSUbanksisassumedtobe

in the range of 6%14%. New private banks, being well capitalized are assumed to keep growing at

fasterpacethantheirPSUcounterparts.

Potentialupsideofupto21%forPSUbanksover12months

We reinitiate coverage on Bank of India, Bank of Baroda, Punjab National Bank State Bank of India,

AxisBank,HDFCBank,ICICIBankandIndusIndBank.OurmostpreferredpickamongPSUbanksisBank

of

Baroda

and

among

private

banks

is

HDFC

Bank

and

ICICIBC

with

largest

potential

upside.

We

apply

25% discount to the 5year mean P/E and P/B for BOI given large volatility in its NPLs and low

capitalizationratios.Also,weapply25%premiumtothe5yearmeanP/EandP/BforICICIBCgivenits

significantlreboundinRoEoverlast3years.

Exhibit46:AssumptionsfortheDCFbasedfairvalues

RoA(%) Growth(%,CAGR) Asset/Equity (Mean)

Actual Explicitperiod Semiexplicit Semiexplicit A ctual Explicitperiod Semiexplicit Actual

Explicit

period Semiexplicit

(FY13FY14) (FY15fFY17f (FY18fFY27f) (FY27f) (FY13FY14) (FY13fFY15f (FY16fFY25f) (FY13FY14) (FY15fFY17f (FY18fFY27f)

BOI

0.59

0.58

0.71

0.80 22.1% 15.9% 5.9%

20.3

21.5 18.0BOB 0.83 0.77 0.90 0.98 17.5% 17.0% 11.3% 17.9 19.3 18.0

PNB 0.83 0.81 0.96 1.00 9.0% 16.3% 16.2% 16.0 16.3 18.4

SBIN 0.76 0.76 0.92 0.95 16.5% 18.5% 13.5% 16.9 17.2 17.9

AXSB 1.69 1.72 1.44 1.21 16.4% 18.6% 22.7% 10.7 10.4 14.3

HDFCB 1.86 2.05 1.71 1.21 25.1% 20.2% 20.9% 11.2 9.7 11.8

ICICIBC 1.69 1.80 1.47 1.21 15.1% 17.6% 22.8% 8.0 8.8 14.1

IIB 1.69 1.82 1.22 1.21 26.5% 25.2% 22.9% 10.5 10.9 14.6


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Exhibit47:AverageP/EandadjustedP/B(02Sep14)

P/E P/B

3M 6M 1year 2years 3years 5years 3M 6M 1year 2years 3years 5years

BOI 4.94 5.23 4.84 4.26 4.62 4.99 0.75 0.81 0.80 0.72 0.84 0.94

BOB 6.58 6.58 6.48 5.75 5.48 5.44 1.03 1.02 0.99 0.86 0.89 0.97

PNB 6.50 6.83 6.33 5.12 4.90 4.94 0.85 0.87 0.80 0.66 0.71 0.82

SBI

9.33

9.86

9.22

8.07 7.52 7.44 1.25 1.33 1.25

1.08

1.14 1.19

AXSB 11.94 12.07 11.14 9.68 9.73 9.52 1.98 1.99 1.82 1.56 1.68 1.68

HDFCB 17.51 17.76 17.28 16.66 17.68 18.03 3.03 3.16 3.30 3.27 3.49 3.48

ICICIBC 14.54 14.37 13.84 12.60 12.90 13.05 2.05 2.02 1.91 1.70 1.69 1.63

IIB 15.25 15.52 15.28 14.55 15.26 14.92 2.72 2.75 2.69 2.50 2.84 2.78


Exhibit48:PE,P/BandDCFbasedfairvaluesandthetargetprice

PE PB DCF/SOP TP CMP(03Sep14) Upside Rating Target valuation Currentvaluation

Weights 35% 35% 30% PE P/B PE P/B

BOI 269 355 314 312 292 7% Add 5.11 0.79 5.83 0.81

BOB 953 1,179 1,101 1,076 886 21% Buy 6.95 1.10 6.84 1.02

PNBK

964

1,217

1,396

1,182

961

23%

Buy

7.09

1.15

7.47

1.05

SBI 2,970 3,119 2,644 2,925 2,501 17% Buy 8.62 1.34 9.31 1.29

AXSB 453 484 423 455 414 10% Add 11.56 1.98 12.51 2.08

HDFCB 1,198 1,179 575 1,004 860 17% Buy 16.34 3.07 17.11 3.09

ICICIBC 2,124 1,550 1,647 1,780 1,579 13% Add 14.36 2.28 14.70 2.22

IndusInd 705 753 514 665 616 8% Add 14.41 2.65 16.59 2.88


Riskfactors

Delay

in

the

roadmap

for

the

capitalization

of

PSU

banks

may

stay

an

overhang.

Basel

III

requirementswouldpressureontheloangrowtheveniftheinvestmentcyclepicksup.

Delay in the recovery in NPL cycle and elevated slippage extending into FY16 may pull down the

profitability.

RegulatorychangessuchasmandatinghigherPCRrequirementsmayimpacttheprofitability.

Elevatedinterestratesin2016mayextendtheNPLcycle,mainlyintheSMEsegmentanddelaythe

revivalintreasuryincome.

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Annexure:StockselectionwithinPSUbanksbasedonthefilters

Exhibit49:NetNPL/NetworthVschangeinnetNPL/NetworthbetweenMar12Mar14

0

10

20

30

40

15 20 25 30 35 40 45 50

ALBK

ANDB

CRPBK

CBOI

IOB

UCO

BOMH DBKPNB

OBC

Net

NPL

/

Networth

(%,

Mar14)ChangeinNetNPL/Networth(Ma

r12

Mar14)

UNBKSBIBOI

SNDB

BOB

INBK

IDBI

CBKVJYK


Exhibit50:GrossNPLratio(Mar14)VschangeingrossNPLratiobasedon2yearagoloans(Mar12)

0.5

1.0

1.5

2.0

2.5

2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5

GrossNPLratio(Mar14)RiseinGro

ssNPLratiobasedon2

yearagoloan

CBOI

ALBKANDB

SBI

PNBIOB

IDBI

UCOUNBK

OBC

INBK

BOMH

BOI

CRPBKDBK

BOB

CBK

VJYK

SNDB


Exhibit51:RoE(FY15f)VsP/B(FY15f)basedonconsensus(02Sep14)

0.5

0.7

0.9

1.1

1.3

1.5

1.7

3 5 7 9 11 13 15 17

RoEbasedonconsensus(FY15f)

