india banks - myirisbreport.myiris.com/macquarie/stabania_20120320.pdf · outperform in banks. top...

Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures.

INDIA

Inside After the high, comes the hangover 2 Interest rate cuts to be limited 6 Cycles are different this time around 8 Basel III – Expect a deluge of capital-raising 12 Brace yourself for lower growth 16 Margin outlook – pressures exist 20 Priority sector lending – the big drag on profitability? 23 Asset quality – Pains not yet over 27 Opex – Pressures to resurface for PSUs 41 Structurally return ratios to come down 45 Valuations – No room for comfort 46 Appendix A: Power projects under stress49 Appendix B: Basel III Capital equirements calculations 51 Appendix C: Impaired assets trends 53 Appendix D: CDR cases referred 55 Axis Bank 57 Bank of Baroda 61 Bank of India 66 Canara Bank 71 HDFC Bank 76 ICICI Bank 82 Kotak Mahindra Bank 89 Punjab National Bank 94 State Bank of India 100 Union Bank of India 107 Yes Bank 112 Analyst(s) Suresh Ganapathy, CFA +91 22 6720 4078 [email protected] Parag Jariwala +91 22 6720 4083 [email protected] Yuvaraj Bhole +91 22 6720 4098 [email protected]

20 March 2012 Macquarie Capital Securities India (Pvt) Ltd

India banks After the high, comes the hangover Structural de-rating – return ratios to come down sharply The eternal long-term optimism on Indian banks in our view is unfounded. What gets neglected is the structurally lower growth, rising opacity of the quality of book thanks to restructuring, grossly under-provisioned state relative to regional peers and increasing burden in the form of priority sector/financial inclusion norms all of which is going to exert pressure on earnings and return ratios over the longer term. Leverage ratio is likely to be structurally lower due to Basel III implementation and we expect a deluge of equity capital raising over the next five years. Our earnings are ~15% below consensus for FY13E/FY14E and we expect ROEs to come down from 18.1% in FY11 to 15.7% by FY14E. Our ROEs are around 300bps lower than consensus for PSU banks. HDFC Bank is the only Outperform in banks. Top Underperforms are PNB and SBI. Gearing up for Basel III: Flood of capital raising in next 5yrs As banks gear up for Basel III beginning 1stJan’2013 to achieve a common equity ratio of 8% and a CAR of 11.5% over the next five years, assuming an 18% CAGR of loan growth, we expect the banking system in India to raise a minimum of US$30bn of equity capital, posing significant dilution risk. Capital required is more for growth than meeting solvency requirements. Socialistic attitude of Govt and regulators add to woes We believe the socialistic mindset of regulators as well as the government is going to exert more pressure on bank profitability. What is good for customers is not necessarily good for shareholders. The tougher priority sector guidelines, financial inclusion targets and a possible farm loan waiver over the next few years are only going to worsen profitability dynamics. Our analysis suggests that the revised priority sector guidelines could impact margins by c.30bps for private sector banks on a ceterus paribus basis. Asset quality – the pain hasn’t disappeared While the government announcements with respect to greater coal supplies to power projects do improve sentiment, their track record of implementation leaves much to be desired. Nevertheless pains with respect to gas based power projects and power projects where PPAs are fixed at low prices will continue to face stress as renegotiation of PPAs is unlikely. Our analysis of independent power projects (IPPs) suggests that close to 23,000MW of power projects or 16% of power exposure of banks could be at risk of restructuring or default. Another 10–15% could be contributed by SEBs. NPLs/restructuring related to SMEs, export oriented sectors etc are unlikely to significantly abate. We are very worried over the moral hazard issue in the agriculture sector. Our worry is also on the under-provisioned state of Indian banks. We expect stressed assets, defined as net NPLs plus restructured assets, to net-worth ratio for the system to increase to a ten-year high of 57% (90% for PSU banks) by FY13. NPL coverage on stressed assets stands at a dismal sub 40% vs. regional peers averaging at 150% plus. Valuations – where is the comfort? Stocks currently are trading above ten-year historical averages on the back of an opaque book which is grossly inflated thanks to restructuring. The 20% re-rating from the recent lows more than adequately factors a ~100bps cut in benchmark rates and aggressive rate cuts are unlikely considering the fiscal and inflation dynamics.

Macquarie Research India banks

20 March 2012 2

After the high, comes the hangover Why do we continue to be bearish? We expect a structural de-rating of the banking sector with ROEs expected to come down

sharply owing to lower ROAs as well as lower leverage ratios.

Our earnings estimates are 15–20% below consensus for PSU banks and ROEs around 300bps lower for FY13E/FY14E.

⇒ We expect ROEs to come down from a level of 18.1% in FY11 to 15.7% in FY14E (c.250bps decline) driven by higher credit costs, operating cost ratios and lower leverage.

⇒ The decline is even sharper at 400bps if we exclude private sector banks.

We believe market isn’t seriously factoring in the extent of equity dilution that can happen due to Basel III and envisage closer to US$30bn of equity capital raising over the next five years.

Asset quality pressures are unlikely to significantly abate and expect stressed assets as a proportion of net-worth to rise to 50%+ by FY13 which will be a 12-year high. For PSU banks this number will likely be closer towards 90%+.

Expect credit costs to remain at elevated levels and closer to ten-year high of 90bps for PSU banks. For private banks also, we expect pick up in credit costs by 25bps over the next two years.

⇒ NPL provisioning coverage ratios including stressed assets stand at abysmally low levels of 23% for PSUs which is grossly inadequate.

⇒ Even on a reported basis, NPL coverage ratios are at 45% for PSUs compared to regional peers whose coverage ratio on an average stand at 150%+.

The proposed draft priority sector guidelines and the continued thrust on financial inclusion by the government are likely to exert pressure on margins, opex and asset quality over the longer term. Private Banks get more impacted with respect to margins as they currently are well below the proposed targets.

Valuations are now above 10yr historical averages for most banks on the back of a book which is grossly inflated due to restructuring and inadequate provision levels.

Limited catalyst from interest rate cuts. We believe banking stocks are pricing in well a 100bps cut in interest rates over the next 12 months. Considering the inflation and fiscal dynamics we believe it’s not possible for RBI to cut rates aggressively and don’t expect more than 100bps cut in the next 12 months.

Earnings estimates and ROE below consensus Our earnings estimates and ROE are significantly below consensus especially for PSU banks as they face significant dilution risk owing to higher capital requirements and also have more issues with respect to asset quality.

We are 14% and 20% below consensus on EPS terms with respect to PSU banks for FY13E and FY14E respectively.

If we look at PAT the corresponding numbers are 9% and 10% respectively. The difference in EPS and PAT is on account of equity dilution that we expect to happen over the course of next two years.

In terms of ROE we are around 300bps lower than consensus ROE for FY13/FY14E for PSU banks. We expect leverage ratios to come down for PSU banks which are currently very high.


20 March 2012 3

Fig 1 Where do we stand? - Macquarie vs. Consensus

PAT (%) EPS (%) ROE (%) FY13E FY14E FY13E FY14E FY13E FY14E

Private banks Axis Bank (0.2) (4.6) 1.4 (9.9) (0.1) (2.7) HDFC Bank (2.7) (5.9) (1.9) (6.3) (0.9) (1.8) ICICI Bank (4.6) (9.2) (4.8) (9.6) (0.8) (1.4) Kotak Mahindra Bank 6.0 4.5 5.8 2.9 0.7 0.6 YES Bank (0.2) (5.2) (4.8) (16.3) (1.8) (4.2) Average (0.4) (4.1) (0.9) (7.8) (0.6) (1.9)PSU banks BOB (4.9) (7.2) (9.5) (17.0) (2.2) (2.8) Bank of India (14.9) (12.0) (22.6) (24.4) (3.9) (3.6) Canara Bank (13.8) (5.1) (13.2) (8.9) (3.1) (1.8) PNB (4.4) (5.7) (11.7) (16.2) (3.0) (3.7) SBI (4.0) (12.9) (7.3) (20.9) (1.2) (1.7) Union Bank (12.6) (18.2) (17.3) (30.9) (3.9) (5.4) Average (9.1) (10.2) (13.6) (19.7) (2.9) (3.2)Source: Bloomberg, Company data, Macquarie Research, March 2012

Earnings and TP changes We have cut our earnings estimates mainly on account of higher credit costs, lower

margins and higher opex. Significant cuts are also due to equity dilution that we have factored in most PSU banks.

Our TP reduction is largely on account of lower ROE emanating from lower leverage ratios and ROA in certain cases. We have also reduced our cost of equity which offsets part of multiple reduction happening due to change in ROE.

Fig 2 Changes to Earnings and TP EPS (FY13E) EPS (FY14E) TP Rs Earlier Now Change% Earlier Now Change% Earlier Now Change%

Private banks Axis Bank 103.3 116.7 13.0% 124.4 124.6 0.2% NA NA NAHDFC Bank 27.7 26.8 -3.4% 34.4 32.4 -5.9% 615 625 1.6%ICICI Bank 58.8 60.4 2.8% 67.6 68.1 0.6% 855 855 0.0%Kotak Bank 32.0 30.8 -4.0% 39.1 37.4 -4.4% 550 535 -2.7%YES Bank 35.7 31.8 -10.7% 42.4 35.1 -17.4% 380 380 0.0%Average Private banks -0.5% -5.4% -0.3% PSU banks BOB 122.1 124.9 2.3% 141.3 132.9 -5.9% 800 705 -11.9%Bank of India 52.0 43.3 -16.8% 65.1 51.8 -20.4% 275 255 -7.3%Canara Bank 93.9 82.6 -12.1% 111.4 99.1 -11.0% 370 385 4.1%PNB 169.0 157.7 -6.7% 199.0 171.8 -13.7% 880 790 -10.2%SBI 186.4 201.6 8.2% 207.7 210.2 1.2% 1,700 1,700 -1.2%Union Bank 47.6 35.8 -24.7% 55.4 36.6 -33.9% 225 185 -17.8%Average PSU banks -7.7% -13.4% -7.4%Source: Macquarie Research, March 2012 Note: We have research restrictions on Axis Bank. Hence no TP or Recommendation is provided.


20 March 2012 4

Top picks – buys and sells Our top pick is HDFC Bank. We don’t have any other Outperform in the banking space. We downgrade ICICI Bank, Kotak and YES to Neutral from Outperform on account of valuations. We have now all Underperforms in the PSU banking space. We downgrade BOB and Union Bank to Underperform.

Top Buy- HDFC Bank (HDFCB IN, OP, CMP Rs528, TP Rs625)

Least concern on asset quality. Retail expected to do well and credit costs expected to remain at low levels.

NPL coverage one of the highest in the sector. Also restructuring of assets is expected to be the least in the sector.

Stellar deposit franchise should help it to deliver sector beating margins and high ROAs.

High capital levels. We don’t envisage any equity dilution for the next 12–18 months.

Top Sells

SBI (SBIN IN, UP, CMP Rs2,355, TP Rs1,700)

Asset quality continues to be the bane. Expect NPLs to remain high driven by agriculture and SME sectors. We don’t envisage any significant recoveries in the agri sector.

Expect frequent equity dilution. We don’t think the current Rs79bn equity capital infusion from government would suffice and expect SBI will soon be raising capital again in the next 12 months.

We expect the wage revision expected in Nov-12 will put pressure on opex ratios for FY14 due to higher salary costs and pensions which are linked to wage hikes.

The stock trades at a 10–15% premium to large cap peers despite having ROEs inferior to them.

PNB (PNB IN, UP, CMP Rs1,027, TP Rs790)

NPLs have been stubbornly high and we don’t expect any reduction in slippages or restructured assets.

ROA is expected to be under pressure. Current high level of margins is unsustainable and opex increases should exert pressure on ROA. PNB historically has had a bad track record of large employee cost increases due to wage revision compared to other PSU banks.

Expect ROEs to come down from 22% levels in FY11 to 17% over the next three years. That could drive de-rating of the stock.-


20 March 2012 5

Fig 3 Valuation matrix for our coverage universe EPS growth (%) P/E (x) P/BV (x) RoE (%) FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E

Private banks Axis Bank 26.2 23.9 13.3 15.4 12.4 11.0 2.8 2.3 2.0 19.3 20.4 19.7HDFC Bank 25.1 30.8 20.4 31.0 23.7 19.7 4.8 4.1 3.5 16.7 18.7 19.1ICICI Bank 25.8 20.7 10.2 21.0 17.4 15.8 2.0 1.8 1.7 9.6 11.0 11.3Kotak Mahindra Bank 16.1 16.1 21.1 26.2 22.5 18.6 3.9 3.3 2.8 16.8 15.9 16.5YES Bank 35.0 31.7 14.5 18.3 13.9 12.1 3.5 3.0 2.0 21.1 23.4 20.5Average Private banks

24.8 24.7 15.8 24.2 19.4 16.6 3.4 3.0 2.5 15.0 16.3 16.4

PSU banks BOB 33.7 4.2 7.2 7.6 7.3 6.8 1.7 1.4 1.2 23.5 19.8 18.1Bank of India 40.1 (11.5) 5.5 8.5 9.6 9.1 1.3 1.2 1.1 15.8 12.3 11.8Canara Bank 28.1 (20.6) 10.2 5.6 7.0 6.4 1.3 1.1 1.0 23.2 15.5 15.0IDBI Bank 8.0 (8.2) 9.6 7.5 7.0 5.8 0.9 0.8 0.7 14.6 11.6 10.9PNB 13.3 18.1 2.0 7.3 6.2 6.1 1.6 1.3 1.1 22.6 22.1 18.9SBI (9.2) 43.6 4.9 14.0 9.7 9.3 1.9 1.6 1.4 13.3 17.4 15.9Union Bank (1.6) (27.1) 27.3 6.1 8.4 6.6 1.2 1.1 0.9 18.0 11.6 13.4Average PSU banks 6.2 21.4 6.5 10.8 8.6 8.1 1.7 1.4 1.2 16.8 17.2 15.8Non banks HDFC Ltd 23.1 14.1 21.5 27.8 24.4 20.1 5.7 5.3 4.7 21.7 22.6 24.9IDFC Ltd 13.4 (5.8) 3.4 16.4 17.4 16.8 2.0 1.9 1.7 14.0 11.1 10.8PFC 11.1 (12.7) 13.8 8.9 10.2 9.0 1.5 1.3 1.2 18.4 14.7 13.8REC 20.7 (11.8) 6.7 8.7 9.9 9.2 1.8 1.6 1.4 21.6 16.8 16.1Reliance Capital (33.0) 101.0 161.4 36.8 18.3 13.9 1.4 1.3 1.2 3.8 7.3 9.1SHTF 40.5 14.3 8.5 10.8 9.5 8.7 2.7 2.2 1.9 28.1 25.8 23.2MMFS 29.7 18.8 11.6 14.7 12.3 11.1 2.8 2.4 2.1 22.9 21.1 20.1LIC Housing Fin. 47.2 (6.9) 37.2 12.4 13.3 9.7 2.9 2.5 2.0 25.8 20.0 23.1Average non banks 20.4 8.7 23.1 19.9 17.7 15.0 3.7 3.3 3.0 20.5 19.1 20.0Source: Bloomberg, Company data, Macquarie Research, March 2012 Note: Valuations are as of 14 March 2012

Fig 4 Recommendation matrix of our coverage universe Recommendation CMP (Rs.) TP (Rs.) Upside/Downside

Private banks Axis Bank Restricted 1,274 NA NAHDFC Bank OP 528 625 18%ICICI Bank N 954 855 -10%Kotak Mahindra Bank N 572 535 -7%YES Bank N 387 380 -2%PSU banks BOB UP 846 705 -17%Bank of India UP 393 255 -35%Canara Bank UP 527 385 -27%IDBI Bank UP 115 90 -22%PNB UP 1,027 790 -23%SBI UP 2,355 1700 -28%Union Bank UP 247 185 -25%Non banks HDFC Ltd OP 678 775 14%IDFC Ltd N 152 120 -21%PFC OP 203 190 -7%REC N 228 190 -16%Shriram Transport Finance N 589 600 2%M&M Financial Services UP 705 525 -26%LIC Housing Finance UP 254 190 -25%Share prices as of 14 March 2012 Source: Bloomberg, Company data, Macquarie Research, March 2012 Note: Prices are as of 14 March 2012


20 March 2012 6

Interest rate cuts to be limited Inflation – The biggest thorn in the bush Though interest rates have gone up 375bps from the bottom, over the next one year we don’t expect rate cuts to be more than 100bps. Inflation will remain a concern and will likely stay above the RBI’s comfort zone of 5.0–5.5% in FY13. We think the RBI will not be able to cut rates as aggressively as will be needed to support growth and kick-start the investment cycle in FY13.

Buoyed by a positive base effect and lower food prices, overall WPI inflation is expected to moderate to below the 7% level by March 2012. The simulation exercise carried out by our economist Tanvee Gupta Jain indicates a good probability of headline inflation remaining below the 6% mark in April 2012, barring a sharp rise in global commodity prices. However, she thinks that the trend of lower inflation won’t sustain for long and expect it to rise again from May 2012 onwards.

Fig 5 Inflation expected to remain above RBI comfort levels

Source: Bloomberg, Macquarie Research, March 2012

Persistently high oil prices pose a significant risk to inflation. Oil accounts for 30% of total imports of India. We estimate every full year US$10 increase in crude prices would increase inflation by ~1%, reduce GDP by ~40bps and increase the current account deficit (CAD) by roughly US$9bn. CAD is already at an all-time high (3.6% GDP). An empirical study by the IMF estimates an impact of over 100bps on GDP growth of countries whose oil imports exceed 5%+ of their GDP; India is at 7%.

Fig 6 Oil prices persistently high and pose risk to inflation


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20 March 2012 7

We expect WPI inflation to remain sticky at around the 7.0–7.5% level in FY13, still remaining above the historical average of 5.0–5.5%. The recent improvement in the core inflation rate is somewhat artificial as the government has avoided raising local fuel prices due to the state elections, despite rising global crude oil prices. The 2012–13 Budget has hiked excise duty and service tax rates which in turn, in the near term, is likely to marginally add to core inflationary pressures.

Fig 7 Rate cuts to be limited

Source: RBI, Macquarie Research, March 2012

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20 March 2012 8

Cycles are different this time around Don’t overlook a weak macro this cycle To begin with, from a macro perspective there are four important factors one needs to look at and on all those counts macroeconomic fundamentals look much weaker.

Growth is much lower, fiscal deficit much higher this cycle

Real GDP growth and fiscal situation in this cycle is in sharp contrast to cycle seen during FY05–07 and FY07–11. We expect GDP growth to be much lower in FY11–13 (average at 6.9%) as compared to 8.8% in FY05–07 and 8.2% (after accounting for poor growth in FY09 at 6.7%) in FY07–11.

Lower tax revenue for the government as a result of slower GDP coupled with high expenditure on social projects is likely to keep fiscal deficit at elevated level. Combined fiscal deficit of central and state governments (including off-balance sheet items) would remain at 8.3% in FY11–13 as against 6.7% in FY05–07.

Fig 8 High fiscal deficit and lower GDP growth this cycle


High oil prices the big issue

Crude is the largest contributor to India’s import bill and therefore benign crude prices are the precondition for higher GDP and lower fiscal deficit. Indian economy is witnessing high crude prices above $100bbl over the past year. Again, this is quite high compared to FY05–07 (average crude price at US$61bbl) and FY07–11 (US$81).

Fig 9 Sustained high crude price since February 2011


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20 March 2012 9

Pressure on exchange rate

A depreciating rupee could spoil the current account and negatively impact the trade balance. We expect the USD/rupee exchange rate to average out at around 49 in FY12 and 50 in FY13, due to lower foreign capital flows given slowing economy, fewer reforms and policy deadlock. This is likely to keep trade deficit high -US$196bn in FY13E vs -US$131bn in FY11.

