India Equity Research | Banking and Financial Services Visit Note

•
UNION BANK OF INDIA
Asset quality concerns to recede

We recently met the management of Union Bank of India (UNBK), to understand the September 13, 2010
trend in its asset quality (major overhang in the past two quarters, with slippages
running high and provision coverage coming off) and margins. While guidance Reuters: UNBK.BO Bloomberg: UNBK IN

regarding slippages was in line with the bank’s earlier stance that it would peak only
in Q2FY11 (due to agri NPLs), what surprised us positively was the pace of recoveries EDELWEISS 4D RATINGS
and trend in margins. Absolute Rating BUY

Rating Relative to Sector Outperformer

ƒ Slippages to peak in Q2FY11; speedy recovery in sight Low
Risk Rating Relative to Sector
Management expects slippages to peak only in Q2FY11, given the flow from agri
Sector Relative to Market Overweight
debt waiver of INR 3.85 bn and slippages from restructured pool. We expect
Note:
slippages (one year lag) of 3% plus in Q2FY11 (1.5% due to agri NPLs). Also, Please refer last page of the report for rating explanation

considering cumulative slippages from restructured pool are pegged at 15% by

this fiscal end (currently ~10%), we have built in slippages of 1.9% for full year
MARKET DATA
FY11. Management sounded positive on the pace of recoveries, and indicated
CMP : INR 370
that recoveries in H1FY11 have been almost double against FY10. Moreover, the
52-week range (INR) : 371 / 215
bank is likely to continue to be aggressive regarding write-offs (including Share in issue (mn) : 505.1
standard advance write-offs), which could help it curtail gross NPLs at 2.1% and M cap (INR bn/USD mn) : 187 / 4,027
subsequently benefit P&L via recoveries in written-off accounts. Avg. Daily Vol. BSE/NSE (‘000) : 805.7

SHARE HOLDING PATTERN (%)

ƒ NIMs likely to sustain above 3%
Promoters* : 55.4
UNBK’s margins are expected to remain relatively stable above 3% through the
MFs, FIs & Banks : 12.2
remaining quarters of FY11, aided by rise in lending rates and migration to base
FIIs : 18.5
rate. The proportion of wholesale deposits for the bank is relatively lower at less
than 10%, and ~30% of retail deposits are estimated to mature in one year. Others : 13.9

Therefore, the hit on funding cost in rising interest rate environment is likely to * Promoters pledged shares
: NIL
(% of share in issue)
be relatively lower. Besides this, ~INR 40 bn of 1000 days deposit raised in 2008
are expected to be repriced by the end of this fiscal. We are inching up our PRICE PERFORMANCE (%)

margin estimate to factor in simultaneous rise in PLR along with deposit rates. Stock Nifty EW Banks and
Financial
Services Index
ƒ Outlook and valuations: NPL concerns receding; maintain ‘BUY’ 1 month 9.8 2.8 8.1
We believe concerns on asset quality are receding as slippages are likely to peak 3 months 18.2 12.8 23.5
in Q2FY11, further supported by strong recoveries. Moreover, the trend in
12 months 62.2 17.2 47.2
margins looks positive (compared with peers) due to lower proportion of
wholesale deposits. We are revising our EPS estimates upwards by 10% for FY11
to INR 47.9 and by 6% for FY12 to INR 61.6, to factor in lower provisions and
better NIMs (22% CAGR in earnings over FY10-12). The stock is currently
trading 1.4x FY12 adj. book for a bank delivering average of ROE of 25%. We
maintain ‘BUY/Sector Outperformer’ recommendation on the stock.

Nilesh Parikh
Financials
+91 22 4063 5470
Year to March FY09 FY10 FY11E FY12E
nilesh.parikh@edelcap.com
Net revenues (INR mn) 52,961 61,672 75,636 88,480
Net rev growth (%) 26.9 16.4 22.6 17.0
Kunal Shah
Net interest income (INR mn) 38,136 41,924 58,487 69,420
+91 22 4040 7579
Net profit (INR mn) 17,266 20,749 24,194 31,127
kunal.shah@edelcap.com
EPS (INR) 34.2 41.1 47.9 61.6
EPS growth (%) 21.8 20.2 16.6 28.7 Vivek Verma
PE (x) 10.8 9.0 7.7 6.0 +91 22 4040 7576
Price to book (x) 2.6 2.1 1.7 1.4 vivek.verma@edelcap.com
ROE (%) 27.2 26.2 24.5 25.3

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Banking and Financial Services

ƒ Other highlights
• The bank is on track to achieve 25% credit growth.

• Management highlighted that shortfall for the second pension option would work out
to INR 12 bn.tIt intends to amortise this cost over 20 quarters with a quarterly hit of
INR 600 mn - the first installment taken in Q1FY11.