P/B(FY15)

SBIN

SNDB

BOB

UCO

PNBCBOI

IOBIDBI

ANDB

UNBKCBK

OBCDBNK

CRPBK

BOI

ALBKINBK


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Exhibit52:P/B(FY15f)Vschangeinpricebetween14Feb14and02Sep14

30

43

56

69

82

95

108

121

0.5 0.7 0.9 1.1 1.3 1.5

P/B

(FY15)

ChangeinPricebetween14

Feb14

2Sep14

SBIN

UNBK

UCO

BOB

CBOI

PNB

VJYK

CBK

SNDB

IDBI

OBC

ANDB

INBK

ALBK BOI

CRPBKDBNK

Source:Company,AvendusResearch

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IndiaEquityResearc

Financial

September04,2014

B U Y BankofBarodaTargetPrice(INR) 1076 Superiorassetquality,RoEtodriveoutperformance

CompanyReport Moderationintheaccretionofstressedassetsinthelastfewquarter

is likely to sustain. We assume a 37bp reduction in the incrementa

NPL,translating

into

8bp

fall

in

NPL

provision/loans

over

FY15f

FY17f

RiseinPCRduringthelastfewquartershaslifteditabovepeersandi

likelytoreducetheincrementalprovisioningburden.Acontraction in

the NIM over the past two years is likely to get arrested, as interes

rates and slippage moderate. Large cut in bulk deposits is likely to

sustain the cost at lower level, supporting NIM. Despite buildingin

elevatedprovisions,weforecasta206bpRoEexpansionoverFY15f

FY17f. BOB is our most preferred stock among PSBs due to superio

asset quality, Tier I ratio and RoE. Reinitiate coverage with a TP o

1,076andaBuyrating.TheTPimplies1yrfwdadjustedP/Bof1.1x.

Recentrise

in

the

PCR

and

moderating

NPLs

to

ease

provision

burden

RiseinthePCRcoupledwithmoderatingadditiontostressedassetsislikelyto

lowertheprovisioningburdenoverFY15fFY17f.Overthe last3quarters,PCR

has increased by 8.2% to 50.2% at endJun14, highest among the PSBs

IncrementalgrossNPLdeclined4bpyoyto1.17%inFY14afterrisingsharply

by79bpintheprecedingtwoyears.Wefactora37bpfallintheincrementa

NPLoverFY15fFY17f to0.80% inFY17translating intoa8bp fall intheNP

provisions/loans. However, improvement in asset quality is builtin during

FY16fFY17fasweassumethestresstocontinueinthecurrentfiscal.

CoreprofitabilitytorevivewithgradualNIMexpansion

NIMexpansionand likelypickup incorefees isestimatedtoexpandRoAand

RoE to c0.80% and c16%, respectively in FY17f. With softening interest rate

andslippage,

the

large

NIM

contraction

over

the

last

two

years

is

likely

to

ge

arrested,ascostofdepositsmoderatesandyieldimproves.Weforecast13bp

NIM expansion over the next three years. The share of CDs to term deposit

declined3.5%qoqto4.0%atendJune14,partlycontributingto10bpqoq

expansioninNIM.WeforecastthePATtoriseata3yearCAGRof18.4%.

DilutionrequiredlikelytostaylowerthanthepeersoverFY15fFY17f

BOBiscapitalisedbetterthanpeersandisunlikelytorequirelowerdilutionin

thenearterm.Weassume3%dilutioninFY15f,likelytobethroughbudgetary

allocation. CET 1 was 8.95% and CAR was 12.28% at the end of Mar14. The

pickup in retainedearningsgrowth is likely tosustainCET1above8.4%ove

thenext3years.Also,moderation inRWAgrowth isassumed tosustainata

lowerlevel3yearCAGRof16%preservingthecorecapital.

MostpreferredamongPSBs;TPvaluesBOBatAdj.P/Bof1.1xBOBisourmostpreferredstockamongPSBsduetosuperiorassetquality,Tie

I ratio and RoE. We value P/E, P/B and DCF to arrive at the blended TP o

INR1,075. Our DCF assumes a cost of equity of 14% and semiexplicit, fade

periodgrowthof11.4%and3%,respectively.Thesemiexplicitperiodcapsthe

asset/equityat18x.OurSep15TPofINR1,076valuesBOBat1yrfwdadjusted

P/B of 1.1x. Reinitiate coverage with a Buy. Lowerthanestimated NIM and

slowrecover inNPLsare ke risk factors.

LastPrice(INR)Bloomberg code

Reuters code

Avg.Vol.(3m)(mn)

Avg.Val.(3m)(INRbn)

52 wk H/L (INR)

Sensex

MCAP(INRbn/USDbn)

Shareholding (%) 03/14 06/14

Promoters

MFs,FIs,Banks

FIIs

Public

Others

StockChart(Relative toSensex)

StockPerfm.(%) 1m 3m 1yr

Absolute

Rel.to Sensex

Financials(INRbn) 03 /14 03/15 f 03/16 f

NII

YoY (%)

Operatingprofit

A.PAT

Sh o/s (diluted)

A.EPS(INR)

YoY (%)

Equity/Assets (%)

P/E(x)

P/B (Adj)(x)

Ro A(%)

Ro E(%)

QuarterlyTrends 09/13 12/13 03 /14 06/14

Op. income (INRbn)

PA T (INRbn)

886.0

119.7

18.6

92.1

15.6

4. 7

4. 9

167.7143.6

17.7

56.3 56.3

27,140

380.46 /6.29

17.0

4. 7

4. 4

140.3

18.0

6. 3

43.2

13.6

444.7

120.8

11.6

43.5

444.7

0. 9

7. 4

1. 9

7. 3

14.7

44.5

1. 01. 1

0. 7

14.1

5. 3

12.7

5. 5

0. 8

7. 5

16.8

111.7

52.9

20.0

129.1

62.4

5. 7

92.9

45.4

5. 5

430.7

106.4

0. 6

BOB IN

BOB.BO

1.57

1, 010/45 0

1.37

11.7

38.7

8. 4

1. 2

0. 8

13.8

10.5

39.9

00

70

40

710

80

50

20

S e p13 J a n14 M a y14 S e p14

Bank of Baroda Sensex Rebased

ChandanaJha,+9102266842854

[email protected]

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BankofBaroda

Financials

25

SustainedriseinthePCRlikelytoeasetheincrementalprovisions

Afterasharpcontractionof23%inthePCRbetweenMar12 Sep13,PCRhasrecoveredinthelastthree

quartersby8.2%to50.2%attheendofJun14,partlybenefitingfromthemoderationinslippageand

marginalrecovery inthecorerevenues.BOBsPCRstayswellabovemostpeerssuchasBOI(37.5%),

PNB(47%),CBK(21.2%)andUNBK(44.2%),andisinlinewithSBIN.