Current account balance as percentage to GDP is likely to remain at -3.5% over next two years vs. -0.8% in FY05–FY07.

Fig 10 Current account balance and depreciating rupee trends


Average inflation much higher this cycle

In contrast to earlier cycles, we believe inflation is likely to remain high going forward, fuelled by high crude prices, ballooning expenditure on social projects by the government and structural issues on the supply side. We expect average annual inflation of 7.8% from FY11–13 (above the RBI comfort zone of 5–5.5%), compared to 5.8% in FY05–07 and 6.6% in FY07–11.

Fig 11 Inflation to remain high


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20 March 2012 10

Weak fundamentals for banking sector Structurally lower growth, weaker asset quality and lower returns this cycle

We have deliberated on growth, asset quality and return ratios in the sections below. The crux of our thesis is that:

i) Loan growth this cycle will be much lower than that seen in the earlier cycles. We expect 16–17% CAGR in loans over FY11–14 due to weak sanctions trend in infrastructure particularly power, sluggish outlook on corporate capex and relatively lower retail loan growth primarily on account of banks withdrawing from several retail segment categories.

Fig 12 Loans to grow at slower rate during FY11-13 (YoY loan growth %)


ii) Asset quality is going to be much weaker, owing to structural issues in several sectors like aviation, power etc and steady increasing restructuring proposals due to sluggish demand and high interest rates. We expect agriculture book to see increased delinquencies owing to deteriorating credit culture in the sector. Consequently, we expect credit costs will remain elevated.

Fig 13 Credit cost to spike over FY11-14E, specifically for PSUs

Source: Company data, Macquarie Research, March 2012

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20 March 2012 11

iii) Return ratios are also going to be lower owing pressure on margins & high operating and credit cost. Basel III regulations which will cap the ability to gear up thereby necessitating frequent equity dilution and thus lowering ROE structurally for Indian banks.

We expect PSU banks’ RoA to remain below 1% given pressure due to social obligation (priority sector lending – lower margins, high credit cost), higher operating cost (pension obligation, branch expansion) and asset quality issue due to high interest rate and slower economic growth.

Fig 14 Pressure on ROA specially for PSU banks


Fig 15 Leverage to be lower than previous cycle due to Basel III


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20 March 2012 12

Basel III – Expect a deluge of capital-raising Capital required more for growth than solvency The average Tier 1 capital ratio of Indian banks is around 10%, with more than 85% of it comprising common equity. The regulatory adjustments demanded by Basel III will reduce the available equity capital only marginally for various reasons. First, items such as goodwill, Deferred Tax Assets (DTAs) etc. are already deducted from Tier 1 capital for Indian banks. Second, some other items which are subject to deduction such as mortgage servicing rights, treasury stocks, gains on account of fair valuation of liabilities which exist in other developed economies, do not exist in India. Third, reciprocal cross-holdings of capital and other investments in the capital of banking, financial and insurance entities are insignificant because these investments are restricted due to existing regulatory limits. Thus, Indian banks will have high common equity capital ratios even under Basel III. However as growth picks up and banks gear up to consistently maintain high levels of common equity and core tier-I, we think capital raising will be imminent.

Fig 16 Capital position of banks (As of FY11) Tier-I Common Equity Ratio Tier-I Leverage Capital Adequacy

Private Banks Axis Bank 9.4% 9.1% 7.6% 12.7%HDFC Bank 12.2% 12.1% 8.7% 16.2%ICICI Bank 13.2% 11.7% 12.4% 19.5%Kotak Bank 18.1% 17.5% 14.2% 19.5%Yes Bank 9.7% 8.6% 7.1% 16.5%PSU Banks BOB 10.0% 8.8% 5.9% 14.5%Bank of India 8.3% 7.3% 4.9% 12.2%PNB 8.4% 7.6% 5.5% 12.4%SBI Group 8.0% 7.4% 6.9% 12.0%Union Bank 8.7% 7.9% 5.2% 13.0%Source: Company data, Macquarie Research, January 2012 Note: Leverage ratio is calculated as Tier-I capital as a percentage of assets. The actual leverage ratio calculation is yet to be prescribed by RBI and could differ. Also note that we haven’t deducted the defined benefit pension amount as that eventually will be taken off from the book by FY14.

Expect banks to raise at least US$30bn equity in the next five years The big issue is that capital is required more from growth perspective than meeting solvency requirements. More than 50% of Indian banks can meet the Basel III capital requirements as of today even without any phasing out period. The issue is as growth picks up compounded with the increase in common equity requirements, capital raising will likely increase.

The RBI’s draft guidelines on Basel III talk about the following:

i) Minimum Tier-I ratio to be at 7% with common equity ratio to be at least 5.5% and total CAR to be at 9%. The balance in Tier I i.e. 1.5% could include hybrid instruments.

ii) Additional capital conservation buffer (CCB) in the form of common equity at 250bps. Hence the total capital requirements would be 11.5% of RWA.

iii) RBI has also specified a minimum Tier-I leverage ratio of 5% (exact calculation of leverage ratio has not been specified).

So what has changed? Currently, banks in India have to maintain a CAR of 9% with minimum Tier-I of 6%, and there are no prescriptions for common equity. There is also no CCB or leverage ratio limit. In general capital requirements have been increased which anyway was not unexpected. Second, Tier-I and Tier-II capital could include hybrids according to the draft regulations; however these hybrids have now been strengthened with respect to their loss absorbency capacity. The current hybrid instruments largely don’t comply with the additional requirements imposed and hence would be grandfathered over a period of time, in our view.


20 March 2012 13

Implementation timeline stricter than actual Basel III: Implementation of Basel III in India is proposed to begin on 1 January 2013 and fully implemented by 31 March 2017 vs. the 1 January 2019 deadline proposed by the Basel Committee. Every year, beginning from 1 January 2013, CCB has to be increased by 0.625%. The grandfathering of various innovative/hybrid capital instruments that exist currently and don’t meet the qualifying criteria proposed will begin from 1 January 2013 going all the way to 1 January 2022.

Fig 17 Capital requirements for Basel III Sr. No. Regulatory Capital % of RWAs

(i) Minimum Common Equity Tier 1 ratio 5.5%(ii) Capital conservation buffer (comprised of Common Equity) 2.5%(iii) Minimum Common Equity Tier 1 ratio plus capital conservation buffer [(i)+(ii)] 8.0%(iv) Additional Tier 1 Capital 1.5%(v) Minimum Tier 1 capital ratio [(i) +(iv)] 7.0%(vi) Tier 2 capital 2.0%(vii) Minimum Total Capital Ratio (MTC) [(v)+(vi)] 9.0%(viii) Minimum Total Capital Ratio plus capital conservation buffer

[(vii)+(ii)] 11.5%

Source: RBI, Macquarie Research, January 2012

Fig 18 Transitional Arrangements for Scheduled Commercial Banks As a percentage of Risk Weighted Assets (RWAs) Minimum capital ratios Jan 1, 2013 Mar 31, 2014 Mar 31, 2015 Mar 31, 2016 Mar 31, 2017

Minimum Common Equity Tier 1 (CET1) 4.5% 5% 5.5% 5.5% 5.5%Capital conservation buffer (CCB) 0.625% 1.25% 1.875% 2.5%Minimum CET1+ CCB 4.5% 5.625% 6.75% 7.375% 8%Minimum Tier 1 capital 6% 7% 7% 7% 7%Minimum Total Capital* 9% 9% 9% 9% 9%Minimum Total Capital +CCB 9% 9.625% 10.25% 10.875% 11.5%Phase-in of all deductions from CET1 (%)

40% 60% 80% 100% 100%

Note: * The difference between the minimum total capital requirement of 9% and the Tier 1 requirement can be met with Tier 2 and higher forms of capital. Source: RBI, Macquarie Research, January 2012


20 March 2012 14

Based on our analysis, we estimate that roughly US$30–35bn would be the equity dilution over the next five years. (For detailed workings refer to the Appendix section). Note that the equity capital raising could be higher if there is lower demand for the banks’ perpetual tier-I bonds and/or tier-II bonds.

Fig 19 Indian banks – Basel III related capital raising INR bn Capital to be raised Market Share of assets

SBI Group 578 23%Union Bank 112 3%BOB 17 5%BOI 46 5%Canara 18 5%PNB 62 5%Total 833 46%All PSU Banks 1,333 74%ICICI Bank 53 6%HDFC Bank - 4%Axis Bank 82 3%YES Bank 31 1%Kotak Bank - 1%Total 166 14%All Private Banks 225 19% PSU banks 1,333 Private Banks 225 Total Capital to be raised 1,558 Equity capital to be raised in USD bn 31 Source: Company data, Macquarie Research, March 2012

Note that SBI in the past had estimated a capital raising figure of Rs200bn for five years based on their estimated growth projections under Basel II. With Basel III being more stringent, this number according to our analysis could easily be double of the amount that management had indicated earlier.

We expect leverage ratios of banks to come down over the next five years and that would result in ROEs also coming down. We have factored around 10–15% equity dilution for most banks in FY14E which will be the first full year of the beginning phase of Basel III implementation.

Fig 20 Leverage ratios to come down for banks

Source: Company data, Macquarie Research, March 2012 Note: We have assumed equity dilution in FY14 and hence leverage ratio which is a function of average assets to average equity will look much more subdued for FY15 than for FY14E.

13.8

11.6

13.3

11.810.7

10.0 10.110.8 10.6 10.3

18.818.2 18.2

17.1 16.917.6 18.0 17.9 17.8 17.5

8.0

10.0

12.0

14.0

16.0

18.0

20.0




20 March 2012 15

The government has no choice; LIC can be used as a vehicle In the past 12 months, LIC [Life Insurance Corporation of India, Unlisted] and the Indian government have together infused or are likely to infuse close to Rs260bn of capital in PSU banks. This is under Basel II. So our analysis that all banks in India would require close to Rs1.5tr of equity over the next five years under Basel III doesn’t seem far-fetched.

Fig 21 Capital infusion done in FY12 by the government and LIC Rs bn Capital infusion by Govt. by LIC Total

BOB 7.8 16.0 23.8 BOI 27.8 - 27.8 IDBI Bank 25.0 6.6 31.6 PNB 12.8 10.8 23.6 SBI 79.0 - 79.0 Union Bank 3.6 6.8 10.3 IOB 14.5 - 14.5 UCO Bank - 2.7 2.7 Allahabad Bank 10.0 5.0 15.0 Andhra Bank 6.2 - 6.2 Dena Bank - 1.3 1.3 Central Bank of India 7.0 - 7.0 Bank of Maharashtra 8.6 1.0 9.6 United Bank 1.4 1.4 2.7 Syndicate Bank 5.4 - 5.4 Vijaya Bank - 1.5 1.5 Punjab & Sind Bank 1.0 1.0 Total 208.9 53.9 262.8 Source: Company data, Macquarie Research, March 2012

LIC will continue to be one of the largest investors in PSU banks. LIC historically has held significant stakes in PSU banks and considering LIC’s annual premium flow of Rs2,034bn (US$45bn) we believe LIC has sufficient money to share the burden of the government time and again. Unfortunately we think it’s the policyholders who are seemingly having to bear the pain of bad fiscal prudence.

Fig 22 LIC’s premium flows have been robust


37.333.8

39.3

44.6

30

32

34

36

38

40

42

44

46

FY2008 FY2009 FY2010 FY2011

$ bn

Total premium income of LIC


20 March 2012 16

Brace yourself for lower growth Loan growth to be around 16–17% Bank credit in India can be broadly classified into: 1) agriculture 2) industry ex- infrastructure 3) infrastructure, and 4) retail credit. Demand for industry (ex-infrastructure) is mainly due to working capital (dependent on commodity prices) and new investment requirements. While we expect disbursement demand for agriculture and working capital remain steady given increased thrust of government on agriculture and high commodity prices, respectively, we expect incremental demand from industry capex and infrastructure to remain weak, resulting in slower bank credit growth.

Infrastructure, retail unlikely to grow very fast

Increase in new project awards by the government has led to 37% growth in credit to infrastructure in FY07–11 as against 24% growth in total industrial credit.

Fig 23 Credit growth from FY07–11 was mainly fuelled by infrastructure


Several projects have either become unviable due to increase in interest rates/commodity prices or caught in supply linkage issues, reducing demand for incremental loans. Corporates are awaiting conducive environment for new project investments like low interest rate/commodity prices, clarity on supply linkages and government policies. Slowdown in infrastructure can be seen in the sanctions trend of infrastructure financing companies.

Fig 24 Slower fresh sanctions of infrastructure financing companies


15%

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Infrastructure credit grew at much higher rate

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Lower snactions indicates lack of new project demand


20 March 2012 17

Retail credit has slowed down considerably given high interest rates and higher prices for underlying assets (mainly for housing and auto loans). It is important to note that credit to infrastructure and retail sector accounted for one-third of overall bank credit as of January 2012. Though there could be some pick-up due to the reduction in interest rates, the magnitude of reduction being small, we don’t expect a very material pick up in retail credit. Housing is expected to do well, but other segments of retail are expected to be relatively weak. There are structural issues to segments like unsecured retail credit and 2W loans which are unlikely to see the momentum witnessed in the earlier high growth phase.

Fig 25 Infrastructure and retail credit slowing down


Gross fixed capital formation and investments to GDP slowing down

Recent data suggests that capital formation/investment in India is slowing down thereby hurting the bank credit demand towards new investments.

Fig 26 Gross fixed capital formation (four quarter moving avg.) on decline


15%

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25%

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35%

40%

Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-1210%

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System Infra loan growth System retail loan growth (RHS)

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20 March 2012 18

Fig 27 Investment-to-GDP declining


Increasing financial disintermediation – another cause of worry

Over the past several years, the credit multiplier has been consistently decreasing. Certainly, this is partly due to increasing financial disintermediation which has resulted in corporates resorting to non-bank sources of credit. This could range from corporate bonds, non -convertible debentures, private equity capital, foreign currency borrowings like ECBs and FCCBs etc.

Fig 28 Credit multiplier has been decreasing


The table below shows increasing share of various resources in overall funding of corporates and we can see that bank funding has steadily come down over the past several years. FY11 did see a sharp pick up in bank credit proportion as the ECB and FCCB borrowings plummeted.

Fig 29 Financial disintermediation: Increasing share of non-bank resources in overall funding Share of resources Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11

Domestic equity 3% 1% 4% 13% 7% 6% 11% 15% 5% 11% 10%Domestic Debt 7% 7% 19% 21% 8% 11% 8% 8% 20% 23% 21%CP 0% 0% 0% 2% 1% 0% 1% 2% 1% 6% 0%ECBs 0% 0% 0% 0% 11% 9% 12% 12% 10% 6% 2%FCCBs 0% 0% 0% 0% 12% 13% 15% 15% 11% 2% 0%NBFC Credit 0% 0% 0% -1% 0% 0% 0% 1% 0% 0% 0%Bank credit 90% 91% 76% 64% 61% 59% 54% 45% 53% 50% 65%Others 0% 0% 0% 1% 1% 3% 0% 3% 0% 2% 1%Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Source: Business Beacon, Macquarie Research, March 2012

33.0%

34.0%

35.0%

36.0%

37.0%

38.0%

39.0%

FY07 FY08 FY09 FY10 FY11 FY12E FY13E

Lack of investments would impact the capex driven credit growth

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0.50

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Nominal credit multiplier Average


20 March 2012 19

However with ECB and FCCB borrowings again back in FY12 plus large corporates increasingly taking recourse to the bond market owing to the base rate system which kept even short-term funding rates very high compared to bond market rates, we expect the share of bank credit to have dipped in FY12 again.

If we look at HDFC Ltd, which is AAA-rated company, the corporate has increasingly avoided bank funding this year owing to high base rates.

Fig 30 HDFC Ltd: Bank loan dependence has substantially reduced this year


0%

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FY08 FY09 FY10 FY11 YTD FY12Term Loans (largely banks) Bonds and Debentures Deposits


20 March 2012 20

Margin outlook – pressures exist Spike in short-term rates can affect NIMs in the near term The recent CRR cuts do give some relief in the near term with respect to short-term rates. However, short-term rates are expected to remain at elevated levels till the end of March mainly due to advance tax outflows. The shortage of cash is also due to a big jump in the amount of currency in the public's hands as a result of state elections and intervention by the RBI to prop up the rupee, which has sucked rupees from the system. Banks, which are already borrowing heavily in the three-month CD segment, are likely to step up issuance despite rising costs as they want to shore up their balance sheets ahead of the end of the quarter, as well as the fiscal year, on March 31.

The demand-supply mismatch is a regular feature in India's short-term money market during 4Q, but conditions are more difficult than usual for borrowers this year because of rule changes that discourage funds from buying short-term paper. The proposed regulatory change would require mutual funds to mark-to-market, or "fair value", all securities on a daily basis. Until now, papers with a maturity of less than 91 days were exempted from this requirement. The rule, which will come into effect later this year, has made funds cautious about investing in short-term assets. No funds want assets on their balance sheet that will inevitably be marked down, especially by the end of fiscal year.

Fig 31 Liquidity to remain in deficit mode


Fig 32 Short-term rates have been very high


(1,600)

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20 March 2012 21

Lag in reduction between deposit and lending rates Lending rates may come down first, deposit rates to react with a lag

Currently LDRs (loan to deposit ratios) are very high – in fact close to record high levels. With loan growth weak and deposit growth also sluggish, we expect banks initially to cut lending rates in response to the RBI rate cuts whereas deposit rate cuts could happen with a bit of a lag. Retail deposit rates are usually sticky and competition from other fixed rate schemes like small savings schemes where rates offered are closer to 8.5% would also limit ability of banks to cut rates sharply in a tight liquidity environment.

Fig 33 LDR levels at close to all-time high levels


Fig 34 Gap between loan growth and deposit growth now negative


63.0

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Abnormally high during global financial crisis

Large capital raising done by the sector

Tight after the 3G auctions and no government spending

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Deposit grow th now low er than loan grow th


20 March 2012 22

Additional pressures in the form of higher PSL compliance The revised priority sector norms suggested by the Nair Committee is also likely to exert pressure on margins, in our view. Our detailed analysis done in the section “Priority sector lending – the big drag on profitability?” reveals that there could be 30bps impact on NIMs for private sector banks. The impact, however, is on a ceterus paribus basis and the norms do give banks enough phasing out period. Also banks now have freedom of pricing the small ticket loans under base rate system which didn’t exist under the PLR rate system and hence the eventual impact could be lower.

Fig 35 NIMs to come under pressure


2.9

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(%)

Private Banks PSU Banks


20 March 2012 23

Priority sector lending – the big drag on profitability? The headache of reaching a 9% SFMF target Our analysis suggest a possible c30bps impact on NIMs on a ceterus paribus basis

The revised priority sector recommendation suggested by the Nair Committee will have far-reaching implications for the profitability of banks, in our view. The most draconian is the sub limit of 9% for small and marginal farmers (SFMF). There has been no relaxation in overall limits of priority sector of 40% and agri credit limit of 18%. However the draft guidelines suggest that 9% of the lending should be to small and marginal farmers. Most private sector banks don’t meet this requirement and they currently only meet 2.8%. So the shortfall is significant. In addition there is also a criterion of increasing the number of accounts under SFMF by atleast 15% every year. Also 7% of overall credit has to be given to the small and micro enterprises sector where again private sector banks currently only have 4.7% exposure.