• Tier 1 stands at 7.9% with overall capital adequacy ratio at 12.6%. In July 2010, the
bank received an amount of INR 1.1 bn from GoI, taking its tier I above 8%.

Chart 1: Asset quality deteriorated in Q1FY11 Chart 2: Margins came off in Q1FY11
30,000 100.0 4.0

24,000 90.0 3.2

(INR mn)

18,000 80.0 2.4

(%)

(%)
12,000 70.0 1.6

6,000 60.0 0.8

0 50.0 0.0
Q109
Q209
Q309
Q409
Q110
Q210
Q310
Q410
Q111

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111
Gross NPA Net NPA Prov. Cov. NIM's

Source: Company, Edelweiss research

Chart 3: Lending rate hiked simultaneously with deposit rates

125

100

75
(bps)

50

25

0
SBI ICICI BOB HDFCB BOI Union PNB

Deposit rate hike (1-2 yrs) BPLR hike

Source: Company, Edelweiss research

2 Edelweiss Securities Limited

  Union Bank Of India

ƒ Company Description
Incorporated in 1919, Union Bank of India (UNBK) is one of the oldest banks in India. Its
network of ~2,800 branches and balance sheet size of ~INR 1.9 tn as on June 2010
makes it one of the larger bank in the country with market cap USD 4 bn. The bank has
the most widespread branch network in India (after SBI), with branches distributed
evenly across all regions. The bank has moved all its branches to CBS platform.
Government of India (GoI) has 55.4% equity holding in the bank as on March 2010,
followed by Foreign Institutional Investors (FIIs) with 19% stake.

The future plan of the bank comprises over 20% growth in deposits and advances over
FY11. Bank will continue to focus on a four-pronged strategy for growth. Retail, Agri
business, SME and Corporate will continue to be the four growth engines. Containment of
cost of funds will form central strategy of the Bank. The most important being, the (NPA),
UBI's gross NPA level is targeted below 2%.

ƒ Investment Theme
We like UNBK due to its high operating efficiency, one of the better asset quality, and
potential to generate high ROE average 25% FY10-12. It has one of the lowest operating
expenses-to-asset-ratio, which can be credited to its high CBS coverage, which is also
helping bank maintain its CASA which currently stands at 32.6%. The bank is also
protected, to a great extent, by the volatile interest rates with its low duration and 95%
of SLR investments in HTM category.

ƒ Key Risks
Liability management will be a key factor to grow loan book at faster than expected rate
in this scenario.

System wide deterioration of asset quality would be challenge for them to maintain their
targets of lower NPA’s.

Maintaining CASA in the current scenario would be challenge for the bank.

Edelweiss Securities Limited 3

 
Banking and Financial Services

Financial Statements

Income statement (INR mn)

Year to March FY08 FY09 FY10 FY11E FY12E
Interest income 92,146 118,894 133,027 169,807 215,466
Interest expenses 63,609 80,758 91,103 111,319 146,046
Net interest income 28,537 38,136 41,924 58,487 69,420
Non interest income 13,196 14,826 19,747 17,149 19,060
- Fee & forex income 5,622 6,519 6,744 7,560 8,725
- Misc. income 3,810 5,000 7,282 6,589 7,335
- Investment profits 3,765 3,307 5,721 3,000 3,000
Net revenues 41,733 52,961 61,672 75,636 88,480
Operating expense 15,922 22,141 25,078 30,873 33,905
- Employee exp 8,453 11,519 13,545 18,271 20,134
- Other opex 7,469 10,622 11,533 12,602 13,770
Preprovision profit 25,811 30,820 36,593 44,763 54,576
Provisions 6,899 7,255 8,264 11,731 12,053
- Loan loss provisions 6,652 6,266 7,199 10,031 10,553
- Investment depreciation 0 (390) (1,173) 700 500
- Other provisions 247 1,379 2,239 1,000 1,000
PBT 18,912 23,566 28,329 33,032 42,523
Taxes 4,734 6,300 7,580 8,838 11,396
PAT 14,178 17,266 20,749 24,194 31,127
Reported PAT 14,178 17,266 20,749 24,194 31,127
EPS 28.1 34.2 41.1 47.9 61.6
DPS 4.0 5.0 5.5 5.5 5.5
Payout ratio (%) 45.5 52.5 15.7 13.3 10.3

Growth ratios (%)

Year to March FY08 FY09 FY10 FY11E FY12E
NII growth 2.3 33.6 9.9 39.5 18.7
Fees growth 19.1 16.0 3.5 12.1 15.4
Opex growth 7.9 39.1 13.3 23.1 9.8
PPOP growth 7.6 24.8 12.2 35.3 23.5
PPP growth 19.7 19.4 18.7 22.3 21.9
Provisions growth 42.8 (5.8) 14.9 39.3 5.2
PAT growth 67.6 21.8 20.2 16.6 28.7