Exhibit

1:Slippage

and

NPL

ratios

0.0%

0.7%

1.4%

2.1%

2.8%

3.5%

Jun12 Dec12 Jun13 Dec13 Jun14

GrossNPLratio NetNPLratioSlippage ratio


Exhibit

2:Provision

coverage

ratio

20%

30%

40%

50%

60%

70%


Provisioncoverageratio(exc.writeoff)


Slippageratio,despitesomevolatility,stayswellbelowthepeakAdditionstothegrossNPLdecreasedinthethreeconsecutivequartersto1.23%intheMar14quarter

(annualised)beforerisingto2.3%intheJun14quarter,drivenbyslippageintheSMEandagri.While

slippage is likely to stay elevated in FY15f as most restructured loans are nearing their moratorium

period,weassume ittostaybelowthepeak.However,NPLratiosare likelytostayhighduetoslow

pickpickintheloangrowth.

PaceofrestructuringhasbeenmoderatinginthepastfourquartersThe addition to the stock of restructured loans has been trending down in the last few quarters.

However,thepercentageofrestructured loansaspercentageof loans increased intheJun14quarter

largelydue

to

4%

sequential

contraction

in

the

outstanding

loans.

Exhibit3:Restructuredloans

Jun12 Sep12 Dec12 Mar13 Jun13 Sep13 Dec13 Mar14 Jun14

Loansrestructured(INRbn) 7.71 9.33 15.87 35.25 19.97 14.84 12.13 17.03 9.86

Domestic 8.03% 8.40% 9.08% 8.31% 9.72% 9.60% 9.39% 8.29% 8.81%

Overseas 4.17% 4.70% 4.82% 3.83% 3.98% 4.08% 3.57% 3.19% 3.20%

Totalrestructuredloans 6.82% 7.21% 7.68% 6.89% 7.83% 7.83% 7.49% 6.68% 7.01%


Exposuretotheriskysectorslowerthantheindustryaverage

Exhibit4:ExposureofBOBandIndustrytotheriskysectors(Mar14)

(INRmn)

Bankof

Baroda

All

banks

Fundbased %ofdomesticloans Outstanding %oftotalloans

Miningandquarrying 25,580 0.92% 353,260 0.59%

BasicMetalandmetalproducts 161,811 5.82% 3,619,690 6.02%

Energy 187,543 6.75% 4,883,460 8.12%

Total 374,933 13.49% 8,856,410 14.73%


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BankofBaroda

Financials

26

Weestimate20bpfallinprovisionsfollowingslowingNPLaddition

IncrementalgrossNPL(rise ino/sgrossNPLasapercentageofstarting loans)declined4bpyoy in

FY14 to1.17%. It increased79bp in thepreceding twoyears.Weassumestable incrementalNPL in

FY15f as the stress may sustain due to large restructured loans nearing their moratorium period.

However,wefactora37bpfallintheincrementalNPLoverFY16fFY17fto0.80%inFY17f.However,

moderationintheloangrowthmayleadtothe86bpriseinthegrossNPLratioto3.80%.

However,fallinNPLprovision/loansisestimatedtobelower,at8bpWebuild inhigherNPLprovisions inourestimate tobring thePCRratiocloser to itshistorical level.

Historically,BOBsPCRhasremainedabovepeers.NPLprovisions/loansdeclined19bpyoyto0.80%

in FY14. We estimate a decline of 8bp to 0.72% FY15fFY17f and estimate 7.5% rise in the PCR to

56.7%. The threeyear average NPL provisions/loan is estimated at 0.76%,just 4bp lower than the

precedingthreeyearsaverage.

Exhibit5:NPLratioandincrementalNPL

0.0%

0.8%

1.6%

2.4%

3.2%

4.0%

Mar11 Mar13 Mar15f Mar17f

IncrementalNPL GNPLratio

NNPLratio


Exhibit6:NPLprovision/loan,PCR

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

Ma r11 Ma r13 Ma r15f Ma r17f

30%

40%

50%

60%

70%

80%

NPLprovision/loans PCR(RHS)


FallinNIMlikelytobearrestedasfundingcost,slippagesmoderate

Withthe

sharp

reduction

in

the

high

cost

bulk

deposits

(CDs/term

deposits

at

4%

at

the

end

of

Jun14)

andstableCASA,weestimate11bpfallinthecostofdeposits.Also,yieldsarelikelytobenefit,asthe

slippagetrendsdownward.ThelargeNIMcontraction,by60bp,seenoverthepasttwoyearsreversed

intheJun14quarterandislikelytosustain.Weestimate5bpexpansioninFY15f.

Exhibit7:NIM,depositcost,yield(quarterly)

5

6

7

8

9

10


2.0

2.2

2.4

2.6

2.8

3.0

Costofdeposits YieldonloansNIM(RHS)


Exhibit8:CalculatedNIMfortheyear(%)

0.5

1.0

1.5

2.0

2.5

3.0

Mar11 Mar13 Mar15f Mar17f

NIM


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BankofBaroda

Financials

27

EstimatedretainedearningscouldsustainCET1above8%tillFY17f

BOB is capitalised better than peers and is unlikely to require dilution in the near term. CET 1 was

8.95%andCARat12.28%attheendofMar14.TierIwas9.06%andCARat11.91%attheendofJun14

(withoutaddingbackquarterlynetprofit).3%dilutioninFY15fandpickupinretainedearninggrowth

islikelytosustainCET1above8.4%overthenextthreeyears.Also,amoderationintheRWAgrowthis

assumedtosustain,preservingthecorecapital.WeassumeRWAtoriseatathreeyearCAGRof16%.