Fig 36 Lending by banks to Small and Marginal Farmers (SFMF)

Lending to SFMF (Rs bn) ANBC (Rs bn) Lending to SFMF as a %

of ANBC (%) Year PSU

BanksPrivate Banks

Domestic SCBs

PSU Banks

Private Banks

Domestic SCBs

PSU Banks

Private Banks

Domestic SCBs

2007 603 21 624 13,177 3,366 16,543 4.57 0.64 3.772008 784 56 839 13,643 3,434 17,077 5.75 1.62 4.922009 1,039 86 1,124 16,934 4,065 21,000 6.13 2.10 5.352010 1,308 133 1,442 20,745 4,686 25,431 6.31 2.85 5.672011 1,577 150 1,727 24,935 5,336 30,271 6.32 2.82 5.71ANBC - Adjusted Net Bank Credit Source: RBI, Macquarie Research, March 2012

Fig 37 Lending by banks to micro enterprises

Lending to micro enterprises

(Rs bn) ANBC (Rs bn)

Lending to micro enterprises as a % of

ANBC (%)

Year PSU BanksPrivate Banks

Domestic SCBs

PSU Banks

Private Banks

Domestic SCBs

PSU Banks

Private Banks

Domestic SCBs

2007 441 33 473 13,177 3,366 16,543 3.34 0.97 2.862008 689 88 778 13,643 3,434 17,077 5.05 2.57 4.552009 895 111 1,006 16,934 4,065 21,000 5.29 2.74 4.792010 1,332 161 1,493 20,745 4,686 25,431 6.42 3.44 5.872011 1,732 249 1,981 24,935 5,336 30,271 6.94 4.67 6.54Source: RBI, Macquarie Research, March 2012

Fig 38 Roadmap for achievement of SFMF and micro enterprises target Targets as a percentage of ANBC (%) Year SFMF Micro Enterprises

2012 - 13 6 62013 - 14 7 72014 - 15 8 NA2015 - 16 9 NANA - Not Applicable Source: RBI, Macquarie Research, March 2012


20 March 2012 24

Currently most of the banks meet the overall priority sector target of 40% of adjusted net bank credit (of previous year). They generally fail in meeting the individual sub limits of agriculture and weaker sections.

Fig 39 Indian banks – Priority sector lending snapshot as of FY11

ANBC

Total PSL advances

Total Agri Advances

Of which Direct Agri

Of which Indirect Agri

Advances to Weaker

Sections Advances to

SFMF

Advances to Micro

Enterprises

Rs mn Amount Amount % of

ANBC Amount % of

ANBC Amount% of

ANBC Amount% of

ANBC Amount% of

ANBC Amount % of

ANBC Amount% of

ANBC

Private Banks

Axis Bank 930,180 413,000 44.4 163,810 15.2 99,610 10.7 6,420 6.9 46,540 5.0 26,231 2.8 43,439 4.7HDFC Bank 1,246,009 580,640 46.6 228,170 14.8 128,480 10.3 99,690 8.0 29,080 2.3 35,137 2.8 58,189 4.7ICICI Bank 1,039,040 551,730 53.1 154,140 14.0 98,970 9.5 55,170 5.3 34,430 3.3 29,301 2.8 48,523 4.7Kotak Bank 212,052 89,910 42.4 41,860 19.5 31,800 15.0 10,060 4.7 19,820 9.4 5,980 2.8 9,903 4.7Yes Bank 222,385 101,630 45.7 58,880 20.1 34,770 15.6 24,110 10.8 13,880 6.2 6,271 2.8 10,385 4.7PSU Banks BoB 1,315,688 573,640 43.6 245,290 17.5 171,580 13.0 73,710 5.6 132,450 10.1 83,151 6.3 91,309 6.9BOI 1,316,557 600,350 45.6 211,350 16.1 152,370 11.6 58,980 4.5 177,130 13.5 83,206 6.3 91,369 6.9Canara Bank 1,604,467 707,570 44.1 296,560 18.5 226,690 14.1 69,870 4.4 178,240 11.1 101,402 6.3 111,350 6.9PNB 1,812,408 737,650 40.7 350,540 19.3 268,370 14.8 82,170 4.5 183,650 10.1 114,544 6.3 125,781 6.9SBI 5,685,929 2,388,090 42.0 942,280 16.6 686,630 12.1 255,650 4.5 592,130 10.4 359,351 6.3 394,603 6.9Union Bank 1,172,506 491,280 41.9 202,540 14.1 113,010 9.6 89,530 7.6 118,490 10.1 74,102 6.3 81,372 6.9Source: Company data, Macquarie Research, March 2012 Note: ANBC stands for adjusted net bank credit

Since we don’t have data regarding advances to the SFMF and micro enterprises sector, we have applied the industry percentage exposure levels to individual banks and arrived at the possible shortfall that they would be having as of FY11.

Fig 40 Indian banks – Shortfall in PSL

INR m Overall PSL shortfall Total Agri shortfall Weaker section

shortfall SFMF shortfall Micro Ent. shortfall Private Banks Amount % of ANBC Amount % of ANBC Amount % of ANBC Amount % of ANBC Amount % of ANBC

Axis Bank 0 0 26,045 2.8 46,509 5.0 57,485 6.2 21,673 2.3HDFC Bank 0 0 39,872 3.2 95,943 7.7 77,003 6.2 29,032 2.3ICICI Bank 0 0 41,562 4.0 69,616 6.7 64,213 6.2 24,210 2.3Kotak Bank 0 0 - - 1,272 0.6 13,105 6.2 4,941 2.3Yes Bank 0 0 - - 8,451 3.8 13,743 6.2 5,182 2.3PSU Banks BoB 0 0 6,578 0.5 - - 35,260 2.7 789 0.1BoI 0 0 25,015 1.9 - - 35,284 2.7 790 0.1Canara Bank 0 0 - - - - 43,000 2.7 963 0.1PNB 0 0 - - - - 48,573 2.7 1,087 0.1SBI 0 0 79,603 1.4 - - 152,383 2.7 3,412 0.1Union Bank 0 0 45,728 3.9 - - 31,423 2.7 704 0.1Source: Company data, Macquarie Research, March 2012

The following table gives a rough impact on margins of banks if the entire shortfall were to be invested in RIDF bonds. Roughly the impact on NIMs is about 30bps for private sector banks and less than 10bps for PSU banks.


20 March 2012 25

Fig 41 NIM impact due to revised PSL norms INR m Shortfall calculation NIM Impact Older method Proposed Method RIDF Inv. (FY10) Earning assets (FY11) Negative Impact on NIM (bps)

Private Banks Axis Bank 72,554 121,485 30,227 2,029,836 30 HDFC Bank 135,815 199,879 41,971 2,347,641 43 ICICI Bank 111,177 98,499 101,100 3,595,267 14 Kotak Bank 1,272 18,046 5,075 604,682 15 Yes Bank 8,451 24,596 2,780 458,348 27 Average Private Banks 26 PSU Banks BOB 6,578 36,050 8,897 3,095,129 5 BOI 25,015 56,373 4,716 2,998,563 8 Canara Bank 0 43,962 6,905 2,921,021 6 PNB 0 49,660 15,863 3,258,526 6 SBI 79,603 155,794 178,339 10,873,809 6 Union Bank 45,728 58,807 19,048 2,090,923 11 Average PSU banks 7 Source: Company data, Macquarie Research, March 2012

RIDF deduction and yield on RIDF bonds – the biggest saviour in the new methodology

In the revised calculation methodology suggested, RIDF bonds existing on the balance sheet need to be netted off to arrive at the final shortfall. This was not done under the earlier methodology and hence this deduction now provides significant relief.

Fig 42 Details of methodology used for calculation of shortfall Old formula for calculation of shortfall A = Shortfall in Overall PSL target B = Shortfall in Agriculture target C = Shortfall in Weaker section target Total shortfall = C + (B or A), whichever is higher New formula for calculation of shortfall A = Shortfall in Overall PSL target B = Shortfall in Agriculture target C = Shortfall in Weaker section target D = Shortfall in target for SFMF E = Shortfall in target for Micro Enterprises F = Outstanding amount of RIDF funds deposited as penalty, as on 31st March of the preceding financial year (1) = [(B+C) or A, whichever is higher] less F (2) = Aggregate D + E Total shortfall for penalty = ((1) + (2)) or (2), if (1) is negative Source: Company data, Macquarie Research, March 2012

The second relief is clearly coming from interest rates on RIDF bonds where under the earlier system interest rates were linked to the bank rate which was at 6% and moreover higher the shortfall lower was the interest rates on RIDF bonds. Though the inverse relationship between shortfall and rate of interest on RIDF bonds has been maintained, the deduction from benchmark rate is lower in the revised methodology. For example, for a shortfall of 2–5%, there is only a 50bps deduction from benchmark rate suggested in the new methodology whereas in the earlier methodology it was 100bps plus, 200–300bps in the second category and 300bps plus in the fourth category of shortfall.

Fig 43 Rate of interest on RIDF bonds Levels/Category Shortfall Interest rate on RIDF bonds

1 Less than 2% Reverse Repo rate2 2% > r > 5% Reverse Repo rate - 50bps3 5% > r > 9% Reverse Repo rate - 100bps4 r > 9% Reverse Repo rate - 200bpsSource: Company data, Macquarie Research, March 2012


20 March 2012 26

Bigger implications for opex and asset quality We think the bigger implications emanating out of the revised priority sector norms would be on operating expenses and asset quality. Trying to access the small and marginal farmer sector is bound to put pressure on opex as banks would have to target larger branch presence in the rural areas to target these segments.

These were also the segments which benefited a great extent from the debt waiver done in 2008 post which moral hazard has crept into the sector and defaults have increased. Case in point is SBI’s agri NPLs which have increased substantially over the past few years.

Fig 44 SBI’s Agri NPLs have risen at an alarming rate in the past few quarters


6.4%7.2%

8.9%9.5%

5.00%

6.00%

7.00%

8.00%

9.00%

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4QFY11 1QFY12 2QFY12 3QFY12

SBI's Agri NPL ratio%


20 March 2012 27

Asset quality – Pains not yet over Agri NPLs – the biggest issue now Don’t underestimate the moral hazard issue here

Over the past few years agriculture sector has grown at a good pace and RBI itself has alluded that the high growth in the agriculture sector could have contributed to the NPL increases in the recent past as typically NPLs follow with a lag especially when a particular segment has witnessed a good acceleration.

Fig 45 Agriculture sector credit growth has been strong


Agri NPLs have been steadily rising and have contributed nearly 44% of last year’s incremental NPLs for banks in India.

Fig 46 Composition of incremental NPLs of domestic banks in FY11


-

50,000

100,000

150,000

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300,000

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FY02 FY03 FY 04 FY 05 FY 06 FY 07 FY08 FY09 FY10 FY11

Agr

icul

ture

cre

dit (

Rs

cror

es)

All PSU banks

CAGR of 22%

Agriculture44%

Non- priority sectors27%

Small scale industries21%

Other prioirty sectors8%


20 March 2012 28

Credit culture has significantly deteriorated in agriculture sector

Despite good monsoons over the past two years and a steady increase in minimum support prices, agri NPLs for banks in India have gone up by 150% in the past two years and NPL ratios have increased from 1.9% in FY09 to 3.5% in FY11 for the PSU banking sector.

Fig 47 Monsoons have been normal in the past two years

Source: IMD, Macquarie Research, March 2012

The key issue is that credit culture in the agriculture has deteriorated. We believe “willingness” to repay is a far greater issue than “affordability” to repay debt. Affordability anyways has been good for the farm sector whereas willingness to repay has been affected due to the large farm loan waiver done three years ago which has created a moral hazard. The figure below clearly shows the trends post FY09 (the year when farm loans waiver was announced by the government).

Fig 48 Agri NPLs – A trend over the past ten years Private banks FY02 FY03 FY 04 FY 05 FY 06 FY 07 FY08 FY09 FY10 FY11

Axis Bank 0.4% 0.3% 0.2% 1.6% 2.1% 1.6% 2.2% 1.5% 2.4% 2.6%HDFC Bank 0.0% 0.0% 0.0% 0.0% 0.4% 0.4% 0.5% 0.8% 0.6% 0.6%ICICI Bank 16.2% 9.7% 1.9% 1.2% 0.3% 2.1% 3.9% 2.8% 4.2% 7.2%Kotak 0.0% 0.4% 0.4% 0.3% 0.5% 1.4% 1.4% 0.6%PSU banks FY02 FY03 FY 04 FY 05 FY 06 FY 07 FY08 FY09 FY10 FY11BOB 18.1% 14.5% 12.9% 9.7% 4.8% 3.9% 3.1% 1.3% 2.9% 3.1%Bank of India 12.3% 11.8% 11.8% 7.3% 5.3% 3.5% 3.1% 2.1% 2.7% 4.2%Canara 11.0% 6.9% 6.5% 2.8% 2.8% 1.5% 1.4% 1.4% 1.8% 2.2%PNB 8.7% 7.3% 5.1% 3.0% 3.0% 3.5% 5.1% 2.3% 3.3% 3.3%SBI 15.6% 14.9% 12.5% 9.3% 6.3% 4.7% 5.2% 2.6% 2.8% 4.8%Union Bank 10.6% 8.0% 6.4% 4.5% 4.4% 3.1% 2.8% 2.0% 2.1% 4.2% FY02 FY03 FY 04 FY 05 FY 06 FY 07 FY08 FY09 FY10 FY11All PSU banks 12.4% 10.5% 8.4% 6.4% 4.0% 3.2% 3.3% 1.9% 2.2% 3.5%All Private Banks

5.5% 4.5% 2.6% 2.2% 1.4% 1.7% 2.5% 1.9% 2.3% 2.4%


We can see that NPLs have sharply increased for PSU banks post FY09.

-25

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20 March 2012 29

It’s not due to system migration – even fully migrated banks have seen sharp increases

On an average nearly 50% of the slippages seen in some PSU banks over the past two to three quarters have been due to migration to the system based recognition of NPLs with most of the slippages being constituted by agriculture sector. However if we look at SBI and BOB’s agri NPLs, they have gone up from 4.5% and 3.4% to 8.9% and 4.6% respectively over the past 15 months which is quite alarming as they didn’t have any migration to the system based recognition. This clearly explains that there is a structural issue with respect to asset quality in the agriculture segment.

Fig 49 SBI and BOB’s Agri NPLs on the rise


Farm loan waiver has caused de-rating in the past

The Congress-led United Progressive Alliance (UPA) government had announced in February 2008 a populist loan waiver scheme to bail out some 36m farmers who had borrowed from various public sector banks. The total waiver was to the tune of Rs720bn (~US$15bn).

Fig 50 Key highlights of farm loan waiver done in 2008 Sr. No Key Highlights

1 Full loan waiver for small farmers and marginal farmers. 2 Waiver will cover short term crop loans as well as all the overdue instalments on the investment credit. 3 For short-term production loans, the amounts disbursed upto March 31st, 2007 and overdue as on December 31st, 2007 and remaining unpaid

until February 28th, 2008 are eligible for loan waiver. 4 For investment loans, the instalments of such loans that are overdue, together with the interest are eligible for all loans disbursed upto March

31, 2007 and overdue as on December 31st, 2007 and remaining unpaid till February 28th 2008. 5 Marginal farmer is defined as cultivating agricultural land up to 1 hectare or 2.5 acres. 6 Small farmer is defined as cultivating between 1 hectare and 2 hectares i.e. less than 5 acres. Small and marginal farmers account for between

70 to 94 percent of all farmers in most states. 7 Other farmers, i.e. owning more than 5 acres or more than 2 hectares, will get one-time settlement (OTS) relief. 8 Bulk of all dry and unirrigated lands fall in districts covered by the drought prone area programme popularly known as DPAP and the desert

development programme (DDP). The total number of such districts is 237. 9 Special package for other farmers in these 237 districts. 10 For other farmers in these 237 districts, the OTS relief will be 25% or Rs. 20,000, whichever is higher and not 25 percent as announced in the

budget. 11 This means bigger relief for other farmers. For instance, if a farmer's overdue was Rs. 20,000 under the original package he would have had

Rs. 5,000, now the farmer will get Rs. 20,000 write off. If earlier the farmer's outstanding was Rs. 60,000, under the earlier package, he would have got Rs. 15,000, now he will get Rs. 20,000 written off.

12 On an average, the larger farmer (holding more than 5 acres) in these areas has a short term crop loan of about Rs. 19,908 and the average size of the investment loan is Rs.13,224. As per these figures, 60-65 percent of large farmers in these 237 districts will get not 25% relief, but full debt waiver.

Source: Ministry of Finance, Macquarie Research, March 2012

0.00%

2.00%

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14.00%

FY 04 FY 05 FY 06 FY 07 FY08 FY09 FY10 Jun-10 Mar-11 Jun-11 Sep-11

SBI BOB

Agri NPLs have been steadily increasing


20 March 2012 30

Fig 51 Severe de-rating of PSU banks post the announcement of farm loan waiver


As shown above, post the announcement of the farm loan waiver in 2008, PSU banks were severely de-rated by 20–25%. The Congress government did eventually go on to win the elections. With state and central government elections due over the course of next two years, agriculture NPLs could continue to be stubbornly high. Further populist measures and debt waivers can’t be ruled out over the course of next two years which could be a looming threat to profitability and is yet to be captured in the price, in our view.

Fig 52 Agri NPLs – Increase has been very sharp post the farm loan waiver in FY09

Private banks FY02 FY03 FY 04 FY 05 FY 06 FY 07 FY08 FY09 FY10 FY112 Yr CAGR

Increase

Axis Bank 4 5 5 26 57 83 109 123 248 419 85%HDFC Bank 23 33 36 101 110 145 20%ICICI Bank 129 219 78 82 46 404 982 874 1,303 1,116 13%Kotak Bank 1 3 5 10 37 49 27 -15%PSU banks BOB 646 592 510 445 332 404 411 225 636 772 85%Bank of India 435 492 556 514 474 397 410 336 490 898 63%Canara 426 372 425 244 333 228 261 287 462 663 52%PNB 444 512 474 354 432 647 1,012 537 977 1,171 48%SBI 2,520 2,369 2,124 1,913 1,929 1,977 2,915 1,789 2,322 4,518 59%Union Bank 306 295 291 279 356 330 325 270 369 856 78% All PSU banks 7,822 7,707 7,240 7,254 6,203 6,506 8,268 5,708 8,330 14,487 59%All Private Banks 439 537 459 465 515 861 1,467 1,441 2,023 2,172 23%Source: RBI, Macquarie Research, March 2012

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29-Feb-08 10-Mar-08 20-Mar-08 30-Mar-08 9-Apr-08 19-Apr-08 29-Apr-08 9-May-08 19-May-08

CNX PSU Banks Index

20% de-rating of PSU banks post the announcement of farm loan waiver


20 March 2012 31

Restructuring proposals already increasing at a rapid pace SME and mid-corporate sector – still not out of the woods

We don’t think that the stress in SME and mid-corporate sector is over. Our channel checks and recent interactions with CDR (Corporate Debt Restructuring) forum indicate that on an average the CDR cell are receiving references for ten cases per month with average exposure per case being around Rs5–6bn. SEBs and aviation sector are not under CDR currently. If we were to take SEB restructuring plus Air India restructuring into account, our estimates suggest that close to 3% of the loan book or around Rs1.4tr of assets are likely to be restructured between September 2011 and September 2012.

The CDR management has articulated that the situation currently looks even worse than 2008 as many more cases are being referred to CDR. Some of the proposals include conversion of debt to equity which is worrying as it indicates the seriousness of the situation. The rapid pace of restructuring proposals is expected to continue for a further three quarters, according to the CDR management.

Currently the sectors which are approaching CDR include construction, solar power, textiles, small steel companies and sugar. On an outstanding basis, steel contributes the largest quantum to CDR but that is largely due to two legacy assets. For a more detailed list of cases referred to CDR in the recent past, please refer to Appendix D.