Operating ratios (%)

Year to March FY08 FY09 FY10 FY11E FY12E
Yield on advances 9.8 10.4 9.0 9.4 9.6
Yield on investments 7.4 7.4 7.2 7.1 7.2
Yield on assets 8.5 8.7 7.7 8.0 8.3
Net interest margins 2.6 2.8 2.4 2.8 2.7
Cost of funds 5.9 6.0 5.4 5.4 5.8
Cost of deposits 6.1 6.1 5.5 5.5 5.8
Cost of borrowings 11.6 7.8 8.0 8.4 8.5
Spread 2.6 2.7 2.3 2.6 2.5
Cost-income 38.2 41.8 40.7 40.8 38.3
Tax rate 25.0 26.7 26.8 26.8 26.8

4 Edelweiss Securities Limited

  Union Bank Of India

Balance sheet (INR mn)

Year to March FY08 FY09 FY10 FY11E FY12E
Liabilities
Equity capital 5,051 5,051 5,051 5,051 5,051
Reserves 51,182 65,493 83,027 104,013 131,933
Net worth 56,233 70,544 88,078 109,064 136,984
Sub bonds/pref cap 37,500 48,900 60,900 65,900 75,900
Deposits 1,038,586 1,387,028 1,700,397 2,113,300 2,622,794
Borrowings 47,600 38,849 31,253 31,753 32,253
Other liabilities 43,564 47,574 54,830 70,046 43,467
Total 1,223,484 1,592,895 1,935,459 2,390,064 2,911,401
Assets
Loans 743,483 965,342 1,193,153 1,491,441 1,864,302
Gilts 282,171 351,451 428,338 530,088 657,462
Others 56,053 78,519 115,697 126,350 138,583
Cash & equi 100,978 159,849 157,767 184,646 212,936
Fixed assets 4,760 6,492 6,895 6,800 6,630
Other assets 36,039 31,242 33,609 50,738 31,488
Total 1,223,484 1,592,895 1,935,459 2,390,064 2,911,401
Balance sheet ratios (%)
Credit growth 18.4 27.8 22.6 24.9 24.9
Deposit growth 21.9 33.5 22.6 24.3 24.1
EA growth 19.7 31.5 21.8 23.1 23.2
SLR ratio 26.0 24.6 25.5 25.0 25.0
C-D ratio 75.5 72.2 72.3 72.6 73.0
Low-cost deposits 34.9 30.1 31.7 32.2 32.7
Gross NPA ratio 2.2 2.0 2.2 2.0 1.8
Net NPA ratio 0.2 0.3 0.8 0.8 0.6
Provision coverage 92.3 83.1 63.9 59.0 68.0
Incremental slippage 1.2 1.6 1.8 2.1 1.5
Net NPA / Equity 2.3 4.6 11.0 11.4 8.0
Capital adequacy 12.5 13.5 14.0 12.2 11.2
- Tier 1 7.5 8.4 8.3 7.7 7.1
Book value 111.3 139.7 174.4 215.9 271.2

ROA decomposition (%)

Year to March FY08 FY09 FY10 FY11E FY12E
Net interest income/Assets 2.6 2.8 2.4 2.8 2.7
Fees/Assets 0.9 0.8 0.8 0.7 0.6
Investment profits/Assets 0.3 0.2 0.3 0.1 0.1
Net revenues/Assets 3.8 3.9 3.6 3.6 3.4
Operating expense/Assets (1.5) (1.6) (1.5) (1.5) (1.3)
Provisions/Assets (0.6) (0.5) (0.5) (0.6) (0.5)
Taxes/Assets (0.4) (0.5) (0.4) (0.4) (0.4)
Total costs/Assets (2.5) (2.6) (2.4) (2.4) (2.2)
ROA 1.3 1.3 1.2 1.1 1.2
Equity/Assets 4.8 4.6 4.6 4.7 4.7
ROAE 27.4 27.2 26.2 24.5 25.3

Edelweiss Securities Limited 5

 
Banking and Financial Services

Valuation metrics
Year to March FY08 FY09 FY10 FY11E FY12E
Diluted EPS 28.1 34.2 41.1 47.9 61.6
EPS growth (%) 67.6 21.8 20.2 16.6 28.7
Book value per share 111 140 174 216 271
Adjusted book value/share 110 135 161 199 256
Diluted P/E 13.2 10.8 9.0 7.7 6.0
Price/ BV 3.3 2.6 2.1 1.7 1.4
Price/ ABV 3.4 2.7 2.3 1.9 1.4
Dividend yield (%) 1.1 1.4 1.5 1.5 1.5
Price to income 11.1 8.4 7.3 7.0 6.3
Price to PPOP 8.5 6.8 6.1 4.5 3.6