Exhibit9:CapitalratiosattheendofJun14

0

3

6

9

12

15

CAR TierI CET1 TierII


Exhibit10:GrowthinRWA,retainedearnings,TierI

5%

6%

7%

8%

9%

10%

Ma r1 4 Ma r1 5f Ma r1 6f Ma r1 7f 0%

5%

10%

15%

20%

TierI(RHS)Retainedearnings(yoy)RWA(yoy)


Despiteelevatedprovisions,scopeforRoEandRoAexpansion

Exhibit11:RoA,RoE

0.4

0.6

0.8

1.0

1.2

1.4

Mar11 Mar12 Mar13 Mar14 Mar15f Mar16f Mar17f

0

6

12

18

24

30

RoA RoE(RHS)


We forecast an expansion in the return ratios over FY15fFY17f, driven by the peaking of NPLs and

gradual NIM expansion. RoA and RoE is estimated to expand 4bp and 206bp, to 0.8% and 15.9%,

respectively.TheimprovementinprofitabilityisestimateddespitefactoringelevatedNPLprovisions.

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MostpreferredamongPSBsonundemandingcurrentvaluation...

Exhibit12:Discount/premiumofBOBtoPNBandSBIN,adjustedP/BofBOB

40%

20%

0%

20%

40%

60%

Jun09 Dec09 Aug10 Mar11 Oct11 May12 Nov12 Jul13 Jan14 Aug14

0.0

0.5

1.0

1.5

2.0

2.5

AdjustedP/B(RHS) PremiumtoPNB DiscounttoSBI


andhigherprofitability

Higher RoE could drive the relative outperformance of BOB. With superior asset quality and

profitabilitycompared to peers, asharp recent fall in itspremium to PNB and rise in itsdiscount to

SBINcouldreverse.BOBisourmostpreferredstockamongPSBs.

Exhibit13:RoEofBOBandpeers

FY13 FY14 FY15f FY16f FY17f

BOB 15.68 13.80 14.09 14.70 15.87

BOI 12.95 11.16 11.22 12.65 13.33

PNB 16.48 10.17 11.30 13.31 15.12

SBIN 15.43 10.03 11.37 12.74 14.03


OurTPvaluesBOBat1yearforwardadjustedP/Bof1.1xOur target price is based on the DCF, P/E and P/B methods. Our DCFbased fair value stands at

INR1,076,whereinweassumeacostofequityof14%aswellassemiexplicitandfadeperiodgrowth

of11%and3%,respectively.Thesemiexplicitperiodcaps theasset/equityat18xand links itto the

growth. Our Sep15 target price of INR1,076 values BOB at 1.1x the oneyear forward adjusted book

value.WereinitiatecoveragewithaBuyrating.

Exhibit14:AverageP/EandP/B(till2Sep13)

1month 3month 6month 12month 2year 3year 5year

P/E 6.58 6.58 6.48 5.75 5.48 5.44 6.15

P/B 1.03 1.02 0.99 0.86 0.89 0.97 1.20


Exhibit15:P/E,P/B andDCFbasedTP,andweightedaverageTP

P/E P/B DCF/SOP TP

Weights 35% 35% 30%

952 1,179 1,101 1,076


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Financials

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Exhibit16:OneyearforwardP/BandtargetP/B

0.4

0.8

1.2

1.6

2.0

2.4

Ja n10 Dec10 Nov11 Nov12 Oct13 Sep14 Sep15

1yearforwardP/ABV(X) 5yearaverage

12monthsmovingaverage


Exhibit17:OneyearforwardP/EandtargetP/E

2

4

6

8

10


1yearforwardP/E(X) 5yearaverage12monthsmovingaverage


Riskfactors:

Some of the large exposures become delinquent, leading to higherthanestimated slippage and

NPLprovisions.

SustainedmonetarytightnessoverFY15FY16islikelytohurtmarginsduetohighercostoffunds,

giventhelowCASAofthebank.

Growthpicksupsignificantlyanddilutionbecomes imminent inthenearterm leadingtoa lower

thanestimatedRoE.

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Financials

30

Financialsandvaluations

Incomestatement(INRbn) DecompositionofRo A (% )Fiscalyear ending 03/14 03/15f 03/16f 03/17f Fiscalyearending 03/14 03/15f 03/16f 03/17f

Ne tinterest incom e 119.7 143.6 167.7 200.0 Netinteresti ncome 1.98 2.03 2.07 2.12

Feei ncome 24.8 2 7.7 3 2.8 39.2 Feei ncome 0.41 0.39 0.40 0.42

Tradingprofi t 7.4 8.1 9.9 11.1 Otheri ncome 0.33 0.32 0.33 0.33

Otheri ncome 12.4 14.8 17.2 20.0 Opera ti ng

i ncome 2.72

2.75

2.80

2.86

Totaloperatingincome 164.3 194.1 227.6 270.4 Operatingexpens es 1.18 1.17 1.21 1.24

Total operatingexpens e 71.4 82.4 98.4 117.6 Operatingprofit 1.54 1.58 1.59 1.62

Operatingprofit 92.9 111.7 129.1 152.8 Loanloss provi s i ons 0.49 0.51 0.47 0.46

Provisionfor ba ddebt 29.4 35.7 38.2 43.3 Pr ovi si onfor i nves tments 0.03 0.01 0.02 0.02

Other provi s i on 8.6 6.5 8.8 10.4 Otherprovi s i ons 0.11 0.08 0.09 0.09

PBT (reported) 55.0 69.6 82.1 99.2 Ta x 0.16 0.24 0.24 0.25

Total taxes 9.6 16.7 19.7 23.8 Netprofi t 0.75 0.75 0.77 0.80

PAT (reported) 45.4 52.9 62.4 75.4

(+)Sharein asso c .ea rni ngs 0.0 0.0 0.0 0.0

Less:Minority i nteres t 0.0 0.0 0.0 0.0 RoA 0.75 0.75 0.77 0.80

Priorperiodi tems 0.0 0.0 0.0 0.0 As s ets /Equi ty 18.34 18.80 19.13 19.90

Netincome(reported) 45.4 52.9 62.4 75.4 RoE 13.80 14.09 14.70 15.87

Adjustednet incom e 45.4 52.9 62.4 75.4

Shares outstanding(mn) 430.7 430.7 430.7 430.7

Dil.shares (mn) 430.7 444.7 444.7 444.7

DilEPS (INR) 105.4 118.9 140.3 169.5

Growthratios(% ) KeyRatiosLoa ns 21.0 15.6 17.7 17.8 Fiscalyearending 03/14 03/15f 03/16f 03/17f

Netinteresti ncome 5.7 20.0 16.8 19.3 Valuationratios(x)