Fig 53 Restructuring references and cases over the past quarters CDR cases (no.) Mar‐10 Mar‐11 Jun‐11 Sep‐11 Dec‐11

Total References Received No. of cases 256 305 323 341 364Aggregate Debt (Rs bn) 1,160 1,386 1,432 1,643 1,835 Cases Rejected/Closed No. of cases 32 42 47 48 52Aggregate Debt (Rs bn) 71 97 166 167 175 Cases under finalization No. of cases 9 21 24 34 37Aggregate Debt (Rs bn) 46 180 75 264 261 Total Cases Approved No. of cases 215 242 252 259 275Aggregate Debt (Rs bn) 1,043 1,109 1,191 1,212 1,400Source: www.cdrindia.org, Macquarie Research, March 2012

Fig 54 Restructured book should expand by ~Rs1.4tr during Sep 2011–12 What is the addition to restructured assets book? Rs bn

Addition to approved cases (Oct-Dec-11) 188Cases under finalisation (Dec-11) 261Short-term SEB restructuring 300Air India debt under restructuring 220Cases to be referred in future 192 Two more quarter restructuring * 300Total restructuring expected by Sep 2012 1,461Total credit outstanding 43,656Restructuring as a % of outstanding credit 3.3%* Roughly the guidance given by CDR cell Source: www.cdrindia.org, Macquarie Research, March 2012


20 March 2012 32

Fig 55 Proposals for restructuring outnumber those witnessed in 2008-09 Financial year ending March No. of cases referred No. of cases approved

2001-02 11 82002-03 43 332003-04 65 552004-05 36 322005-06 19 182006-07 7 62007-08 10 112008-09 34 292009-10 31 232010-11 49 272011-12 (Till Dec 2011) 59 332011-12 (Projected) 80 Source: www.cdrindia.org, Macquarie Research, March 2012

Note this doesn’t include bilateral restructuring that happens between a bank and a corporate. The CDR restructuring just constituted 20% of overall restructuring done in the past two years. So actual restructuring of loans could be much higher in our view.

Fig 56 Nearly 20% of restructuring has happened through CDR in the past (Rs m) FY 2009 FY 2010 FY 2011 CDR SME Others Total CDR SME Others Total CDR SME Others Total

BoB 1,999 8,195 15,771 25,964 3,558 4,024 16,623 24,204 1,660 3,827 8,897 14,384 % of total 8% 32% 61% 100% 15% 17% 69% 100% 12% 27% 62% 100%BoI 680 15,107 36,773 52,560 6,892 3,397 43,113 53,402 1,548 2,045 21,320 24,913 % of total 1% 29% 70% 100% 13% 6% 81% 100% 6% 8% 86% 100%Canara Bank 1,337 1,817 16,423 19,577 14,055 3,325 37,347 54,727 1,783 1,017 4,184 6,984 % of total 7% 9% 84% 100% 26% 6% 68% 100% 26% 15% 60% 100%IDBI Bank 5,608 - 25,706 31,314 35,097 - 57,906 93,002 32,378 - 65,996 98,373 % of total 18% 0% 82% 100% 38% 0% 62% 100% 33% 0% 67% 100%PNB 3,526 6,161 28,837 38,524 17,064 2,593 60,141 79,798 3,899 4,521 23,477 31,897 % of total 9% 16% 75% 100% 21% 3% 75% 100% 12% 14% 74% 100%SBI 2,850 12,905 92,018 107,773 27,931 10,205 130,434 168,571 7,524 3,694 35,784 47,002 % of total 3% 12% 85% 100% 17% 6% 77% 100% 16% 8% 76% 100%Union Bank 744 6,474 21,968 29,185 1,762 3,246 22,102 27,110 560 1,222 4,483 6,264 % of total 3% 22% 75% 100% 6% 12% 82% 100% 9% 19% 72% 100%PSU Coverage 16,743 50,659 237,495 304,897 106,359 26,790 367,666 500,814 49,351 16,326 164,141 229,817 % of total 5% 17% 78% 100% 21% 5% 73% 100% 21% 7% 71% 100%Source: Company data, Macquarie Research, March 2012

SBI’s SME NPLs increasing sharply

We don’t have a system wise classification of NPLs into various sectors and hence we can take SBI’s SME NPLs as a proxy to the system SME NPLs. Over the past several quarters we see a rapid rise in SME NPLs for the sector.

Fig 57 SBI – SME NPL ratios rising rapidly


3.66%4.19%

4.99%

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20 March 2012 33

Air India exposure and some SEB exposures to be restructured in 4Q12

The beleaguered state-run airline Air India is likely to be restructured by the end of March 2012. Though the total exposure of banks to Air India is around Rs700bn, only working capital loans of Rs225bn are going for restructuring. Part of loans (of Rs85bn) would be converted into bonds with non-SLR status but with central government backing; the bond paper would carry coupon rate of 9.25% and with zero risk-weight. Of the total exposure, banks are expected to take NPV losses of 10–12% (of almost Rs23bn).

Fig 58 Exposure of banks to Air India (as of Dec 2011) Rs m Exposure to Air India % of loans % of networth

Bank of India 25,000 1.1% 12.7%Punjab National Bank 22,000 0.8% 8.8%Bank of Baroda 22,000 0.8% 8.7%Canara Bank 18,000 0.8% 8.0%SBI 11,570 0.1% 1.5%Source: Company data, Macquarie Research, March 2012

Also, some SEBs like Rajasthan SEB, Haryana SEB etc might enter into restructuring agreements with banks for their working capital loans. All these could result in sharp bump up in restructured assets portfolio of PSU banks in 4Q.

Fig 59 Exposure of banks to SEBs (as of Dec 2011) Rs m Exposure to SEBs % of loans % of networth

Canara Bank 100,000 4.6% 44.5%Punjab National Bank 71,800 2.7% 28.8%SBI 65,000 0.8% 8.6%Union Bank 65,000 4.2% 50.7%Bank of India 65,000 2.8% 33.1%Bank of Baroda 40,000 1.5% 15.8%Source: Company data, Macquarie Research, March 2012

Fig 60 SEBs that have been restructured recently by banks Rs m SEB Period Amount restructured

Punjab National Bank Tamil Nadu 2QFY12 18,000Oriental Bank of Commerce Haryana 3QFY12 9,000Bank of Maharashtra Rajasthan 3QFY12 11,000Uco Bank Haryana 3QFY12 8,600Bank of Maharashtra Haryana 3QFY12 1,500Dena Bank Haryana 3QFY12 1,300Source: Company data, Macquarie Research, March 2012


20 March 2012 34

Power sector – the pain is not over; NPLs unsustainably low Growth in power sector has been rapid with NPLs at unsustainably low levels

The biggest issue in general with banks is the rapid pace at which infrastructure book has grown over the past few years. This has predominantly been led by the power sector, which forms 50% of the overall infrastructure book of banks.

Fig 61 Infrastructure has grown very rapidly, led by the power sector


Infrastructure now constitutes nearly 15% of the overall loan book of banks and has been close to 22% of the incremental loan book built up over the past two years.

Fig 62 Infrastructure now constitutes a large part of overall loan book


0102030405060708090

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20 March 2012 35

The following are some of the key concerns that we have:

1) Banks have not had prior experience lending to the infrastructure sector, and the portfolio has yet to become seasoned, considering much of the book was built up in the past three years, and these are very long-tenure loans. Hence, seasoning also takes time and NPLs will come with a lag, in our view.

2) Second, a look at the chart below reflects that NPLs are very low in this sector, i.e., close to the 50bps level. Even mortgages in India, which are considered to be among the safest assets, have NPL levels of 2% plus. In the power sector, where there are maximum concerns, NPLs are a mere 10bps, which is clearly unsustainable, in our view. Hence, we do believe that NPLs will pick up in this sector or that heavy restructurings are likely to be done to mask NPLs.

Fig 63 NPLs from infrastructure sector are unsustainably low at sub-50bps


Detailed analysis of IPPs – close to 23,000 MW of power projects at risk

While the government announcements with respect to greater coal supplies to power projects do improve sentiment, the track record of implementation leaves much to be desired. Nevertheless we believe pains with respect to gas based power projects and power projects where PPAs are fixed at low prices will continue to face stress as renegotiation of PPAs is unlikely.

Appendix A shows the list of projects in respect of the member organisations of the Association of Power Producers, which post-bidding or after signing MoU with respective States, have got stuck because of reasons such as shortage of coal linkage, coal mines stuck in ‘Go/No Go’ areas, gas shortage and increase in price of imported coal due to resource nationalism of source countries.

After consulting our India Infrastructure team and a possible increase in coal supply to some projects, we conclude that close to 23,000 MW of Independent Power Projects are at risk. Most of them are gas based projects where supplies are hit. The appendix section indicates which power projects have a large probability of default or restructuring. We have excluded projects where there has been no financial closure achieved and also projects which are expected to be commissioned pretty late (2015–16).

Gas-based power plants have been facing severe fuel shortages due to falling gas supply from Reliance’s KG-D6 basin. We estimate that the incremental supply of gas would be limited over next 3-4 years and, hence, gas-based capacities are likely to be limited in future.

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20 March 2012 36

Fig 64 All India gas supply unlikely to increase significantly in the near future figs in mmscmd FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E FY14E FY15E

ONGC 62.9 61.9 61.5 60.8 61.6 63.5 64.9 65.3 70.8 81.8 81.1Existing assets 62.9 61.9 61.5 60.8 61.6 63.5 62.2 61.0 59.8 58.6 57.4Others (C - series, etc) 2.7 4.3 11.1 23.3 23.7Oil India 5.5 6.2 6.2 6.5 6.2 6.6 6.9 7.2 7.4 7.4 7.4JVs 12.1 12.9 13.3 17.8 19.6 18.9 18.1 18.9 18.4 16.9 16.4RIL 39.4 57.1 47.2 45.6 44.7 60.7KG D-6 39.4 56.6 46.7 45.0 44.0 50.0 RIL - others 0.5 0.6 0.6 0.7 10.7GSPC Deendayal 0.0 10.0 12.0Others 6.5 7.3 6.0 3.7 2.6 1.7 3.1 3.1 3.1 3.1 3.1CBM and other forms 0.1 0.1 1.1 2.0 3.0 3.8 5.6LNG 9.5 19.1 25.7 31.5 30.5 32.9 38.9 44.0 57.7 73.6 87.1Total 96.5 107.4 112.7 120.3 120.5 163.1 190.1 187.6 206.0 241.3 273.5Total (ex-LNG) 87.0 88.2 87.0 88.8 90.1 130.3 151.2 143.7 148.3 167.6 186.4Source: MoPnL, Company data, Macquarie Research, March 2012

Fuel risks exist to upcoming gas-fired power plants. Our infrastructure team estimates that ~9,000MW gas-fired capacity is under construction or has been commissioned but does not have gas supply.

Fig 65 ~9,000MW capacity is awaiting gas supply

Fig 66 Major companies with large gas-based capacities under construction

Source: CEA, Infraline, Macquarie Research, March 2012 Source: CEA, Infraline, Macquarie Research, March 2012

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20 March 2012 37

The table shows below the bifurcation of power projects which are at risk. The overall list of IPPs likely to default submitted by association of power producers is shown in the appendix. Based on inputs received from our infrastructure team which takes into account increased allocation of coal from Coal India, we arrived at close to 16% of power exposure which is at risk of default or restructuring. This doesn’t include State Electricity Boards (SEBs) which could contribute another 10–15% to restructuring of overall power exposure.

Fig 67 IPP exposure at risk of default or restructuring

IPP at risk of restructuring/Defaults Capacity Capacity adjusted for

commissioning time line Cost of Project per MW Total Cost Total Debt

(at 70%)

Gas based power projects 7,008 6,288 40 251,520 176,064Coal based power projects 14,070 10,005 50 500,225 350,158 Other Gas based power projects 2,000 2,000 40 80,000 56,000Total Power Projects at Risk 23,078 18,293 582,222Out of which Banks' exposure at 85% 494,888 Total Power Sector Exposure 3,171,000As a % of total power sector 16%As a % of total loans 1.2%Source: Company data, Macquarie Research, March 2012

In the table above, we have adjusted the capacity for commissioning time line. Since disbursements to power projects usually happen in stages, we have taken into account 70% of overall capacity (and its equivalent disbursements by banks for projects to be commissioned in 2012–13, 45% for projects to be commissioned in 2013–14 and 20% for projects to be commissioned in 2014–15.

Expect stressed assets to net-worth to increase significantly Over the next year, we expect stressed assets as a proportion of net-worth to reach a ten-year high of 57% driven by PSU banks whose stressed assets as a proportion of net-worth is expected to touch a level of 90% by FY13E.

Fig 68 Stressed assets as a proportion of net-worth to increase significantly


0%10%20%30%40%50%60%70%80%90%

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Stressed assets/net-w orth - System Stressed assets/net-w orth -PSUs

Stressed assets/net-w orth - Privates


20 March 2012 38

NPL coverage ratios – They remain very poor India has the worst NPL coverage ratio in the Asia-Pacific region

A look at NPL coverage ratios of Indian banks reveals that most of them have reported NPL coverage ratios which are below 70%. RBI requires banks to have NPL coverage ratio of 70% based on September 2010 Gross NPLs and Gross NPLs since then have increased substantially thereby bringing down the NPL coverage ratios.

Fig 69 NPL coverage – PSU banks have poor ratios Fig 70 NPL coverage – Private banks much better

Source: Company data, Macquarie Research, March 2012 Note: NPL coverage ratios are as of 3Q FY12

Source: Company data, Macquarie Research, March 2012 Note: NPL coverage ratios are as of 3Q FY12

If we were to take into account restructured assets and 10% coverage on them which is usually what banks provide, the effective stressed assets (defined as NPLs plus restructured assets) coverage ratio looks even worse.

Fig 71 Stressed assets coverage ratio is very poor in Indian banks


66%

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20 March 2012 39

If we look at the NPL coverage ratio for Indian banks and compare it with the Asia-Pacific region, we see that India has the worst NPL coverage ratio in the region.

Fig 72 India has the worst reserve coverage ratio in the region


Even if we were to look at loan loss reserves to loans, Indian banks rank very poor reflecting the under-provisioned state compared to regional peers.

Fig 73 Reserves to loans – India again ranks poorly


252%

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Phillipines Thailand Indonesia Malaysia China Korea Singapore India Taiwan

LLR to loans


20 March 2012 40

RBI could tighten provisioning norms, credit costs to remain at elevated levels

The RBI has already alluded in the October 2011 monetary policy review that it is planning to re-look at the provisioning norms and introduce some countercyclical provisioning norms. We expect further burden on provisions going ahead which could keep credit costs at elevated levels.

Fig 74 Stressed assets as a percentage of advances should increase further


Fig 75 Credit costs to remain at elevated levels


1.0% 1.5%2.5%

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Private Banks PSU Banks Coverage Universe

0.25%

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1.80%




20 March 2012 41

Opex – Pressures to resurface for PSUs Tenth bipartite settlement to happen soon Tenth bipartite settlement expected to start in November 2012: Proactive provisions could be made

The Reserve Bank of India (RBI) said in its financial stability report that, going forward, banks will need to build adequate provisions for pension liabilities in a phased manner and that banks should avoid seeking regulatory dispensation to take the pension burden through reserves. This ensures that the burden will not be concentrated in the year in which the settlement is signed. The RBI has said that there are systemic stability issues arising from under-provisioning, and it has taken up the matter with the Indian Banks’ Association (IBA). In fact, the RBI has also pointed out that it did not agree to SBI’s request to amortise the pension liabilities because it believed that the liability could have been reasonably anticipated.

Clearly, we believe that, this time around, banks will have to provide for pensions as well as wage arrears earlier than expected and, consequently, that FY13 will continue to see staff expenses at elevated levels, a situation which we believe is not being factored by the street.

Pension pains still not over Larger employee base on defined benefit – cost of servicing to go up

We believe the market is underestimating the pension issue in PSU banks and, in our view, pension expenses are likely to remain high. After the opening of second option of pension, a large number of employees of PSU banks now have defined benefit option pensions compared to a defined contribution PF (Provident Fund). Hence, any changes in actuarial assumptions, which have been very aggressive, in our view, are likely to affect the cost of servicing pensions.

Outdated mortality tables and conservative wage hike assumptions

PSU banks calculate pension obligations based on outdated mortality tables of LIC, which were last revised in the late-1990s. Our calculations show that an increases in life expectancy by five years could increase pension obligations for PSU banks by ~30%.


20 March 2012 42

Fig 76 Sample calculation of increase in pension obligations due to increase in life expectancy

Assumptions Base case Year√ Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year10 Year11

Year12(Age

60)

Annual salary 100 107 114 123 131 140 150 161 172 184 197 210 225Age yrs 48 To retirement yrs 12 Salary increase 7.0%

Life expectancy of 70 yrs)

Age 61 Age 62 Age 63 Age 64 Age 65 Age 66 Age 67 Age 68 Age 69 Age 70

Pension payable 113 113 113 113 113 113 113 113 113 113 Discount rate 7.5% Discount factor 0.930 0.865 0.805 0.749 0.697 0.648 0.603 0.561 0.522 0.485 Pension corpus required

773

Current investment yields

7.5%

Required NPV of Pension Corpus 325

Life expectancy of 75 yrs Age 61 Age 62 Age 63 Age 64 Age 65 Age 66 Age 67 Age 68 Age 69 Age 70 Age 71 Age 72 Age 73 Age 74 Age 75

Pension payable 113 113 113 113 113 113 113 113 113 113 113 113 113 113 113Discount rate 7.5% Discount factor 0.930 0.865 0.805 0.749 0.697 0.648 0.603 0.561 0.522 0.485 0.451 0.420 0.391 0.363 0.338Pension corpus required 994 Current investment yields 7.5% Required NPV of Pension Corpus 417

Increase in pension obligation

28%


Also, different PSU banks used different salary increase assumptions. If we assume a 200bps increase in salary increase assumption, the pension obligations increase by another 20%.

Fig 77 Aggressive assumptions used by PSU banks for calculation of pension provisions SBI PNB BOB Canara BOI Union FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY11 FY10 FY11

Salary increase 5.00% 5.00% 6.50% 5.00% 4.00% 4.00% 7.00% 4.00% 5.00% 4.00% 4.00% 4.00%Discount rate 8.50% 8.50% 7.87% 8.45% 8.00% 8.50% 8.40% 8.50% 8.00% 8.50% 8.00% 8.50%Return on plan assets 8.00% 8.00% 8.56% 8.56% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00% 8.00%Source: Company data, Macquarie Research, March 2012

Although total pension provisioning is unavailable for every bank, our conversations with bank managements reveal that pensions, gratuity and other retirement benefits constitute nearly 35% of overall staff expenses, or closer to 25% of overall expenses for PSU banks.


20 March 2012 43

Large-scale recruitment likely in PSU banks Currently, Indian banks employ close to 1m people. Of these, around 0.75m people are employed by the public sector banks. IBPS (Institute of Banking Personnel Selection - IBPS is the nodal agency for recruitment of specifically state-owned bank employees) estimates that PSU banks will have to recruit about 0.6m people over the next five years and that there will be a situation in which only about 40% of bank staff will be experienced.

PSU banks during the early part of the decade stopped recruitment because they were moving towards computerization, whereby requirements for manpower were less and branch expansion was virtually absent. However, with increasing financial inclusion obligations, coupled with increasing competition and the need to explore more areas, PSU banks have now embarked on an expansion drive, as a result of which recruitment needs have increased.

This is clearly evident in the recent increase in manpower after nearly a decade-long virtual stoppage in recruitment.