6 Edelweiss Securities Limited

 
RATING & INTERPRETATION Union Bank Of India

Company Absolute Relative Relative Company Absolute Relative Relative

reco reco risk reco reco Risk
Allahabad Bank BUY SO H Axis Bank BUY SO M
Bank of Baroda BUY SO L Federal Bank BUY SO M
HDFC HOLD SU L HDFC Bank HOLD SP L
ICICI Bank BUY SO L Indian Overseas Bank HOLD SU H
Infrastructure Development HOLD SU M ING Vysya HOLD SP H
Finance Co Ltd
Karnataka Bank BUY SO L Kotak Mahindra Bank BUY SP L
LIC Housing Finance BUY SO M Manappuram General BUY SO M
Finance
Oriental Bank Of Commerce BUY SO H Power Finance Corp BUY SP L
Punjab National Bank BUY SO L Reliance Capital HOLD SP M
Rural Electrification Corporation BUY SO L Shriram City Union Finance BUY SP H
South Indian Bank BUY SO H SREI Infrastructure Finance BUY SO L
State Bank of India BUY SP L Syndicate Bank BUY SP H
Union Bank Of India BUY SO L Yes Bank BUY SO M

ABSOLUTE RATING
Ratings Expected absolute returns over 12 months

Buy More than 15%

Hold Between 15% and - 5%

Reduce Less than -5%

RELATIVE RETURNS RATING

Ratings Criteria
Sector Outperformer (SO) Stock return > 1.25 x Sector return

Sector Performer (SP) Stock return > 0.75 x Sector return

Stock return < 1.25 x Sector return

Sector Underperformer (SU) Stock return < 0.75 x Sector return

Sector return is market cap weighted average return for the coverage universe
within the sector

RELATIVE RISK RATING

Ratings Criteria

Low (L) Bottom 1/3rd percentile in the sector

Medium (M) Middle 1/3rd percentile in the sector

High (H) Top 1/3rd percentile in the sector

Risk ratings are based on Edelweiss risk model

SECTOR RATING
Ratings Criteria
Overweight (OW) Sector return > 1.25 x Nifty return

Equalweight (EW) Sector return > 0.75 x Nifty return

Sector return < 1.25 x Nifty return

Underweight (UW) Sector return < 0.75 x Nifty return

Edelweiss Securities Limited 7

 
Banking and Financial Services

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021.
Board: (91-22) 2286 4400, Email: research@edelcap.com

Vikas Khemani Head Institutional Equities vikas.khemani@edelcap.com +91 22 2286 4206

Nischal Maheshwari Head Research nischal.maheshwari@edelcap.com +91 22 6623 3411

Coverage group(s) of stocks by primary analyst(s): Banking and Financial Services

Allahabad Bank, Axis Bank, Bank of Baroda, Federal Bank, HDFC, HDFC Bank, ICICI Bank, Infrastructure Development Finance Co Ltd,
Indian Overseas Bank, Karnataka Bank, Kotak Mahindra Bank, LIC Housing Finance, Manappuram General Finance, Oriental Bank Of
Commerce, Punjab National Bank, Power Finance Corp, Reliance Capital, Rural Electrification Corporation, State Bank of India, Shriram City
Union Finance, South Indian Bank, Syndicate Bank, SREI Infrastructure Finance, Union Bank Of India, ING Vysya, Yes Bank

Union Bank of India EW Indices

1,720
380
Buy 1,490
310 Buy
Buy 1,260
240
Buy
(INR)

1,030
170
800

100 9-Sep-09 9-Mar-10 9-Sep-10

Union Bank Of India

Jul-10
Feb-10

May-10
Mar-10
Dec-09
Sep-09

Jan-10
Oct-09
Aug-09

Jun-10

Aug-10
Nov-09

Apr-10

EW Banks and Financial Services Index

Nifty

Distribution of Ratings / Market Cap Recent Research

Edelweiss Research Coverage Universe Date Company Title Price (INR) Recos
Buy Hold Reduce Total 12-Aug-10 State Bank Strong core operating 2,784 Buy
of India performance; Result Update
Rating Distribution* 109 52 12 177
* 4 stocks under review 11-Aug-10 Banking RBI issues discussion paper
for new private banking
> 50bn Between 10bn and 50 bn < 10bn licenses; Sector Update
Market Cap (INR) 108 54 15 09-Aug-10 Reliance Lower capital gain and 770 Hold
Capital general insurance loss
dragged profitability;
Result Update

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