Feei ncome 20.2 1 1.7 1 8.6 19.6 P/E(on dil.EPS) 8.40 7.45 6 .31 5.23

Provisionfor ba ddebt 4.3 2 1.5 7.1 13.3 P/BV 1.06 0 .96 0 .86 0 .77

Adjusted neti nc ome 1.3 16.4 18.0 20.8 P/Adj us tedBV 1.21 1.09 0.96 0.85

Dil.EPS 0.6 12.7 18.0 20.8 Di vi dendyield(%) 2.84 3.39 4.06 5.30

Operating ratios(% ) Pe rshare ratios(INR)NII/operatingi ncome 72.8 74.0 73.7 74.0 Bas i c ReportedEPS (INR) 106.4 122.7 144.9 175.0

Feeincome/operatingi ncome 15.1 14.3 14.4 14.5 Di l utedReportedEPS (I NR) 106.4 120.8 140.3 169.5

Operatingprofitma rgi n 56.6 57.5 56.7 56.5 ReportedBookValue(BV) 8 35 .6 9 26 .1 1 ,0 30 .4 1 ,1 52 .9

Netprofitmargi n 27.6 27.2 27.4 27.9 Adj us tedBookValue(ABV) 731.4 810.0 919.6 1,043.8

EffectiveTa xrate 17.4 24.0 24.0 24.0 Di vi dendper sh ar e(INR) 25.2 30.0 36.0 47.0Ba ance s e e t I N R n Return/Profitability Ratios(%)

Yieldon

advances 7.69

7.81

7.86

7.97

Fiscalyear ending 03/14 03/15f 03/16f 0 3/17f Yieldon i nves tments 7.32 7.39 7.40 7.41

Equitycapi tal 4.3 4.4 4.4 4.4 Cos tofdepos i ts 4.84 4.73 4.74 4.76

Preferencec api ta l 0.0 0.0 0.0 0.0 Netinterestmargi n 2.03 2.08 2.11 2.16

Reserves a nd s urpl us 355.5 407.4 453.8 508.2 Feeincome/Op revenue 15.07 14.25 14.41 14.50

Ne tworth 359.9 411.8 458.2 512.7 Tradingprofit/Oprevenue 4.53 4.16 4.33 4.12

Depos i ts 5,688.9 6,599.2 7,712.2 9,069.9 Opexpense/Op revenue 43.44 42.47 43.26 43.50

Total borrowi ngs 191.2 168.2 178.2 187.5 CapitalizationRatios(%)

Other l iabil ities an dprovi s ion 355.0 340.0 371.3 408.4 Equi ty/As s ets 5.46 5.48 5.25 5.04

Totalliabilities 6,595.0 7,519.2 8,719.9 10,178.5 Loans /As s ets 60.20 61.04 61.97 62.55

Casha nd bankb al a nc es 1 ,3 08 .8 1 ,4 27 .7 1 ,6 32 .3 1 ,9 04 .0 I nves tmen ts /As s ets 17.61 17.64 17.08 16.63

Inves tments 1,161.1 1,326.1 1,489.5 1,692.6 Di vi dendpa yout 23.86 25.24 25.66 27.74

Loa ns 3,970.1 4,589.7 5,404.1 6,366.5 Interna l capital growth 10.81 10.98 11.26 11.88

Fixeda s s ets 27.3 2 9.9 3 1.7 33.0 Capi tal a dequa cy 12.28 10.67 10.26 9.74

Other a s s ets 127.7 145.8 162.2 182.4 AssetQuality

Totalassets 6,595.0 7,519.2 8,719.9 10,178.5 Gross NPL ra ti o 2.94 3.55 3.69 3.80

BusinessRatios(%) NetNPL ra ti o 1.52 1.80 1.73 1.68

Loan/Depos i t 69.8 69.5 70.1 70.2 NetNPL /networth 17.5 20.6 20.7 21.0

Investment/Depos i t 20.4 20.1 19.3 18.7 Loanl o ss reserve /Gross NPL 49.2 50.2 54.1 56.7

SLRInvestment/Depos i t 17.0 17.0 16.6 16.2 Loanprovisions/NII 24.5 24.9 22.8 21.6

SLRInvestment/NDTL 16.5 16.6 16.2 15.9 Loanprovisions/Total l oa ns 0.74 0.78 0.71 0.68

Debenture/Inves tment 3.4 2.9 2.6 2.3 Productivity/Efficiencyratios

Businessper branch( IN Rm n) 1 ,9 8 1.7 2,121.5 2,353.1 2,627.9

Netprofitper employee(I NRmn 0 .9 9 1.11 1.28 1.51

8/10/2019 2014-09-04_1409808826


IndiaEquityResearc

Financial

September04,2014

B U Y HDFCBankTargetPrice(INR) 1004 Sharpfallinvaluationpremiumunlikelytosustain

CompanyReport A sustained cost advantage and fall in provisions is likely to suppor

RoAexpansionoverFY15fFY17f.DuringFY14,alargedeclineof32bp

inthe

cost/asset

ratio

over

FY13

FY14

offset

the

weakness

in

fees

and

NIM.Retailloangrowthislikelytoreboundwiththebottomingofthe

vehicle loans in the 2HFY15. The retail loan proportion is likely to

stabilise near 49%. The asset quality cycle is poised to stabilise; we

forecast a 0.15% incremental NPL by Mar16f, 12bp fall over FY14. A

sharpdrop inthevaluationpremiumoverpeers is inconflictwith its

superiorreturnratios.OurSep15TPofINR1,004valuesthestockata

P/Eof16.3xandP/Bof3.07x,15%discounttoits5yearmean.Were

initiatecoveragewithaBuyrating.

Sharpfallinvaluationpremiumtopeersunlikelytosustain

The

valuation

premium

of

HDFCB

to

AXSB

and

ICICIBC

in

P/B

(adjusted)

hafallenby c60% in thepastsixmonths, wellbelow the fiveyearmean.Highe

NIM and low credit cost has sustained superior RoA and RoE of HDFCB

compared to peers. The average (FY13FY14) RoA and RoE of HDFCB were

higherthanpeersbyupto0.17%and7.25%,respectively.Thesuperiorasse

quality and NIM isunlikely to fade away. Hence,asharp fall in thevaluation

premium of HDFCB to peers is unlikely to sustain and the current valuation

couldprovidereasonablereturnwithrelativeoutperformanceover12months

Assetqualitypoisedtostabilisewithgradualreboundinretailsegment

The asset quality in the CV/CE portfolio has likely peaked, but should stay

stable rather than improve until there is a material change in the underlying

industryconditions.WeforecastanincrementalNPLof0.15%adeclineof12

bpover

FY14

by

FY16f.