Fig 78 PSU banks have started hiring workforce again


Again, competition, coupled with the need to achieve financial inclusion targets and priority sector obligations, has resulted in PSU banks once again embarking on branch expansion. This too has increased recruitment needs.

Fig 79 PSU banks have begun to expand their network


20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

FY2002 FY2003 FY2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011170,000

180,000

190,000

200,000

210,000

220,000

230,000

BOB BOI Canara Bank PNB Union Bank SBI

Hiring after a long period of lull phase

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

6,000

FY2002 FY2003 FY2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 20119,000

10,000

11,000

12,000

13,000

14,000

15,000

BOB BOI Canara Bank PNB Union Bank SBI

Expansion after a long period of lull phase


20 March 2012 44

Expect cost-income ratio to be high for PSU banks We expect cost-income ratio to move up by 100–150bps on an average over the next two years driven by higher employee benefit provisioning. Note that part of the increase in costs gets offset by the large number of expensive top management personnel retiring, and new employees joining at lower costs.

Fig 80 PSU banks – Cost-to-Income ratio to move upwards


40%

42%

44%

46%

48%

50%

52%

54%

FY2003 FY2005 FY2007 FY2009 FY2011 FY2013E

Cost to Income

Cost Income ratio to inch upw ards


20 March 2012 45

Structurally return ratios to come down Earnings growth weaker this cycle We expect earnings to witness pressure from all components of ROA namely 1) Net interest income (slower loan growth and pressure on margins) 2) higher operating cost mainly for PSU banks 3) increase in credit cost due to structural problems in some segments of infrastructure, deteriorating credit behaviour in agriculture and increased slippages from mid-corporate segments given higher interest rates and slowing economy.

We expect PSU banks earnings growth to decelerate in FY12 and they will post sluggish growth of 11-12% for FY13/14. Private sector banks earnings growth momentum is likely to moderate considerably (an average growth of about 15% over FY12-14E).

Fig 81 Earnings to slow down considerably over FY12-14E


ROA and ROE under pressure ROA declining this cycle

Return ratios are also going to be lower, owing to pressure on margins and high operating and credit costs. We expect PSU banks’ RoA to remain well below 1% given the pressure due to social obligation (priority sector lending – lower margins, high credit cost), higher operating cost (pension obligation, branch expansion) and asset quality issue due to high interest rate and slower economic growth.

Leverage to be lower

We expect Basel III regulations will cap the ability to leverage, thereby necessitating frequent equity dilution and thus lowering ROE structurally for Indian banks.

Refer figures 14 and 15 for the trends in ROA and ROE.

21.5%

51.5%

13.6%

43.6%

25.6% 24.6%

15.9% 14.4%16.5%

44.3%

36.8%

14.6%17.3%

-3.3%

12.8% 10.3%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

FY2007 FY2008 FY2009 FY2010 FY2011 FY2012E FY2013E FY2014E



20 March 2012 46

Valuations – No room for comfort The book value this time around is not reflective of the stressed state Looking at a series of P/BV valuation charts, we see that most of the stocks are now trading close to historical averages if we use a ten-year historical average. The stocks have been re-rated in the past five to seven years owing to structural factors; and hence, a five-year average should result in these stocks, especially the PSUs, trading slightly below their five-year average.

Fig 82 PSU banks: Trading above ten-year historical average

Source: Bloomberg, Company data, Macquarie Research, March 2012

Fig 83 Private banks: Trading at a ten-year historical average


However, this time around, the book value doesn’t reflect the true state due to large scale restructuring being done, which we believe overstates the book value. Hence, looking at historical averages could be misleading, in our view.

0.00.20.40.60.81.01.21.41.61.82.0

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20 March 2012 47

Discount of PSU banks over private banks set to expand further

With the clear divergence in performance expected, the discount of PSU banks over private banks, which had narrowed to as low as 38% two years ago, has now expanded back to 55% levels based on a ten-year average. We have seen cycles where this discount has been as high as 85%, and we don’t rule out a scenario like that occurring again due to increased stresses on the loan books of PSU banks compared to private banks.

Fig 84 PSU banks’ discount over private banks widening again


Valuation snapshot

Fig 85 Valuation matrix for our coverage universe EPS growth (%) P/E (x) P/BV (x) RoE (%) FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E

Private banks Axis Bank 26.2 23.9 13.3 15.4 12.4 11.0 2.8 2.3 2.0 19.3 20.4 19.7HDFC Bank 25.1 30.8 20.4 31.0 23.7 19.7 4.8 4.1 3.5 16.7 18.7 19.1ICICI Bank 25.8 20.7 10.2 21.0 17.4 15.8 2.0 1.8 1.7 9.6 11.0 11.3Kotak Mahindra Bank 16.1 16.1 21.1 26.2 22.5 18.6 3.9 3.3 2.8 16.8 15.9 16.5YES Bank 35.0 31.7 14.5 18.3 13.9 12.1 3.5 3.0 2.0 21.1 23.4 20.5Average Private banks

24.8 24.7 15.8 24.2 19.4 16.6 3.4 3.0 2.5 15.0 16.3 16.4

PSU banks BOB 33.7 4.2 7.2 7.6 7.3 6.8 1.7 1.4 1.2 23.5 19.8 18.1Bank of India 40.1 (11.5) 5.5 8.5 9.6 9.1 1.3 1.2 1.1 15.8 12.3 11.8Canara Bank 28.1 (20.6) 10.2 5.6 7.0 6.4 1.3 1.1 1.0 23.2 15.5 15.0IDBI Bank 8.0 (8.2) 9.6 7.5 7.0 5.8 0.9 0.8 0.7 14.6 11.6 10.9PNB 13.3 18.1 2.0 7.3 6.2 6.1 1.6 1.3 1.1 22.6 22.1 18.9SBI (9.2) 43.6 4.9 14.0 9.7 9.3 1.9 1.6 1.4 13.3 17.4 15.9Union Bank (1.6) (27.1) 27.3 6.1 8.4 6.6 1.2 1.1 0.9 18.0 11.6 13.4Average PSU banks 6.2 21.4 6.5 10.8 8.6 8.1 1.7 1.4 1.2 16.8 17.2 15.8Non banks HDFC Ltd 23.1 14.1 21.5 27.8 24.4 20.1 5.7 5.3 4.7 21.7 22.6 24.9IDFC Ltd 13.4 (5.8) 3.4 16.4 17.4 16.8 2.0 1.9 1.7 14.0 11.1 10.8PFC 11.1 (12.7) 13.8 8.9 10.2 9.0 1.5 1.3 1.2 18.4 14.7 13.8REC 20.7 (11.8) 6.7 8.7 9.9 9.2 1.8 1.6 1.4 21.6 16.8 16.1Reliance Capital (33.0) 101.0 161.4 36.8 18.3 13.9 1.4 1.3 1.2 3.8 7.3 9.1SHTF 40.5 14.3 8.5 10.8 9.5 8.7 2.7 2.2 1.9 28.1 25.8 23.2MMFS 29.7 18.8 11.6 14.7 12.3 11.1 2.8 2.4 2.1 22.9 21.1 20.1LIC Housing Fin. 47.2 (6.9) 37.2 12.4 13.3 9.7 2.9 2.5 2.0 25.8 20.0 23.1Average non banks 20.4 8.7 23.1 19.9 17.7 15.0 3.7 3.3 3.0 20.5 19.1 20.0Source: Bloomberg, Company data, Macquarie Research, March 2012 Note: Valuations are as of 14 March 2012

-90%

-80%

-70%

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-50%

-40%

-30%

-20%

-10%

0%

Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12Discount of PSU over Pvt Discount of PSU over Pvt excl ICICIAvg discount of PSU Avg discount of PSU over Private (excl ICICI)


20 March 2012 48

Fig 86 Recommendation matrix of our coverage universe Recommendation CMP (Rs.) TP (Rs.) Upside/Downside

Private banks Axis Bank Restricted 1,274 NA NAHDFC Bank OP 528 625 18%ICICI Bank N 954 855 -10%Kotak Mahindra Bank N 572 535 -7%YES Bank N 387 380 -2%PSU banks BOB UP 846 705 -17%Bank of India UP 393 255 -35%Canara Bank UP 527 385 -27%IDBI Bank UP 115 90 -22%PNB UP 1,027 790 -23%SBI UP 2,355 1700 -28%Union Bank UP 247 185 -25%Non banks HDFC Ltd OP 678 775 14%IDFC Ltd N 152 120 -21%PFC OP 203 190 -7%REC N 228 190 -16%Shriram Transport Finance N 589 600 2%M&M Financial Services UP 705 525 -26%LIC Housing Finance UP 254 190 -25%Share prices as of 14 March 2012 Source: Company data, Macquarie Research, March 2012

Macquarie R

esearch India banks

20 March 2012

49

Appendix A: Power projects under stress

Fig 87 Power projects under stress

Sr. No. Name of Project Name of Developer State Type Commissioning

Installed capacity

(MW) Cause of risk

Risk of restructuring/

NPLs

1 Mundra Phase 1 U-1,2 Adani Enterprises Gujarat Imported Coal 2009-10 660 Indonesian coal price hike NO 2 Mundra Phase 2 U-3,4 Adani Enterprises Gujarat Imported Coal 2010-11 660 Indonesian coal price hike YES 3 Mundra Phase 3, U-5,6 Adani Enterprises Gujarat Domestic Coal U5: 2010-11

U6: 2011-12 660 Denial of GMDC’s commitment to supply coal from

coal block. The alternative coal sourcing from Indonesia will have the coal price hike risk.

NO

4 Tiroda Unit 1,2,3 Adani Enterprises Maharashtra Domestic Coal U1 – 2011-12 U2,3- 2012-13

1,980 Denial of EC for captive coal (800 MW) and linkage coal shortages (1180 MW)

NO

5 Mundra Phase 4 Adani Enterprises Gujarat Blended Coal (70% Domestic, 30% Imported Coal)

2011-12 1,980 Linkage Coal Shortages & Indonesian Coal price Hike

NO

6 Kawai Project Adani Enterprises Rajasthan Domestic Coal 2012-13 1,320 Linkage Coal Shortages NO 7 Tiroda Phase 3 (U#4&5) Adani Enterprises Ltd Maharashtra Domestic Coal 2012-13 1,320 Linkage Coal Shortages NO 8 AES Chhatisgarh AES Chhatisgarh Captive Coal 2016-17 1,320 Delayed due to No-go issues NO 9 AES Orissa AES Orissa Captive Coal 2016-17 1,320 Delayed due to No-go issues NO 10 Singhitarai TPP Athena Chattisgarh

Power Ltd Chhattisgarh Domestic Coal

(Linkage + captive mine)

2014-15 1,200 Shortage of linkage coal and delay in signing of FSA. Delay in TOR approval for captive block

YES

11 Bhavanapadu Stage I East Coast Energy Pvt Ltd (Athena Energy Ventures Pvt. Ltd.)

AP Blended Coal (70% domestic and 30% imported)

2013-14 1,320 Shortage of linkage coal and delay in signing of FSA. MoEF order for work suspension since March 2011

NO

12 CLP Jhajjar CLP Haryana Domestic Coal 2012-13 1,320 Linkage shortages. Partly covered since this is Case-2

NO

13 DB Power project DB Power Limited (Dainik Bhaskar Group)

Chhattisgarh Linkage Coal 2013-14 1,200 Awaiting signing of FSA NO

14 Mahan Essar MP Captive Coal 2010-11 1,200 Captive mine stuck in No-Go issues YES 15 Salaya Essar Gujarat Imported Coal 2010-11 1,200 Indonesian coal price hike YES 16 Tori Essar Jharkhand Captive Coal 2013-14 1,200 Delayed due to No-go issues YES 17 Vemagiri (Expansion) GMR AP Gas 2011-12 768 Non availability of gas YES 18 Kamalanga GMR Orissa Domestic Coal 2012-13 1,050 Linkage coal shortages NO 19 Warora (EMCO) GMR Maharashtra Domestic Coal 2012-13 600 Linkage coal shortages NO 20 Raipur GMR Chattisgarh Domestic Coal 2013-14 1,370 Awaiting allocation of coal YES 21 Amravati TPS Ph-I Indiabulls Power Ltd Mahrashtra Linkage Coal 2012-13 1,350 Linkage Coal shortage NO 22 Amravati TPS Ph-II Indiabulls Power Ltd Mahrashtra Linkage Coal 2013-14 1,350 Linkage Coal shortage NO 23 Nasik TPS Ph-I Indiabulls Power Ltd Mahrashtra Linkage Coal 2012-13 1,350 Linkage Coal shortage NO 24 Nasik TPS Ph-II Indiabulls Power Ltd Mahrashtra Linkage Coal 2013-14 1,350 Linkage Coal shortage NO 25 Raj West Power Ltd. JSW Rajasthan Lignite 2011-12 1,080 Delay in land acquisition by Govt. of Rajasthan and

delay by RERC in determining provisional tariff NO

26 Ratnagiri U-1,2,3,4 JSW Energy Maharashtra Imported Coal 2010-11 1,200 Indonesian coal price hike NO 27 Udupi U-1,2 Lanco Karnataka Imported Coal 2011-12 1,200 Indonesian coal price hike YES 28 Amarkantak Phase 1 Unit

1,2 Lanco Chhatisgarh Steam Unit 1: 2008-09

Unit 2: 2009-10 600 Linkage coal shortage NO

29 Babandh Phase 2 Lanco Orissa Steam 2015-16 1,320 Linkage applied for but awaiting FSA NO 30 Himavat Lanco UP Steam 2015-16 1,320 Linkage applied for but awaiting FSA NO Source: Association of Power Producers, Macquarie Research, March 2012

Macquarie R

esearch India banks

20 March 2012

50

Fig 88 …Power projects under stress - cont

Sr. No. Name of Project Name of Developer State Type Commissioning

Installed capacity

(MW) Cause of risk

Risk of restructuring/

NPLs

31 Babandh Phase I Lanco Orissa Steam 2013-14 1,320 Linkage given is 10% less than NCDP norms. NO 32 Amarkantak Unit 3 Lanco Chattisgarh Steam 2013-14 660 Linkage given for 600MW only instead of 660 MW.

Also coal allocation is 10% less than NCDP norms.NO

33 Amarkantak Unit 4 Lanco Chattisgarh Steam 2013-14 660 Linkage given is 10% less than NCDP norms. NO 34 Kondapalli Stage 2 Lanco AP Gas 2009-10 368 Reduction in supply by RIL to 70% of allocated

quantity. YES

35 Anpara C Lanco UP Steam 2011-12 1,200 Linkage given is 10% less than NCDP norms. NO 36 Vidarbha Power Project LANCO Maharashtra Steam 2013-14 1,320 Linkage given is 10% less than NCDP norms. NO 37 Kondapalli Stage 3 Lanco AP Gas 2011-12 742 Non availability of gas YES 38 Anuppur Phase 1 Moserbaer Power

(Madhya Pradesh Ltd) MP Steam 2013-14 1,200 Disbursements from PFC/ REC are held up in

absence of 85% power tied up through Case-1 bids Since 35% each is already tied-up with MP Govt and PTC condition cannot be met.

YES

39 Anuppur Phase 2 Moserbaer Power (Madhya Pradesh Ltd)

MP Steam 2015-16 1,320 Financial closure pending in absence of coal linkage

NO

40 Birra Moserbaer Power (Madhya Pradesh Ltd)

Chhatisgarh Steam 2015-16 1,320 Financial closure pending in absence of coal linkage

NO

41 Butibori Reliance Maharashtra Steam 2011-12 300 FSA delayed NO 42 Chitrangi Reliance MP Steam 2015-16 4,000 Awaiting coal linkage NO 43 Samalkot Reliance AP Gas 2012-13 2,400 Non availability of gas YES 44 Krishnapattnam UMPP Reliance Power AP Imported Coal 2016-17 4,000 Indonesia coal price increase NO 45 RKMPPL 4x360 MW TPP RKM Powergen Pvt Ltd Chhattisgarh Domestic Coal 2012-13 1,440 FSA delayed YES 46 SPEGPL Supercritical TPP Shapoorji Pallonji

Energy (Gujarat) Pvt Ltd

Gujarat Imported Coal 2015-16 1,320 Indonesian coal price increase NO

47 Sterlite Jharsuguda Unit 1-4

Sterlite Energy Ltd Orissa Steam 2010-11 2,400 Linkage coal shortage NO

48 Rithala CC Tata Power Delhi Gas 2011-12 95 Relatively better placed, but cost could increase due to gas shortfalls

NO

49 Mundra UMPP Tata Power Gujarat Imported Coal 2012-13 4,000 Indonesian coal price increase YES 50 Sugen (Already operational

since 2009-10) Torrent Gujarat Gas 2009-10 1,148 Non availability of gas YES

51 Uno Sugen Torrent Gujarat Gas 2011-12 383 Non availability of gas YES 52 DGEN Torrent Gujarat Gas 2011-12 1,200 Non availability of gas YES Total 68,563 Source: Association of Power Producers, Macquarie Research, March 2012


20 March 2012 51

Appendix B: Basel III Capital requirements calculations We are showing only few banks’ capital requirements calculated here. The main assumption here is that we have taken into account a common equity of 8.5% while calculating capital requirements. Though RBI requires 8% common equity ratio including capital conservation buffer by FY17E, we believe in practice banks would never raise capital when their CE touches 8% and will keep a cushion and go ahead and raise capital. Hence we have assumed a CE of 8.5%.