With

low

NPLs

and

astrong

capital

position,

HDFCB

i

wellplacedtorebound ingrowth,asdemandpicksup.Weexpecttotal loan

andretailloanstoincreaseata3yearCAGRof21%and20%,respectively.

Significantleverspresenttosustaincostratioimprovement

Despite assuming normalised employee addition and a rise in the average

pay/employee, a 32bp fall in the costasset ratio in the past two years may

sustainduringFY15fFY17f.Thereisscopeforcost/incomeratioimprovement

ledbytheoperatingleverage,derivingbenefitsfromsignificantinvestmentsin

distribution (including branches) that is yet to reach full productivity. Some

structural techbased improvements in process, led by digitisation, could

translateintostructuralcostbenefits.Weforecastthecostincomeratiotostay

closeto44%,lowerthanthelastthreeyearaverageof48%.

CAGRof

24%

in

PAT

likely

to

drive

19

bp

RoA

expansion

We forecasta CAGR of 24% in PAT over FY15fFY17f, driven by a14bpNIM

expansion, sustainable cost advantage and declining provisioning burden. A

decrease in provisions is likely to support RoA expansion. An uptrend in the

RoAisbelievedtosustain;weforecasta19bpexpansionto2.09%.OurSep15

TPofINR1,004valuesthestockat16.45xand3.07xtheoneyearforwardP/E

andP/B,respectively.WereinitiatecoverageonthestockwithaBuyrating.

LastPrice(INR)Bloomberg code

Reuters code

Avg.Vol.(3m)(mn)

Avg.Val.(3m)(INRbn)

52 wk H/L (INR)

Sensex

MCAP(INRbn/USDbn)

Shareholding (%) 03/14 06/14

Promoters

MFs,FIs,Banks

FIIs

Public

Others

StockChart(Relative toSensex)

StockPerfm.(%) 1m 3m 1yr

Absolute

Rel.to Sensex

Financials(INRbn) 03 /14 03/15 f 03/16 f

NII

YoY (%)

Operatingprofit

A.PAT

Sh o/s (diluted)

A.EPS(INR)

YoY (%)

Equity/Assets (%)

P/E(x)

P/B (Adj)(x)

Ro A(%)

Ro E(%)

QuarterlyTrends 09/13 12/13 03 /14 06/14

Op. income (INRbn)

PA T (INRbn)

856.7

184.8

9. 9

52.3

34.1

8. 0

25.4

276.0227.9

10.1

22.6 22.6

27,140

2,067 /34.18

33.9

8. 1

25.4

55.7

24.2

15.4

3. 4

23.2

2,411.1

44.9

23.3

69.5

2,411.1

5. 1

1. 5

3. 9

5. 3

19.9

67.8

2. 83. 3

2. 0

20.5

10.3

26.9

10.5

2. 1

19.1

21.1

179.9

108.1

23.3

219.4

134.3

16.9

143.6

84.8

8. 8

2,399.1

35.5

25.0

HDFCBIN

HDBK.BO

1.99

86 5/55 7

1.64

18.4

63.4

24.2

4. 7

1. 9

21.3

19.8

63.2

20

00

80

60

40

20

S e p13 J a n14 M a y14 S e p14

HDFC Bank Sensex Rebased

ChandanaJha,+9102266842854

[email protected]

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HDFCBank

Financials

32

Pickupinretailloanslikelyasvehicleloansbottomout

Retail loans reported a sharp slowdown in FY14 due to the slump in the vehicle loan segment. As a

percentageofnet loans,retail loanswere49%attheendofMar14,decliningfromapeakof57%at

the end of Mar12. Retail loans increased at a CAGR of 18% over FY13FY14, largely driven by

unsecured loanspersonal loansandcreditcards; theytogethercomprise22%ofretail loans.While

creditcardsroseataCAGRof33%,personalloansandbusinessbankingwentupatCAGRsof21%and

16%,respectively.

HDFCB

has

the

option

of

retaining

c70%

of

mortgages

that

the

bank

originates

for

theparentHDFC(HDFCIN,NR).ThemortgagebooksizewasINR193bnattheendofMar14;HDFCB

originatescINR5bnmortgagespermonthandwebelieve,itislikelytoaidloangrowth.

Exhibit1:Breakupofretailloans

24.6% 22.1%

12.2%9.6%

13.0%13.6%

17.4%16.7%

13.3%12.9%

6.5%8.2%

13.0% 16.8%

0%

25%

50%

75%

100%

Mar12 Mar14

Auto CV PL BB Home Creditcard Others


Vehicle loanhasseenasignificantslowdown inthepasttwoyearswiththeCAGR inCV/CEandauto

loansat5%and12%,respectively.Commercialvehicleloans,asapercentageofretailandtotalloans,

havebeendecliningconsistentlyoverthepasttwoyears.Theshareinretailloansdeclinedfrom12.2%

atthe

end

of

Mar12

to

8.9%

at

the

end

of

Jun14.

Exhibit2:Growthinretailloansandretailasapercentageofnetloans

0%

8%

16%

24%

32%

40%

Mar12 Jun12 Sep12 Dec12 Mar13 Jun13 Sep13 Dec13 Mar14

45%

48%

51%

54%

57%

Retail/net loans(RHS) Totalloangrowth Retailloangrowth


CAGRof20%assumedinretailloansduringFY15fFY17fWithlowNPLsandstrongcapitalposition,HDFCBiswellplacedtoreboundingrowth,asdemandpicks

up; the competitions ability to absorb elevated demand may be limited. During FY15fFY17f, we

expecttotalloanstoriseataCAGRof21%andretailloansat20%.

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Exhibit3:CAGRinloans

Mar11Mar12 Mar13Mar14 Mar15Mar17f

Totalloans 23.7% 23.9% 20.7%

Retailloans 39.8% 18.2% 19.8%


SBdeposits

to

gain

traction

as

newly

opened

branches

yield

benefits

The pace of branch additions has increased in thepast three years ended Mar14 with1,417 branch

additions, much higher than the 574 branches added in the preceding two years (Mar09Mar11).

DuringFY14,74%of the banksbranches opened in the semiurban andrural regions; this lifted the

shareofsemiurbanandruralbranchesfrom53%attheendofMar13to55%attheendofMar14.The

SB deposits grew at a CAGR of 18% during FY12FY14, moderating from 35% in the preceding two

years, partly due to high inflation. The CAGR in SB deposits may begin to pick up, as inflation

moderates and large branch expansion undertaken in the last three years yield benefits. While we

assume branch addition to moderate in the forthcoming years, we forecast a CAGR of 20% in SB

depositsduringFY15fFY17f.WeexpecttheCASAratiotoremainwithin45%47%overFY15fFY17f.

Exhibit4:Savingsdeposits

0%

5%

10%

15%

20%

25%

J un1 2 De c1 2 J un1 3 De c1 3 J un1 4

25%

26%

27%

28%

29%

30%

SBdeposits

growth

SBdepositsproportion(RHS)


Exhibit5:CAGRinsavingsdeposits

0%

7%

14%

21%

28%

35%

Mar09Mar11Mar11Mar14Mar14Mar17f

500

700

900

1100

1300

1500

CAGRinSBdeposits Bra nchesadded


Significantleverspresenttosustainimprovementincostratios

DeclineincostratioexceededfallinfeeintensityoverFY12FY14Exhibit6:Cost/asset,fee/assetandNII/assetratios(%)

1.0

1.7

2.4

3.1

3.8

Mar10 Mar11 Mar12 Mar13 Mar14 Mar15f Mar16f Mar17f

3.4

3.7

4.0

4.3

4.6

Fee /assets Cost/assets NII/asset(RHS)


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During the two years ended Mar14, HDFCBs cost/asset ratio decreased 32bp, while the fee/asset

ratiofell21bpandtheNII/assetratiodeclinedmarginallyby6bp.Thus,therelativeadvantageoffees

andNIIovercosthasincreasedby5bp.

Exhibit7:Costratios(%)


Employee

cost/asset

1.13 1.13 1.11 1.07

0.94

0.94 0.96 0.98Nonemployeecost/asset 1.80 1.73 1.91 1.97 1.76 1.68 1.71 1.70

Totalcost/asset 2.93 2.86 3.02 3.04 2.70 2.62 2.66 2.68

Costincome 48.0 48.1 49.7 49.6 45.6 44.5 44.1 43.8


Despitenormalisedemployeeaddition,riseinaveragepay/employeeDuringFY14,HDFCBsoperatingexpenseincreasedjust7%;employeecostwentupevenlower,justby

5%yoy,partlydrivenbythedeclineinnumberofemployeesby900to68,165attheendofMar14.

This follows a largenet additionof 13,200 employees in the past twoyears.We assumeaddition of

employeestobenormalisedwith11,338netadditionsduringFY15fFY17f.Ourforecastassumesthe

average pay per employee to grow at an accelerated pace of 17% (compared tojust 5% in the

precedingthreeyearsoverthenextthreeyears,astheeconomyrebounds).

improvementincostratiosforecasttosustainduringFY15fFY17fWithanincreaseinthepaceofrevenueandassetgrowth,theimprovementincostratiosisforecastto

sustain. The biggest driver in sustaining cost ratios would be the operating leverage. The bank has

madesignificantinvestmentsoverthelastfewyearsindistribution(includingbranches)andthatisyet

to reach full productivity.Thisoperating leverage impactshould last another 12years at least.The

strongcostcuttingexerciseoverthepastyearorsohasalsoyieldedresults.Someofthisisvulnerable

tobeingunwoundwhengrowthreturns,butthemanagementbelievesthatsomeofthiscostcontrol

willremain.Therearesomestructuraltechbasedimprovementsinprocess,largelyledbydigitisation.

Theprimarybenefithasbeen inbettercustomerserviceand fasterturnaroundtimes,but thiscould

translateintosignificantstructuralcostbenefitsoverthelongterm.

DecliningprovisionstosupportRoAexpansionoverFY15fFY17f

IncrementalNPLforecastat0.17%,4bplowerthanpast3yearaverageTheassetqualityintheCV/CEportfoliohas likelypeaked,butshouldstaystableratherthan improve

untilthereisamaterialchangeinunderlyingindustryconditions.

Exhibit8:NPLratiosandincrementalNPL(%)

0.0%

0.3%

0.6%

0.9%

1.2%

Ma r1 1 Ma r1 3 Ma r1 5f Ma r1 7f

0.13%

0.03%

0.07%

0.17%

0.27%

GNPLratioNNPLratioIncrementalNPL(RHS)


Exhibit9:Provisions/assetsandPCR

0.00%

0.12%

0.24%

0.36%

0.48%

Ma r11 Ma r13 Ma r15 f Ma r17f

65%

70%

75%

80%

85%

NPLprovisions/assets

Otherprovisions(exc.taxand invest.)/assets

NPLprovisions/grossNPL


Theassetqualityinotherretailloansisstillstrong,creditcostsanddelinquencieshavebeenrisingover

thepastyearorso,butthemanagementseesthataspartofthenormalisationprocess.Therecouldbe

somemoreuptickiftheeconomystaysweak,butthemanagementdoesnotexpectanalarmingspike,

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HDFCBank

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35

given the overall standards of credit control. The overall corporate loan portfolio is likely to remain

stable;apartfromsomeaccountspecificrisks,theoverallportfolio isstable.Weassume incremental

NPL to decline 12bp to 0.15% over FY15fFY16f. The average incremental NPL for FY15fFY17f is

assumed at 0.17%, 4bp lower than the preceding three years. The gross NPL ratio is estimated to

decline7bpto0.98%bytheendofFY17f.Theprovisioncoverageratioisforecasttoremainatc70%

duringFY15fFY17f.TheNPLprovision/assetsincreased6bpto0.37%;weforecasta7bpdeclineover

thenext

three

years,

following

the

softening

in

the

incremental

NPL.

A

large

rise

in

other

provisions

during FY11FY12 was driven by a floating provision of INR13.7bn. We assume the decline in other

provisionswiththenormalisationofNPLsinthepasttwoyearstosustainandremaincloseto5bp.

CAGRof24%inPATlikelytodrive19bpRoAexpansionWe forecast aCAGR of 24% in PAT over FY15fFY17f, driven bya 14bp NIM expansion, sustainable

costadvantageandthedecliningburdenofprovisions.Adecreaseinprovisionsisbelievedtosupport

earningsgrowthandRoAexpansion.Arise inRoA inthepastfouryears isbelievedtosustainduring

thefollowingthreeyearswithaforecastedexpansionof19bpto2.09%.TheRoEislikelytostayclose

tothe21%level.