Fig 89 SBI Group capital raising requirements under Basel III INR bn FY11 FY12E FY13E FY14E FY15E FY16E FY17E

Tier-I 849 1,053 1,190 1,356 1,548 1,767 2,020Tier-II 449 574 661 760 874 1,005 1,155Deductions to Tier-I 61 64 64 64 64 64 64Common Equity Tier-I 788 989 1,126 1,292 1,483 1,703 1,956 RWA 10,591 12,497 14,622 17,400 20,706 24,847 29,817RWA Growth 18% 17% 19% 19% 20% 20% Common Equity Tier-I 7.44% 7.91% 7.70% 7.43% 7.16% 6.86% 6.56%Tier-1 Ratios 8.02% 8.43% 8.14% 7.80% 7.47% 7.11% 6.78%Tier-2 Ratios 4.24% 4.60% 4.52% 4.37% 4.22% 4.04% 3.87%CAR 12.26% 13.02% 12.66% 12.16% 11.69% 11.16% 10.65% PAT 107 158 171 208 239 275 316PAT growth 48% 8% 21% 15% 15% 15%Dividend Payout Ratio 20% 20% 20% 20% 20% Common Equity Ratio 8.5% Capital to be raised 578Source: Company data, Macquarie Research, March 2012

Fig 90 Union Bank capital raising requirements under Basel III INR bn FY11 FY12E FY13E FY14E FY15E FY16E FY17E

Tier-I 122 123 140 159 181 206 235Tier-II 60 79 91 105 121 139 159Deductions to Tier-I 12 12 12 12 12 12 12Common Equity Tier-I 110 112 129 148 170 195 224 RWA 1,401 1,654 1,935 2,302 2,740 3,288 3,945RWA Growth 18% 17% 19% 19% 20% 20% Common Equity Tier-I 7.87% 6.77% 6.66% 6.42% 6.19% 5.93% 5.67%Tier-1 Ratios 8.69% 7.47% 7.25% 6.92% 6.61% 6.28% 5.96%Tier-2 Ratios 4.26% 4.79% 4.71% 4.55% 4.40% 4.21% 4.04%CAR 12.95% 12.26% 11.96% 11.47% 11.01% 10.49% 10.00% PAT 21 16 21 24 27 31 36PAT growth -25% 35% 13% 15% 15% 15%Dividend Payout Ratio 20% 20% 20% 20% 20% Common Equity Ratio 8.5% Capital to be raised 112Source: Company data, Macquarie Research, March 2012


20 March 2012 52

Fig 91 Axis Bank capital raising requirements under Basel III INR bn FY11 FY12E FY13E FY14E FY15E FY16E FY17E

Tier-I 184 219 258 301 350 407 472Tier-II 64 71 81 94 108 124 142Deductions to Tier-I 5 5 5 5 5 5 5Common Equity Tier-I 179 214 252 295 345 402 467 RWA 1,960 2,391 2,869 3,472 4,236 5,210 6,461RWA Growth 22% 20% 21% 22% 23% 24% Common Equity Tier-I 9.14% 8.95% 8.79% 8.51% 8.14% 7.71% 7.23%Tier-1 Ratios 9.41% 9.17% 8.98% 8.66% 8.26% 7.81% 7.31%Tier-2 Ratios 3.24% 2.96% 2.84% 2.69% 2.54% 2.37% 2.20%CAR 12.65% 12.13% 11.81% 11.35% 10.80% 10.18% 9.51% PAT 34 42 48 54 62 71 82PAT growth 25% 13% 12% 15% 15% 15%Dividend Payout Ratio 20% 20% 20% 20% 20% Common Equity Ratio 8.5% Capital to be raised 82Source: Company data, Macquarie Research, March 2012

Fig 92 ICICI Bank capital raising requirements under Basel - III INR bn FY11 FY12E FY13E FY14E FY15E FY16E FY17E

Tier-I 450 463 519 578 647 725 816Tier-II 218 218 250 288 331 380 437Deductions to Tier-I 52 52 52 52 52 52 52Common Equity Tier-I 398 411 467 526 595 673 764 RWA 3,415 3,996 4,715 5,611 6,677 8,012 9,614RWA Growth 17% 18% 19% 19% 20% 20% Common Equity Tier-I 11.65% 10.28% 9.90% 9.38% 8.90% 8.40% 7.94%Tier-1 Ratios 13.17% 11.58% 11.00% 10.30% 9.68% 9.05% 8.49%Tier-2 Ratios 6.37% 5.44% 5.31% 5.13% 4.95% 4.75% 4.55%CAR 19.54% 17.03% 16.30% 15.43% 14.64% 13.80% 13.04% PAT 52 63 70 74 86 98 113PAT growth 23% 10% 7% 15% 15% 15%Dividend Payout Ratio 20% 20% 20% 20% 20% Common Equity Ratio 8.5% Capital to be raised 53Source: Company data, Macquarie Research, March 2012


20 March 2012 53

Appendix C: Impaired assets trends

Fig 93 PSU Banks’ asset quality has deteriorated in the past few quarters driven by large restructurings Rs m 1Q FY11 2Q FY11 3Q FY11 4Q FY11 1Q FY12 2Q FY12 3Q FY12

PSU banks Bank of Baroda Gross NPL % 1.41% 1.39% 1.32% 1.36% 1.46% 1.41% 1.48% Net NPL % 0.39% 0.38% 0.36% 0.35% 0.44% 0.47% 0.51% Slippage ratio % 1.51% 0.61% 0.57% 1.27% 0.98% 0.87% 1.58% Coverage Reserve % 73% 73% 73% 75% 70% 67% 66% Restructured Assets O/S 52,834 54,327 60,468 67,114 71,663 78,292 99,455 Restructured Assets % 2.82% 2.79% 2.89% 2.90% 3.05% 3.24% 3.78% Impaired Assets 60,007 61,640 67,910 75,023 81,907 89,478 112,708 Impaired Assets % 3.20% 3.16% 3.25% 3.25% 3.49% 3.71% 4.28% Bank of India Gross NPL % 2.71% 2.64% 2.36% 2.23% 2.69% 3.02% 2.74% Net NPL % 1.18% 1.14% 0.88% 0.91% 1.27% 1.98% 1.78% Slippage ratio % 1.44% 1.85% 1.05% 2.07% 3.12% 5.25% 0.96% Coverage Reserve % 57% 57% 63% 60% 54% 35% 36% Restructured Assets O/S 101,287 100,324 103,480 106,446 111,015 111,152 136,737 Restructured Assets % 5.64% 5.45% 5.29% 4.86% 5.09% 5.07% 5.81% Impaired Assets 121,899 121,028 120,083 125,896 137,912 153,598 177,668 Impaired Assets % 6.79% 6.57% 6.14% 5.75% 6.33% 7.01% 7.55% Canara Bank Gross NPL % 1.46% 1.49% 1.44% 1.45% 1.67% 1.73% 1.81% Net NPL % 1.00% 1.06% 1.05% 1.11% 1.34% 1.43% 1.49% Slippage ratio % 1.24% 1.44% 1.18% 3.88% 2.58% 2.30% 1.58% Coverage Reserve % 32% 29% 28% 24% 20% 18% 18% Restructured Assets O/S NA 84,330 87,400 80,780 84,983 85,190 95,550 Restructured Assets % NA 4.77% 4.58% 3.79% 3.94% 3.90% 4.34% Impaired Assets NA 102,927 107,310 104,253 113,693 116,360 128,204 Impaired Assets % NA 5.82% 5.63% 4.89% 5.27% 5.32% 5.83% IDBI Bank Gross NPL % 1.94% 2.47% 2.22% 1.76% 2.10% 2.47% 2.94% Net NPL % 1.19% 1.57% 1.20% 1.06% 1.25% 1.57% 1.98% Coverage Reserve % 39% 37% 47% 40% 41% 37% 34% Restructured Assets O/S 93,628 93,151 106,110 105,470 105,607 91,246 99,246 Restructured Assets % 6.87% 5.92% 7.81% 6.67% 6.76% 5.80% 6.29% Impaired Assets 109,685 117,580 122,205 122,249 124,935 115,674 129,824 Impaired Assets % 8.04% 7.47% 8.99% 7.73% 7.99% 7.35% 8.23% Punjab National Bank Gross NPL % 1.82% 1.91% 2.03% 1.79% 2.00% 2.05% 2.42% Net NPL % 0.66% 0.69% 0.72% 0.85% 0.86% 0.84% 1.11% Slippage ratio % 2.61% 1.85% 1.87% 2.23% 1.94% 1.64% 2.70% Coverage Reserve % 64% 65% 65% 53% 57% 59% 55% Restructured Assets O/S 69,734 75,446 83,620 93,140 98,770 137,370 155,470 Restructured Assets % 3.54% 3.61% 3.78% 3.85% 4.07% 5.52% 5.92% Impaired Assets 82,568 89,701 99,371 113,526 119,678 158,255 184,484 Impaired Assets % 4.19% 4.30% 4.49% 4.69% 4.93% 6.36% 7.03% State Bank of India Gross NPL % 3.14% 3.35% 3.17% 3.28% 3.52% 4.19% 4.61% Net NPL % 1.70% 1.70% 1.61% 1.63% 1.61% 2.04% 2.22% Slippage ratio % 2.54% 2.66% 1.82% 3.05% 3.20% 4.20% 4.03% Coverage Reserve % 47% 50% 50% 51% 55% 53% 53% Restructured Assets O/S 153,040 191,270 212,070 228,060 233,700 238,790 260,670 Restructured Assets % 2.31% 2.76% 2.87% 2.95% 2.97% 2.95% 3.00% Impaired Assets 263,780 307,282 329,020 351,520 358,050 399,995 448,702 Impaired Assets % 3.97% 4.43% 4.45% 4.55% 4.54% 4.93% 5.16% Union Bank of India Gross NPL % 2.20% 2.79% 2.68% 2.37% 2.57% 3.49% 3.33% Net NPL % 0.94% 1.18% 1.21% 1.19% 1.32% 2.04% 1.88% Slippage ratio % 2.09% 3.68% 2.46% 1.23% 2.03% 5.07% 1.56% Coverage Reserve % 58% 59% 55% 50% 49% 42% 45% Restructured Assets O/S 49,768 51,164 52,571 56,162 58,448 66,011 86,430 Restructured Assets % 3.99% 4.05% 3.93% 3.68% 4.02% 4.48% 5.53% Impaired Assets 61,264 65,785 68,545 74,196 77,381 95,600 115,219 Impaired Assets % 4.91% 5.20% 5.12% 4.86% 5.32% 6.49% 7.38%Source: Company data, Macquarie Research, March 2012


20 March 2012 54

Fig 94 Private Banks have been lesser impacted by negative headwinds in stressed sectors Rs m 1Q FY11 2Q FY11 3Q FY11 4Q FY11 1Q FY12 2Q FY12 3Q FY12

Private banks Axis Bank Gross NPL 13,409 13,624 14,829 15,994 15,731 17,438 19,145 Gross NPL % 1.13% 1.12% 1.09% 1.01% 1.06% 1.08% 1.10% Net NPL 4,134 4,094 3,855 4,104 4,625 5,488 6,829 Net NPL % 0.35% 0.34% 0.29% 0.26% 0.31% 0.34% 0.39% Slippage 4,210 4,460 3,340 2,480 2,960 4,960 5,350 Slippage ratio % 1.60% 1.63% 1.20% 0.80% 0.82% 1.49% 1.51% Coverage Reserve 9,275 9,530 10,974 11,891 11,107 11,950 12,316 Coverage Reserve % 69% 70% 74% 74% 71% 69% 64% Gross Loans 1,095,365 1,115,411 1,246,444 1,435,969 1,330,103 1,412,843 1,499,707 Restructured Assets O/S 21,510 20,610 21,170 19,300 21,510 24,100 27,010 Restructured Assets % 1.96% 1.85% 1.70% 1.34% 1.62% 1.71% 1.80% Impaired Assets 25,644 24,704 25,025 23,404 26,135 29,588 33,839 Impaired Assets % 2.34% 2.21% 2.01% 1.63% 1.96% 2.09% 2.26% HDFC Bank Gross NPL 17,912 18,412 17,818 16,943 18,331 18,949 20,206 Gross NPL % 1.21% 1.16% 1.11% 1.05% 1.04% 1.00% 1.03% Net NPL 4,125 4,085 3,307 2,964 3,185 3,553 3,980 Net NPL % 0.30% 0.30% 0.20% 0.20% 0.20% 0.20% 0.20% Coverage Reserve 13,787 14,327 14,511 13,979 15,146 15,397 16,226 Coverage Reserve % 77% 78% 81% 83% 83% 81% 80% Gross Loans 1,476,271 1,585,233 1,606,347 1,613,806 1,770,306 1,900,419 1,959,254 Restructured Assets O/S 2,953 1,585 1,606 1,614 3,541 1,900 1,959 Restructured Assets % 0.20% 0.10% 0.10% 0.10% 0.20% 0.10% 0.10% Impaired Assets 7,078 5,671 4,913 4,578 6,726 5,453 5,939 Impaired Assets % 0.48% 0.36% 0.31% 0.28% 0.38% 0.29% 0.30% ICICI Bank Gross NPL 98,290 101,410 101,866 100,343 99,828 100,210 97,230 Gross NPL % 5.15% 5.04% 4.76% 4.48% 4.37% 4.14% 3.83% Net NPL 34,562 31,920 28,726 24,074 23,025 21,810 20,850 Net NPL % 1.87% 1.64% 1.39% 1.11% 1.04% 0.93% 0.85% Slippage 3,484 4,461 455 - 7,500 7,800 8,770 Slippage ratio % 0.75% 0.94% 0.09% 0.00% 1.34% 1.37% 1.45% Reductions - 1,340 - 1,524 8,015 7,418 11,750 Coverage Reserve 63,729 69,490 73,140 76,269 76,802 78,400 76,380 Coverage Reserve % 65% 69% 72% 76% 77% 78% 79% Gross Loans 1,907,509 2,011,500 2,140,060 2,239,919 2,283,732 2,417,922 2,537,950 Restructured Assets O/S 37,370 25,780 25,620 19,700 19,660 25,010 30,700 Restructured Assets % 1.96% 1.28% 1.20% 0.88% 0.86% 1.03% 1.21% Impaired Assets 71,932 57,700 54,346 43,774 42,685 46,820 51,550 Impaired Assets % 3.77% 2.87% 2.54% 1.95% 1.87% 1.94% 2.03% Kotak Bank Gross NPL 9,357 9,043 8,637 7,120 7,174 7,052 6,780 Gross NPL % 2.79% 2.37% 2.12% 1.71% 1.59% 1.38% 1.27% Net NPL 3,930 3,320 2,747 2,427 2,407 2,326 2,465 Net NPL % 1.19% 0.88% 0.69% 0.59% 0.54% 0.46% 0.47% Coverage Reserve 5,426 5,724 5,890 4,693 4,767 4,727 4,315 Coverage Reserve % 58% 63% 68% 66% 66% 67% 64% Gross Loans 335,478 380,873 406,854 417,114 446,848 510,537 532,785 Restructured assets NA 1,300 1,140 600 810 720 630 Restructured Assets % NA 0.34% 0.28% 0.14% 0.18% 0.14% 0.12% Impaired Assets NA 4,620 3,887 3,027 3,217 3,046 3,095 Impaired Assets % NA 1.21% 0.96% 0.73% 0.72% 0.60% 0.58% Yes Bank Gross NPL 597 677 728 805 559 688 721 Gross NPL % 0.23% 0.22% 0.23% 0.23% 0.17% 0.20% 0.20% Net NPL 111 172 174 92 27 136 144 Net NPL % 0.04% 0.06% 0.06% 0.03% 0.01% 0.04% 0.04% Coverage Reserve 486 506 555 714 532 552 577 Coverage Reserve % 81% 75% 76% 89% 95% 80% 80% Gross Loans 263,054 303,987 311,677 344,350 331,572 342,493 359,255 Restructured Assets O/S 804 690 837 829 870 1,755 1,757 Restructured Assets % 0.31% 0.23% 0.27% 0.24% 0.26% 0.51% 0.49% Impaired Assets 915 862 1,011 921 897 1,891 1,901 Impaired Assets % 0.35% 0.28% 0.32% 0.27% 0.27% 0.55% 0.53%Source: Company data, Macquarie Research, March 2012


20 March 2012 55

Appendix D: CDR cases referred

Fig 95 CDR cases referred during the period 1 April 2011 to 30 June 2011 Name of case Total Exposure (Rs m)

Sabare International Ltd. 1,056 Euo Ceramics Ltd. 4,524 Malwa Industries Ltd. 2,743 Crosslay Remedies Ltd. 1,011 Ruchi Power & Steel Industries Ltd. 6,015 KLG Systel Ltd. 3,322 Rim Jhim Stainless Ltd. 2,022 Eastern Silk Industries Ltd. 4,481 Bengal Waterproof Ltd. 291 Mackeil Ispat & Forgings Ltd. 1,231 Sparta Cements & Infra Ltd. 1,364 Maithan Ispat Ltd. 4,358 Solar Semiconductor Pvt. Ltd. 3,884 SPL Industries Ltd. 849 New Tirupar Area Development Corp. Ltd. 7,794 Maneesh Pharmaceutical Ltd. 11,790 Total 56,735 Source: www.cdrindia.org, Macquarie Research, March 2012

Fig 96 CDR cases referred during the period 1 July 2011 to 30 September 2011 Name of case Total Exposure (Rs m)

Amulya Exposts Ltd. 671 Soni Ispat Ltd. 2,519 Metalman Industries Ltd. 2,123 GTL Infrastructure Ltf. 45,648 J. U. D. Cements Ltd. 1,841 Chennai Network Infrastructure Ltd. 63,198 Sree Rayalseema Papers mills Ltd. 1,062 Pokarana Engineered Stone Ltd. 1,108 Empee Sugars & Chemicals Ltd. 4,775 GTL Ltd. 59,199 Sirius Overseas Pvt. Ltd. 1,716 Venna Industries ltd. 2,059 Yash Papers Ltd. 1,028 SBQ Steels Ltd. 10,656 KS Oils Ltd. 25,644 Gold Plus Glass Industry Ltd. 4,040 Primus Retail Pvt. Ltd. 885 Maruti Cotex Ltd. 2,419 Mint Biofuels Ltd. 119 Total 230,709 Source: www.cdrindia.org, Macquarie Research, March 2012


20 March 2012 56

Fig 97 CDR cases referred during the period 1 October 2011 to 31 December 2011 Name of case Total Exposure (Rs m)

Kanco Enterprises ltd. 405 Indo Solar Ltd. 7,934 Punjab Chemicals & Crop Protection Ltd. 3,153 MSM Energy Ltd. 691 Vijai Electricals Ltd. 21,987 Vikas Smelters & Alloys Ltd. 2,213 Progressive Constructions Pvt. Ltd. 16,034 Dighi Port Ltd. 8,649 White Metal Ltd. 1,780 Kemrock Industries & Export Ltd. 15,868 Futura Polyesters Ltd. 1,940 Karnal Agriculture Industries Ltd. 1,199 ICSA (India) Ltd. 16,142 Vikash Metal & Power Ltd. 2,027 Bharati Shipyard Ltd. 56,497 Steelco Gujarat Ltd. 1,677PBA Infrastructure Ltd. 3,218 Total 161,415 Source: www.cdrindia.org, Macquarie Research, March 2012

Fig 98 Industry wise classification of approved cases – Infra, Telecom, Steel & Textile show maximum stress (Rs bn) Mar‐10 Mar‐11 Jun-11 Sep-11 Dec-11 Dec-11

Industry No. Debt No. Debt No. Debt No. Debt No. Debt % of total% Incremental

(9 months)

Iron & Steel 25 367 25 367 26 368 28 375 30 382 27.3% 5.2%Fertilizers 8 85 8 85 8 85 8 85 8 85 6.0% 0.0%Textiles 47 89 54 102 54 102 55 107 57 114 8.1% 3.9%Petrochemicals 3 55 3 55 3 55 3 55 3 55 3.9% 0.0%Refineries 1 49 1 49 1 49 1 49 1 49 3.5% 0.0%Cements 6 47 8 59 8 59 8 59 9 61 4.4% 0.6%Telecom 7 53 8 54 8 54 8 54 9 92 6.6% 13.0%Sugar 20 53 23 61 61 23 61 24 66 4.7% 1.5%Power 7 38 7 38 7 38 7 38 7 38 2.7% 0.0%Chemicals 13 27 14 28 15 29 15 29 15 29 2.1% 0.3%Metals (Non-ferrous Metals)

5 22 5 22 5 22 5 22 5 22 1.6% 0.0%

Electronics 2 21 2 21 2 21 3 25 3 25 1.8% 1.3%Infrastructure 9 52 9 52 10 56 10 56 12 171 12.2% 41.0%Pharmaceuticals 6 21 6 21 8 32 8 32 9 33 2.4% 4.2%Paper/Packaging 11 12 13 19 14 20 14 20 16 21 1.5% 0.9%Cables 7 8 8 12 8 12 8 12 8 12 0.9% 0.0%Automobiles 2 6 2 6 2 6 2 6 2 6 0.4% 0.0%Auto Components 7 6 7 6 7 6 7 6 7 6 0.4% 0.0%Wood Products 1 5 1 5 1 5 1 5 1 5 0.3% 0.0%Engineering 6 5 8 8 8 8 8 8 9 9 0.6% 0.4%Ceramic 5 3 6 4 6 4 7 8 7 8 0.6% 1.4%Ship Building / Ship-Breaking

1 2 2 9 2 9 2 9 2 9 0.6% 0.0%

Rubber 3 2 3 2 3 2 3 2 3 2 0.1% 0.0%Hotels 2 1 3 4 3 4 3 4 3 4 0.3% 0.0%Forgings 1 1 1 1 1 1 1 1 1 1 0.1% 0.0%Glass 2 1 2 1 2 1 2 1 2 1 0.1% 0.0%Plastic 2 2 3 4 3 4 3 4 3 4 0.3% 0.0%Retail 1 5 1 5 1 5 1 5 1 5 0.3% 0.0%Battery 1 0 2 1 2 1 2 1 2 1 0.0% 0.0%NBFC 0 2 2 6 66 6 66 6 66 4.7% 21.9%Hospital & Healthcare 0 0 0 1 1 1 1 0.1% 0.3%Food & Food Processing 0 0 0 3 5 3 5 0.4% 1.8%Other 4 8 5 9 5 9 3 5 6 15 1.1% 2.2%Total 215 1,043 242 1,109 252 1,191 259 1,212 259 1,400 Source: www.cdrindia.org, Macquarie Research, March 2012


20 March 2012 57

INDIA

AXSB IN Close Price* 15 Mar 12 Rs1,242.15

GICS sector Banks

Market cap Rsm 512,851

30-day avg turnover US$m 6.7

Market cap US$m 10,179

Number shares on issue m 412.9

Investment fundamentals

Year end 31 Mar 2011A 2012E 2013E 2014E Net interest Inc bn 65.6 81.6 94.5 109.8 Non interest Inc bn 46.4 54.0 63.0 74.6 PBT bn 51.4 63.1 71.5 80.2 PBT growth % 33.5 22.6 13.3 12.1 Reported profit bn 34.0 42.3 47.9 53.7 EPS rep Rs 82.72 102.95 116.68 118.95 EPS rep growth % 33.3 24.5 13.3 1.9 PER rep x 15.0 12.1 10.6 10.4 Total DPS Rs 14.51 18.40 18.40 18.40 Total div yield % 1.2 1.5 1.5 1.5 ROA % 1.6 1.6 1.5 1.4 ROE % 19.4 20.4 19.7 17.3 Equity to assets % 7.8 7.7 7.6 8.6 P/BV x 2.7 2.3 1.9 1.6

AXSB IN rel BSE Sensex performance

Source: FactSet, Macquarie Research, March 2012 (all figures in INR unless noted)

Analyst(s) Suresh Ganapathy, CFA +91 22 6720 4078 [email protected] Parag Jariwala +91 22 6720 4083 [email protected] Yuvaraj Bhole +91 22 6720 4098 [email protected]


Axis Bank Present perfect, future tense? Event

Good franchise but some worries persist: Axis Bank continues to have a reasonably good liabilities franchise. However key worries are slowing loan growth and a possible pick up in credit costs as slippages and restructuring increase. We are restricted on the stock and hence we can’t comment on rating

or TP.