Exhibit10:TrendinRoEandRoA

0

5

10

15

20

25


1.20

1.40

1.60

1.80

2.00

2.20Asset

/

Equity RoE RoA


ValuationpremiumofHDFCBtopeerswellbelow3yearmean

Exhibit11:ValuationpremiumofHDFCBoverAXSBandICICIBCinadjustedP/B

0%

70%

140%

210%

280%

Jun11 Sep11 Dec11 Mar12 Jun12 Sep12 Dec12 Mar13 Jun13 Sep13 Dec13 Mar14 Jun14 Sep14

AXSB ICICIBC


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HDFCBank

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ThevaluationpremiumofHDFCBtopeers, intheadjustedP/Bhascontractedsignificantly inthe last

sixmonths.ThepremiumofHDFCBtoICICIBCcontractedbyc74%andtoAXSBbyc79%toc42%and

c50%,respectively,inthepastsixmonths;thiswaswellbelowthethreeyearmean.

SustainedhigherRoA,RoEtoreversethefallinvaluationpremium

HighermarginsandlowcreditcosthaveledtoasustainedsuperiorRoAforHDFCBcomparedtopeers.

Thecompetitiveedge inassetqualityandlowcostfunds isunlikelytofadeawayoverthenextthree

years.Hence,asharpfallinthevaluationpremiumofHDFCBtopeersisunlikelytosustain.

Exhibit12:AverageRoE(%)

0

7

14

21

FY13FY14 FY15f FY17f

AXSB HDFCB ICICIBC


Exhibit13:AverageRoA(%)

0.0

0.7

1.4

2.1

FY13FY14 FY15f FY17f

AXSB HDFCB ICICIBC


Targetpricevaluesstockat3.07x,1yearforwardadj.P/B

WevalueHDFCBcombiningtheDCF,P/EandP/Bmethods.OurthreestageDCFusesexplicitforecasts

untilFY17,followedby10yearsofsemiexplicitforecasts,whereweassumeaCAGRof21% in loans

and a dividend payout of 20%. We also assume the RoA at the end of the semiexplicit period to

converge to 1.2% (fiveyearaverage for new privatebanks).The finalstageof 12 yearsassumes the

convergenceofRoEandCoE(expectedtobe14%).ThismethodresultsinafairvalueofINR575.

WeestimatethemeanoneyearforwardP/EandP/Bforthefiveyearperiodended02Sep14at19.5x

and3.6x,respectively.WeapplythesetoourforecastedEPSandP/BforSep15toarriveatfairvalues

of INR1,198 and INR1,179, respectively. Our Sep15 TP of INR1,004 is a weightedaverage, where we

assignaweightof30%toourDCFvalueand35%eachtoourP/EandP/Bvalues.

Exhibit14:OneyearforwardP/E(x)andtargetP/E

10

15

20

25

30


1yearforwardP/E(X) 5yearaverage12monthsmovingaverage


Exhibit15:OneyearforwardP/BandtargetP/B

2.2

2.9

3.6

4.3

5.0


1yearforwardP/ABV(X) 5yearaverage

12monthsmovingaverage


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Exhibit16:AverageP/EandP/B(till02Sep14)

1month 3month 6month 12month 2year 3year 5year

P/E 17.51 17.76 17.28 16.66 17.68 18.03 19.49

P/B 3.03 3.16 3.30 3.27 3.49 3.48 3.60


Exhibit17:P/E,P/B andDCFbasedTP,andweightedaverageTP

P/E P/B DCF/SOP TP

Weights 35% 35% 30%

1,198 1,179 575 1,004


Keyriskstoourestimates

Lowerthanestimatedsavingsdepositsgrowth inFY15fandFY16fmaydecreasetheproportionof

savingsdeposits,leadingtolowerNIMexpansion.

NPLratiosmayrise in linewithhigherthanestimated incrementalNPLs.Loanlossprovisionsmay

behigherunderthisscenario,resultinginadownwardrisktoearnings.

A

rebound

in

fee

intensity

may

be

higher

than

our

estimates,

resulting

in

an

upward

risk

to

earnings.

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IndiaEquityResearc

Financial

September04,2014

A D D ICICIBankTargetPrice(INR) 1780 Uptrendinprofitabilitytodrivethevaluation

CompanyReport ICICIBChasderisked its loanbook inrecentyears;thequalityof the

retail book has been resilient, as the bank has focused on secured

retail

loans

in

the

past

34

years

and

cut

down

on

risky

retail

loansignificantly. Given the strong liability mix (CASA ratio of 43% at the

end of FY14) and increase in yields, partly driven by rising working

capital lending, we forecast NIM expansion to sustain in FY15f

althoughbya lesserextentof9bpto3.24%.The incrementalNPLo

ICICIBChasremainedwellbelowthepeakduringFY07FY08(average

of1.25%).APATCAGRof16%wouldlifttheRoEby2.62%to16.7%by

FY17f.OurSep15TPofINR1,780valuesthestockat2.23xtheoneyea

forwardadjustedP/B.WereinitiatecoveragewithanAdd.

LargereboundinNIMduringFY11FY14islikelytosustain

DuringFY11FY14,

the

NIM

expanded

54

bp,

driven

by

a172

bp

improvemen

intheyieldon loans,whilecostofdepositsrose lowerby101bp.Addressing

structural issuessuchas,reductionofthedragfromsecuritisationlosses,loan

pricingandreductionofexcess liquidity intheoverseasbranchescontributed

tothe improvement intheyieldon loans.Giventhestrong liabilitymix(CASA

ratio of 43% at the end of Jun14) and increase in yields, partly led by rising

working capital lending, we forecast NIM expansion to sustain in FY15f

although by a lesser extent of 9bp to 3.24%. The NII/assets is estimated a

2.99%forFY15f,an8bpimprovementyoy.

Despiterise,incrementalNPLwellbelowpeakduringFY07FY09

ICICIBCsincrementalNPLduringFY13FY14hasremainedwellbelowthepea

during FY07FY08 (average of 1.25%). While the management has guided fo

an

improvement

in

FY15f,

we

assume

the

incremental

addition

at

0.25%similartothatinFY14.NPLprovision/loanisunlikelytodeclinemateriallyfrom

the current level and is estimated at 0.42% of the loans over FY15fFY17f

similartothemeanoftheprecedingthreeyears.

ExpansioninRoEaheadofsomepeers;gapnarrowssignificantly

ICICIBC reported large expansion in its return ratios in the preceding three

yearswith itsRoEandRoAexpandingby40bpand437bp,respectively.The

large gap in RoE with some peers such as AXSB and HDFCB has contracted

significantly.APATCAGRof16%wouldlifttheRoEby2.62%to16.7%byFY17f

Mostpreferredamongnewbanks

2014-09-04_1409808826

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