Impact

Slippages and restructured assets to pick up: Slippages for the past 2 quarters have been around 150bps (annualised). This is much lower than the 220bps seen during 2009. Restructured assets quantum is also increasing steadily at the rate of Rs3bn per quarter for the past two quarters. We do expect a pick up in restructured assets going forward. Stressed assets as a proportion of net worth is expected to increase to 25% by end of FY14 from 12% seen at the end of FY11.

Moving up the risk curve, that’s a worrying sign: If we look at the ratings of corporates that Axis Bank discloses, we see that the bank has been moving toward lower rated corporates both in large & mid corporate and SME sector. This perhaps has resulted in its ability to keep margins at high levels of 3.7%. However we would be wary of such a move in such a weak economic scenario.

Fee income growth is very encouraging and expected to be strong: What impresses is the continued momentum in fee income growth. When overall fee income growth for the sector itself is slowing down, Axis Bank continues to impress us on fees owing to its diversified product suite and debt syndication abilities. Fee income growth continues to be above balance sheet growth. The third party distribution fees from its tie up with Max New York Life insurance is also helping fee income growth.

Could benefit from falling wholesale rates: Though liquidity is currently very tight, it is expected to improve in 1Q FY13 and that should help to protect margins in the near term as nearly 40% of Axis Bank’s deposits is constituted

by wholesale/bulk/corporate deposits and wholesale rates are expected to come down in 1Q FY13 by when even RBI is expected to cut benchmark rates. Hence current high level of margins could continue for some time and could be above the management guided range of 3.25% to 3.50% in the near term.

Earnings and target price revision

We are increasing FY13E earnings by 13% mainly on account of higher fees and margins both of which have surprised us positively.

Price catalyst

Due to research restrictions, Macquarie cannot advise its valuation on AXSB IN at present.

Action and recommendation

We are restricted on the stock.


20 March 2012 58

Fig 1 Select Ratios

% FY09 FY10 FY11 FY12E FY13E FY14E

GROWTH PROJECTIONS Growth in Net interest income 42.6 35.8 31.1 24.4 15.8 16.1 Growth in Operating profit (PPP) 67.3 40.7 22.4 19.7 14.8 15.5 Growth in Net profit 69.5 38.5 34.8 24.7 13.3 12.1 Growth in Total assets 34.8 22.3 34.4 19.4 18.8 20.5 Growth in Shareholder's Equity 16.5 57.1 18.4 17.8 17.6 35.6 ASSET ANALYSIS Net interest income / average assets 2.9 3.0 3.1 3.1 3.0 2.9 Earning assets to Total assets 90.4 91.9 91.4 92.3 93.3 93.1 Return on Avg Earning Assets 1.6 1.7 1.7 1.7 1.6 1.5 Loans to earning assets 61.1 62.8 64.2 64.5 64.4 64.3 LOAN ANALYSIS Loan growth 36.7 27.9 36.5 21.0 20.0 20.0 Corporate loan growth 42.6 27.4 44.6 21.0 20.0 20.0 Retail loan growth 18.1 29.7 33.3 21.0 20.0 20.0 SME loan growth 39.4 21.2 9.9 21.0 20.0 20.0 Agriculture loan growth 49.2 40.4 50.2 21.0 20.0 20.0 DEPOSIT ANALYSIS Deposits growth 33.9 20.4 33.9 21.0 21.0 21.0 Current & savings to total deposit 43.1 46.7 41.1 41.1 41.1 41.1 Time deposit to total deposit 56.9 53.3 58.9 58.9 58.9 58.9 Deposits to Interest Bearing Liabilities 92.0 92.3 90.0 91.2 92.3 93.2 LIQUIDITY LDR 69.5 73.8 75.3 75.2 74.6 74.0 Loans to Assets 55.2 57.8 58.7 59.5 60.1 59.8 Customer Deposits to Earning Assets 87.9 85.1 85.3 85.7 86.3 86.9 ASSET QUALITY Gross NPA ratio 1.10 1.26 1.12 1.13 1.44 1.82 Loan loss coverage ratio 63.6 68.2 74.3 55.4 53.5 57.0 Provisions to Loans 1.13 1.46 0.77 0.69 0.80 0.88 Reserves to Loans 0.70 0.86 0.84 0.62 0.77 1.04 CAPITAL ADEQUACY Tier I CAR 9.26 11.18 9.41 9.17 8.87 9.90 Total CAR 4.43 4.62 3.24 2.96 2.43 1.99 Equity to assets 6.9 8.9 7.8 7.7 7.6 8.6 SPREAD ANALYSIS Yield on average assets 8.87 7.42 7.47 8.45 8.17 8.04 Average cost of funds 6.23 4.53 4.56 5.69 5.55 5.54 Spread 2.64 2.90 2.91 2.76 2.62 2.50 Net interest margin 3.33 3.75 3.67 3.63 3.50 3.40 OTHER INCOME Non interest income to total income 21.10 25.32 23.41 19.94 20.04 20.11 Fees to non interest income 75.02 65.01 72.48 75.90 79.36 81.70 Fees to total income 15.83 16.46 16.97 15.13 15.90 16.43 OPERATING EFFICIENCY Cost to income 43.4 41.4 42.7 43.3 44.0 44.8 Cost to assets 2.2 2.3 2.3 2.2 2.2 2.2 Interest bearing liabilities /Total liabilities 92.8 93.0 94.0 93.9 94.5 94.9 PROFITABILITY ROA 1.41 1.53 1.60 1.59 1.51 1.42 ROE 19.1 19.2 19.3 20.4 19.7 17.3 Pre provision ROE 39.2 39.9 36.6 37.1 36.2 32.8 Dividend yield 0.8 1.0 1.2 1.5 1.5 1.5 Basic EPS (Rs) 50.6 65.8 83.1 102.9 116.7 118.9 Diluted EPS (Rs) 50.3 65.4 82.6 102.3 116.0 118.9 VALUATIONS (x) P/E 24.5 18.9 15.0 12.1 10.6 10.4 P/BV 4.4 3.1 2.7 2.3 1.9 1.6 PUP 12.0 9.6 8.0 6.6 5.8 5.5 Source: Company data, Macquarie Research, March 2012


20 March 2012 59

Valuation chart

Fig 2 Axis Bank: 1 yr fwd P/BV


0.00.51.01.52.02.53.03.54.04.5

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PBV Average +1 std -1 std


20 March 2012 60

Axis Bank (AXSB IN) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 22,411 21,849 22,229 21,031 Net Interest Income m 65,630 81,617 94,515 109,758 + Loan Fees m 11,247 10,965 11,753 11,120 + Loan Fees m 33,574 40,961 49,972 60,966 + Trading Income m 2,581 2,516 2,198 2,080 + Trading Income m 9,299 9,398 9,346 9,970 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 994 970 858 813 + Other Income m 3,524 3,617 3,654 3,690 Non Interest Income m 14,822 14,450 14,809 14,012 Non Interest Income m 46,397 53,976 62,971 74,625 Total Operating Inc m 37,233 36,299 37,039 35,043 Total Operating Inc m 112,027 135,593 157,486 184,383

+ Staff expenses m 5,413 5,277 5,381 5,091 + Staff expenses m 16,139 19,712 22,880 26,484 + Other expenses m 10,724 10,455 10,924 10,335 + Other expenses m 31,655 39,056 46,444 56,092 Total Operating Exp m 16,137 15,732 16,305 15,426 Total Operating Exp m 47,794 58,769 69,324 82,576

Pre-Provision Profit m 21,096 20,567 20,734 19,617 Pre-Provision Profit m 64,233 76,824 88,162 101,807 Loan Provisions m 3,774 3,679 3,920 3,708 Loan Provisions m 12,800 13,743 16,666 21,631 Post Provision Profit m 17,322 16,888 16,814 15,909 Post Provision Profit m 51,432 63,081 71,496 80,176 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 17,322 16,888 16,814 15,909 Pre-Tax Profit m 51,432 63,081 71,496 80,176 - Taxation m 5,716 5,572 5,549 5,250 - Taxation m 17,472 20,815 23,592 26,456 Net Profit After Tax m 11,606 11,316 11,266 10,659 Net Profit After Tax m 33,961 42,266 47,904 53,720 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 11,606 11,316 11,266 10,659 Reported Profit m 33,961 42,266 47,904 53,720 Adjusted Profit m 11,606 11,316 11,266 10,659 Adjusted Profit m 33,961 42,266 47,904 53,720 Attributable Profit m 11,606 11,316 11,266 10,659 Attributable Profit m 33,961 42,266 47,904 53,720 EPS (rep) 28.27 27.56 27.44 25.96 EPS (rep) 82.72 102.95 116.68 118.95 EPS growth pcp (rep) % 24.5 24.5 13.3 13.3 EPS growth yoy (rep) % 33.3 24.5 13.3 1.9 EPS (adj) 28.27 27.56 27.44 25.96 EPS (adj) 82.72 102.95 116.68 118.95 EPS growth pcp (adj) % 24.5 24.5 13.3 13.3 EPS growth yoy (adj) % 33.3 24.5 13.3 1.9 DPS 4.60 4.60 4.60 4.60 DPS 14.51 18.40 18.40 18.40 Payout ratio % 17.5 17.9 15.8 15.5 Book Value p.s (wgted) 462.8 545.0 641.0 790.0 Tangible Book Value p.s (wgted) 462.8 545.0 641.0 790.0 Weighted average shares m 411 411 411 452

Key Ratios 3Q/12A 4Q/12E 1Q/13E 2Q/13E Key Ratios 2011A 2012E 2013E 2014E

Interest Spread % 1.50 1.46 1.34 1.16 Interest Spread % 2.74 2.73 2.61 2.49 Net Interest Margin % 1.68 1.63 1.51 1.31 Net Interest Margin % 2.96 3.05 2.94 2.84 Non Int Inc / Total Inc % 39.8 39.8 40.0 40.0 Non Int Inc / Total Inc % 41.4 39.8 40.0 0.0 Cost to Income % 43.3 43.3 44.0 44.0 Cost to Income % 42.7 43.3 44.0 44.8 Cost to Assets % 1.11 1.09 0.95 0.90 Cost to Assets % 1.97 2.03 2.01 1.99 Provisions / Loans % 0.44 0.42 0.38 0.36 Provisions / Loans % 0.89 0.79 0.80 0.87 Tax Rate % 33.0 33.0 33.0 33.0 Tax Rate % 34.0 33.0 33.0 33.0 Loan Deposit Ratio (LDR) % 75.2 75.2 74.6 74.6 Loan Deposit Ratio (LDR) % 75.3 75.2 74.6 74.0 NPLs % 1.12 1.12 1.43 1.43 NPLs % 1.11 1.12 1.43 1.19 Reserve Cover % 55.4 55.4 53.5 53.5 Reserve Cover % 74.3 55.4 53.5 53.5 Tier 1 Capital Ratio % 9.2 9.2 8.9 8.9 Tier 1 Capital Ratio % 9.4 9.2 8.9 8.9 Total Capital Ratio % 12.1 12.1 11.3 11.3 Total Capital Ratio % 12.7 12.1 11.3 11.3 Equity to Assets % 7.7 7.7 7.6 7.6 Equity to Assets % 7.8 7.7 7.6 8.6 ROA (ave) % 0.87 0.85 0.71 0.67 ROA (ave) % 1.60 1.59 1.51 1.42 ROE (ave) % 11.2 10.9 9.3 8.8 ROE (ave) % 19.4 20.4 19.7 17.3 ROTE (ave) % 11.2 10.9 9.3 8.8 ROTE (ave) % 19.4 20.4 19.7 17.3

Growth rates 2011A 2012E 2013E 2014E Income Growth % 25.2 21.0 16.1 17.1 Cost Growth % 28.8 23.0 18.0 19.1

Pre-Prov Profit Growth % 22.6 19.6 14.8 15.5 PBT Growth % 33.5 22.6 13.3 12.1 Loan Growth % 36.5 21.0 20.0 20.0 Ave Int Earning Assets % 33.7 20.4 20.1 20.2 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 15.0 12.1 10.6 10.4 P/E (adj) x 15.0 12.1 10.6 10.4 P/B (wgted) x 2.7 2.3 1.9 1.6 P/TB (wgted) x 2.7 2.3 1.9 1.6 Dividend yield % 1.2 1.5 1.5 1.5 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 138,862 152,748 168,023 184,825 Net Loans to Customer m 1,424,078 1,723,135 2,067,762 2,481,314 Other Interest Earning Assets m 795,141 949,893 1,143,725 1,380,053 Other Assets m 69,053 71,468 62,444 100,683 Total Assets m 2,427,134 2,897,244 3,441,953 4,146,875 Customer Deposits m 1,892,378 2,290,171 2,771,660 3,354,473

Other Int Bearing Liab m 210,872 220,984 231,888 243,693 Other Liabilities m 133,896 162,338 175,254 191,927 Total Liabilities m 2,237,145 2,673,493 3,178,803 3,790,094 Ordinary Equity m 4,106 4,106 4,106 4,516 Retained Earnings m 0 0 0 0 Reserves m 185,883 219,645 259,045 352,266 Minority Interests m 0 0 0 0 Total S/H's Funds m 189,988 223,750 263,150 356,782

All figures in INR unless noted. Source: Company data, Macquarie Research, March 2012


20 March 2012 61

INDIA

BOB IN Underperform Close Price* 15 Mar 12 Rs840.30

12-month target Rs 705.00

Upside/Downside % -16.1

Valuation Rs 705.00 - Gordon Growth

GICS sector Banks







BOB IN rel BSE Sensex performance, & rec history

Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period.




Bank of Baroda Comforts waning, concerns prop up Event

Downgrade to Underperform. Historically BOB has traded at a premium to its peers owing to its sound asset quality and superior management. However with those seen waning with increasing slippages and management change, we expect the stock will de-rate. Downgrade to Underperform with a revised TP of Rs705.

Impact

Asset quality concerns to accelerate: Slippages and credit cost at 1% and 0.5% in FY11 are the lowest reported by BOB in its history. Delinquencies have started increasing with 2Q12 and 3Q12 reporting slippage ratio of 1.5% and 2.2% respectively. Restructured assets have also increased 50% in 9M FY12 and currently stand at 3.8% of loans. BOB, although last in the league of PSU banks to see asset quality problems would incur high credit cost over next couple of years. We expect credit cost to shoot up by 24.2% over FY12-14E.

Business growth to moderate considerably. BOB’s loan growth has

remained healthy till FY11 (CAGR of 29% over FY08-11). However, in 9MFY12 growth was aided by INR depreciation fuelling overseas advances growth. Domestic credit growth was muted at 6% YTD. We expect loans growth to come-off sharply from the high of FY11 and likely to remain at 17% over FY12-14. This would put pressure on leverage and drag ROE.

Margins to remain under pressure: We expect NIM to slide from 3.1% seen in FY11 by ~20bps over FY12-14 owing to lagged effect of repricing of deposits and slowing CASA traction (declined from 37% since two year ago to 34% in 3Q12).

Management change makes us more cautious: BOB has done extremely well under the current CMD Mr. Mallya (since FY09) in terms of franchise creation, business growth with one of the best asset quality among peers. This has led BOB to trade at premium to basket of comparable PSU banks. We would remain cautious of management change as they tend to be quite disruptive in PSU banks. Mr. Mallya retires in Nov-2012.


We marginally adjust our FY13E EPS and reduce FY14E EPS by 6% on account of slower growth and higher credit costs. We reduce our TP by 5% to Rs705 on account of lower ROE and lower adjusted book value.

Price catalyst

12-month price target: Rs705.00 based on a Gordon Growth methodology.

Catalyst: Increase in NPLs, restructured assets and loan growth


Downgrade to underperform: We expect BOB’s ROE to come down from

24% seen in FY11 to 17% by FY14E driven by lower ROA and leverage. Downgrade to Underperform with a revised TP of Rs705.


20 March 2012 62

Valuations and TP

We value BOB on a two stage Gordon growth model using:

P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)} where g=growth rate for the first n (high-growth period) years, p=payout ratio in the first n years, gn=perpetual growth rate, pn=perpetual payout ratio.

Fig 1 BOB – sum-of-parts methodology

Cost of equity 14% RoE 14.8% g (initial growth) 12% n(initial growth period) 5 Steady growth 4% Theoretical P/BV – using two stage Gordon growth model 1.24x FY13E adjusted book value (INR) – Adjusted for Net NPLs 678 Assumed restructuring hit at 20% to gross book value 106 Book value used in calculation of fair value 573

Target Price (Rounded off) 705

Source: Macquarie Research, March 2012


20 March 2012 63

Fig 2 Select ratios


GROWTH PROJECTIONS Growth in Net interest income 31.0 15.9 48.2 16.9 16.3 17.7 Growth in Operating profit (PPP) 42.1 14.6 41.5 27.4 14.3 14.7 Growth in Net profit 55.2 37.3 38.7 10.6 9.8 11.7 Growth in Assets 26.6 22.4 28.8 20.8 17.6 17.9 Growth in Shareholder's Equity 16.2 17.7 39.0 25.3 15.9 26.2 ASSET ANALYSIS Net interest income / average assets 2.5 2.3 2.8 2.6 2.5 2.5 Earning assets to Total assets 97.0 97.6 97.6 97.1 96.2 95.4 Return on Avg Earning Assets 1.1 1.2 1.4 1.2 1.1 1.1 Loans to earning assets 65.3 64.4 65.4 66.9 67.2 67.2 LOAN ANALYSIS Loan growth 34.9 21.6 30.6 23.0 17.0 17.0 Domestic Corp loan growth 33.7 18.0 29.3 23.0 17.0 17.0 Retail loan growth 16.3 23.4 30.6 23.0 17.0 17.0 International loan growth 56.4 25.0 33.3 23.0 17.0 17.0 Agri loan growth 27.8 27.4 30.6 23.0 17.0 17.0 DEPOSIT ANALYSIS Deposits growth 26.5 25.4 26.6 22.7 19.1 18.5 Current & savings to total deposit 29.6 29.6 28.7 28.5 29.2 30.1 Time deposit to total deposit 70.4 70.4 71.3 71.5 70.8 69.9 Deposits to Interest Bearing Liabilities 97.2 98.0 96.4 97.1 97.5 97.9 LIQUIDITY LDR 74.8 72.5 74.9 75.1 73.7 72.8 Loans to Assets 63.3 62.9 63.8 65.0 64.6 64.1 Customer Deposits to Earning Assets 87.2 88.8 87.3 89.1 91.1 92.4 ASSET QUALITY Gross NPA ratio 1.28 1.37 1.38 1.13 1.45 1.63 Loan loss coverage ratio 75.6 74.9 74.9 85.8 76.4 80.9 Provisions to Loans 0.27 0.56 0.52 0.54 0.69 0.74 Reserves to Loans 0.97 1.03 1.03 0.97 1.11 1.32 CAPITAL ADEQUACY Tier I ratio 8.49 9.20 9.99 9.85 9.59 10.19 Total Capital ratio 14.05 14.36 14.52 14.12 13.15 13.16 Equity to assets 5.6 5.4 5.9 6.1 6.0 6.4 SPREAD ANALYSIS Yield on average assets 7.71 6.82 7.07 7.69 7.51 7.51 Average cost of funds 5.48 4.71 4.50 5.31 5.12 5.04 Spread 2.23 2.11 2.58 2.38 2.40 2.47 Net interest margin 2.91 2.74 3.12 2.94 2.89 2.91 OTHER INCOME Non-interest income/ total income 15.4 14.4 11.4 10.0 9.6 9.3 Fees to non interest income 27.0 32.0 36.3 38.6 41.8 44.8 Fees to total income 4.2 4.6 4.1 3.9 4.0 4.2 OPERATING EFFICIENCY Cost to income 45.4 43.6 39.9 34.4 34.8 35.7 Cost to assets 1.8 1.5 1.5 1.2 1.2 1.2 Interest bearing liabilities /Total liabilities 92.3 93.5 94.0 94.9 95.6 96.1 PROFITABILITY ROA 1.09 1.21 1.33 1.19 1.09 1.04 ROE 18.7 21.9 23.5 19.8 18.1 16.7 Pre provision ROE 36.1 35.3 38.7 37.6 35.8 33.8 Dividend yield 1.2 2.1 2.3 2.4 2.5 2.5 Basic EPS (Rs) 60.9 83.7 108.0 113.7 124.9 126.9 Diluted EPS (Rs) 60.9 83.7 108.0 113.7 124.9 126.9 VALUATIONS (x) P/E 13.8 10.0 7.8 7.4 6.7 6.6 P/BV 2.7 2.2 1.6 1.3 1.1 1.0 PUP 7.1 6.2 4.7 3.9 3.4 3.3 Source: Company data, Macquarie Research, March 2012


20 March 2012 64

Fig 3 BOB: 1 yr fwd P/BV chart


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20 March 2012 65

Bank of Baroda (BOB IN, Underperform, Target Price: Rs705.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 29,013 27,890 27,773 25,699 Net Interest Income m 88,023 102,889 119,636 140,817 + Loan Fees m 3,569 3,431 3,526 3,262 + Loan Fees m 15,819 12,656 15,187 18,225 + Trading Income m 3,216 3,092 2,780 2,572 + Trading Income m 7,681 11,405 11,975 12,858 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 2,461 2,365 2,129 1,970 + Other Income m 4,592 8,726 9,172 9,640 Non Interest Income m 9,245 8,887 8,435 7,805 Non Interest Income m 28,092 32,787 36,334 40,723 Total Operating Inc m 38,258 36,777 36,208 33,504 Total Operating Inc m 116,114 135,676 155,970 181,540


Pre-Provision Profit m 25,089 24,118 23,611 21,847 Pre-Provision Profit m 69,816 88,975 101,705 116,660 Loan Provisions m 6,717 6,457 5,758 5,327 Loan Provisions m 13,313 23,821 24,801 30,732 Post Provision Profit m 18,372 17,661 17,853 16,520 Post Provision Profit m 56,503 65,154 76,904 85,927 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 18,372 17,661 17,853 16,520 Pre-Tax Profit m 56,503 65,154 76,904 85,927 - Taxation m 5,144 4,945 5,892 5,451 - Taxation m 14,086 18,243 25,378 28,356 Net Profit After Tax m 13,228 12,716 11,962 11,068 Net Profit After Tax m 42,417 46,911 51,526 57,571 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 13,228 12,716 11,962 11,068 Reported Profit m 42,417 46,911 51,526 57,571 Adjusted Profit m 13,228 12,716 11,962 11,068 Adjusted Profit m 42,417 46,911 51,526 57,571 Attributable Profit m 13,228 12,716 11,962 11,068 Attributable Profit m 42,417 46,911 51,526 57,571 EPS (rep) 32.07 30.83 29.00 26.84 EPS (rep) 107.98 113.74 124.93 126.90 EPS growth pcp (rep) % 5.3 3.8 9.8 9.8 EPS growth yoy (rep) % 29.1 5.3 9.8 1.6 EPS (adj) 32.07 30.83 29.00 26.84 EPS (adj) 107.98 113.74 124.93 126.90 EPS growth pcp (adj) % 5.3 3.8 9.8 9.8 EPS growth yoy (adj) % 29.1 5.3 9.8 1.6 DPS 7.50 7.50 7.50 7.50 DPS 30.00 30.00 30.00 30.00 Payout ratio % 27.8 26.4 24.0 23.6 Book Value p.s (wgted) 534.4 637.8 739.1 847.9 Tangible Book Value p.s (wgted) 534.4 637.8 739.1 847.9 Weighted average shares m 393 412 412 454




Pre-Prov Profit Growth % 41.5 27.4 14.3 14.7 PBT Growth % 33.3 15.3 18.0 11.7 Loan Growth % 30.6 23.0 17.0 17.0 Ave Int Earning Assets % 28.8 20.2 16.6 16.9 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 7.8 7.4 6.7 6.6 P/E (adj) x 7.8 7.4 6.7 6.6 P/B (wgted) x 1.6 1.3 1.1 1.0 P/TB (wgted) x 1.6 1.3 1.1 1.0 Dividend yield % 3.6 3.6 3.6 3.6 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 198,682 217,464 238,103 260,784 Net Loans to Customer m 2,286,764 2,812,719 3,290,882 3,850,331 Other Interest Earning Assets m 1,013,265 1,173,704 1,371,762 1,616,747 Other Assets m 85,261 126,505 193,818 279,031 Total Assets m 3,583,972 4,330,393 5,094,565 6,006,893 Customer Deposits m 3,054,395 3,746,224 4,463,419 5,290,479




20 March 2012 66

INDIA

BOI IN Underperform Close Price* 15 Mar 12 Rs375.65



Valuation Rs 255.00 - Gordon growth methodology

GICS sector Banks






Year end 31 Mar 2011A 2012E 2013E 2014E Net interest Inc bn 78.1 79.3 90.7 109.8 Non interest Inc bn 26.4 31.5 32.0 34.9 PBT bn 35.0 34.2 39.9 51.3 PBT growth % 40.2 -2.3 16.8 28.5 Reported profit bn 24.9 23.9 26.7 34.4 EPS rep Rs 45.48 38.73 43.31 48.40 EPS rep growth % 37.5 -14.8 11.8 11.8 PER rep x 8.3 9.7 8.7 7.8 Total DPS Rs 8.12 7.50 7.50 7.50 Total div yield % 2.2 2.0 2.0 2.0 ROA % 0.8 0.6 0.6 0.6 ROE % 15.8 12.3 11.8 12.8 Equity to assets % 4.9 5.2 4.8 5.2 P/BV x 1.2 1.1 1.0 0.9

BOI IN rel BSE Sensex performance, & rec history





Bank of India Gone case Event

Reiterate Underperform: We expect BOI’s ROE to come down from 16% in FY11 to 12% by FY14E driven by lower ROA and leverage. Maintain Underperform with a revised TP of Rs255.

Impact

Asset quality pains to come over again: Although asset quality has shown some improvement in 3Q12, several concerns still remain. BOI’s exposure to

the power sector (SEB and private power projects 5% each) and Aviation (mainly Kingfisher, which has already restructured once and is having difficulty servicing interest); chances of it slipping into an NPL are increasing (BOI has ~Rs6bn exposure). In addition, slippages could increase in coming quarters from stressed sectors like SME, iron & steel, construction and sugar.

Stressed assets to net-worth to cross 100% by FY13E. Restructuring picked up considerably in 3Q12 and has already reached 6% of overall loans. We expect the trend to continue, as indicated by the management in looking at the pipeline of applications for restructuring and stress in the economy. We estimate stressed assets to net-worth to shoot up and cross the alarming level of 100% by FY13.

Loans and fees growth to slow: Overall advances grew by 20.9% YoY in Dec’11; however, domestic advances performed dismally with 8.2% growth. We expect loan growth to moderate considerably for the remainder of FY12 and estimate a 17% CAGR in loans over FY12-14E. This is likely to put pressure on fees as well.

Poor NPA coverage to drag earnings: The reported provision coverage ratio as of Dec’11 stood at 36% (61% including technical write-offs), one of the poorest in the sector. The average slippage ratio over the past three years (FY09-YTDFY12) has remained above 2.5%. An increase in slippages with a slowing economy going forward would compel the bank to stiffen credit costs as there is little room available to reduce PCR. This in turn would drag ROA.


We have reduced our FY13E and FY14E earnings by 17% and 20% on account of the increase in credit cost. We reduce our TP by 7% to Rs255 on account of lower ROA and lower adjusted book value

Price catalyst

12-month price target: Rs255.00 based on a Gordon growth methodology.

Catalyst: Increase in NPLs and restructured assets


Maintain Underperform, Management change in the near term adds to

uncertainty: The current CMD Mr. Misra retires in August 2012. Management changes at PSU banks have been quite disruptive at times and we remain cautious on the stock. Reiterate Underperform with TP of Rs255.


20 March 2012 67

Valuations and TP

We value BOI on a two stage Gordon growth model using


Fig 1 BOI – sum-of-parts methodology

Cost of equity 13.0% RoE 12.4% g (initial growth) 10% n(initial growth period) 5 Steady growth 4% Theoretical P/BV – using two stage Gordon growth model 0.95x FY13E adjusted book value (INR) – Adjusted for Net NPLs 324 Assumed restructuring hit at 20% to gross book value 54 Book value used in calculation of fair value 269




20 March 2012 68

Fig 2 Select ratios


GROWTH PROJECTIONS Growth in Net interest income 30.0 4.7 35.7 1.5 14.4 21.1 Growth in Operating profit (PPP) 47.4 (13.8) 14.4 19.4 7.4 20.1 Growth in Net profit 49.7 (42.1) 42.9 (3.9) 11.8 28.5 Growth in Total assets 26.1 21.9 27.7 18.9 17.2 17.4 Growth in Shareholder's Equity 27.4 5.4 21.5 24.9 9.9 25.5 ASSET ANALYSIS Net interest income / average assets 2.7 2.3 2.5 2.1 2.0 2.1 Earning assets to Total assets 96.4 97.0 95.8 94.3 95.0 95.6 Average Return on Earning Assets 1.5 0.7 0.8 0.7 0.6 0.7 Loans to earning assets 65.8 63.2 63.4 63.9 63.3 62.6 LOAN ANALYSIS Loan growth 25.9 17.9 26.5 18.0 17.0 17.0 DEPOSIT ANALYSIS Deposits 26.5 21.1 30.1 20.7 18.5 17.8 Current & savings to total deposit 26.8 27.8 25.4 25.3 25.6 26.1 Time deposit to total deposit 73.2 72.2 74.6 74.7 74.4 73.9 Deposits to Interest Bearing Liabilities 95.2 94.2 95.9 96.5 97.0 97.4 LIQUIDITY LDR 75.3 73.3 71.3 69.7 68.8 68.4 Loans to Assets 63.4 61.3 60.7 60.2 60.1 59.9 Customer Deposits to Earning Assets 87.3 86.1 88.9 91.6 92.0 91.6 ASSET QUALITY Gross NPA ratio 1.73 2.90 2.26 2.27 2.63 3.10 Loan loss coverage ratio 74.6 54.8 59.6 61.9 68.6 73.1 Provisions to Loans 0.31 0.70 0.34 0.47 0.50 0.47 Reserves to Loans 1.29 1.59 1.35 1.41 1.80 2.27 CAPITAL ADEQUACY Tier I CAR 8.91 8.48 8.33 8.72 7.91 8.21 Total CAR 13.01 12.94 12.17 12.08 10.83 10.74 Equity to assets 6.0 5.2 4.9 5.2 4.8 5.2 SPREAD ANALYSIS Yield on average assets 8.40 7.43 7.25 7.98 7.75 7.72 Average cost of funds 5.91 5.31 4.87 6.05 5.86 5.80 Spread 2.49 2.13 2.38 1.93 1.89 1.92 Net interest margin 2.97 2.51 2.92 2.43 2.35 2.41 OTHER INCOME Non-interest income to total income 15.7 12.8 10.8 9.7 8.7 8.1 Fees to non interest income 35.8 41.9 44.7 45.0 50.9 53.7 Fees to total income 5.6 5.4 4.8 4.4 4.4 4.4 OPERATING EFFICIENCY Cost to income 36.2 43.8 48.5 42.0 43.7 42.7 Cost to assets 1.5 1.5 1.6 1.2 1.2 1.2 Overhead ratio 0.8 18.3 31.1 18.9 23.8 24.5 Break even yield 5.6 5.4 5.4 6.2 6.2 6.1 Interest bearing liabilities /Total liabilities 94.0 93.5 93.4 94.4 94.6 94.8 PROFITABILITY ROA 1.49 0.70 0.79 0.62 0.59 0.65 ROE 25.0 12.6 15.8 12.3 11.8 12.8 Pre provision ROE 45.3 33.9 34.2 33.1 30.5 31.0 Dividend yield 2.5 2.2 2.2 2.0 2.0 2.0 Basic EPS (Rs) 57.2 33.1 45.5 38.7 43.3 48.4 Diluted EPS (Rs) 57.2 33.1 45.5 38.7 43.3 48.4 VALUATIONS (x) P/E 6.6 11.3 8.1 9.1 8.7 7.3 P/BV 1.7 1.6 1.3 1.1 1.0 0.9 PUP 3.6 4.2 3.8 3.6 3.4 3.2 Source: Company data, Macquarie Research, March 2012


20 March 2012 69

Fig 3 BOI: 1 yr fwd P/BV chart


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20 March 2012 70

Bank of India (BOI IN, Underperform, Target Price: Rs255.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 17,714 21,951 29,192 16,154 Net Interest Income m 78,107 79,315 90,709 109,845 + Loan Fees m 3,165 3,922 5,245 2,903 + Loan Fees m 23,199 14,173 16,299 18,743 + Trading Income m 2,173 2,692 2,487 1,376 + Trading Income m 3,218 9,728 7,728 7,728 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 1,698 2,105 2,573 1,424 + Other Income m 0 7,605 7,994 8,403 Non Interest Income m 7,036 8,719 10,305 5,702 Non Interest Income m 26,418 31,505 32,021 34,874 Total Operating Inc m 24,750 30,670 39,497 21,856 Total Operating Inc m 104,525 110,821 122,729 144,719


Pre-Provision Profit m 14,362 17,797 22,231 12,302 Pre-Provision Profit m 53,842 64,307 69,078 82,957 Loan Provisions m 6,734 8,345 9,392 5,197 Loan Provisions m 18,888 30,154 29,184 31,685 Post Provision Profit m 7,628 9,452 12,839 7,105 Post Provision Profit m 34,954 34,153 39,894 51,271 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 7,628 9,452 12,839 7,105 Pre-Tax Profit m 34,954 34,153 39,894 51,271 - Taxation m 2,288 2,836 4,237 2,344 - Taxation m 10,067 10,246 13,165 16,920 Net Profit After Tax m 5,339 6,616 8,602 4,760 Net Profit After Tax m 24,887 23,907 26,729 34,352 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 5,339 6,616 8,602 4,760 Reported Profit m 24,887 23,907 26,729 34,352 Adjusted Profit m 5,339 6,616 8,602 4,760 Adjusted Profit m 24,887 23,907 26,729 34,352 Attributable Profit m 5,339 6,616 8,602 4,760 Attributable Profit m 24,887 23,907 26,729 34,352 EPS (rep) 8.65 10.72 13.94 7.71 EPS (rep) 45.48 38.73 43.31 48.40 EPS growth pcp (rep) % 57.0 -30.6 11.8 11.8 EPS growth yoy (rep) % 37.5 -14.8 11.8 11.8 EPS (adj) 8.65 10.72 13.94 7.71 EPS (adj) 45.48 38.73 43.31 48.40 EPS growth pcp (adj) % 57.0 -30.6 11.8 11.8 EPS growth yoy (adj) % 37.5 -14.8 11.8 11.8 DPS 1.88 1.88 1.88 1.88 DPS 8.12 7.50 7.50 7.50 Payout ratio % 17.9 19.4 17.3 15.5 Book Value p.s (wgted) 316.0 349.8 384.4 419.5 Tangible Book Value p.s (wgted) 316.0 349.8 384.4 419.5 Weighted average shares m 547 617 617 710


Interest Spread % -69.69 -86.37 -115.21 -63.65 Interest Spread % -101.48 -156.03 -178.71 -206.83 Net Interest Margin % 0.96 1.19 1.45 0.74 Net Interest Margin % 2.48 2.15 2.08 2.13 Non Int Inc / Total Inc % 28.4 28.4 26.1 26.1 Non Int Inc / Total Inc % 24.2 28.4 26.1 24.1 Cost to Income % 42.0 42.0 43.7 43.7 Cost to Income % 48.5 42.0 43.7 42.7 Cost to Assets % 0.50 0.62 0.71 0.39 Cost to Assets % 1.44 1.11 1.10 1.07 Provisions / Loans % 0.53 0.65 0.63 0.35 Provisions / Loans % 0.87 1.18 0.98 0.91 Tax Rate % 30.0 30.0 33.0 33.0 Tax Rate % 28.8 30.0 33.0 33.0 Loan Deposit Ratio (LDR) % 69.7 69.7 68.8 68.8 Loan Deposit Ratio (LDR) % 71.3 69.7 68.8 68.4 NPLs % 2.24 2.24 1.92 1.92 NPLs % 2.23 2.24 1.92 1.64 Reserve Cover % 61.9 61.9 61.9 61.9 Reserve Cover % 59.6 61.9 61.9 61.9 Tier 1 Capital Ratio % nmf nmf nmf nmf Tier 1 Capital Ratio % nmf nmf nmf nmf Total Capital Ratio % nmf nmf nmf nmf Total Capital Ratio % nmf nmf nmf nmf Equity to Assets % 5.2 5.2 4.8 4.8 Equity to Assets % 4.9 5.2 4.8 5.2 ROA (ave) % 0.28 0.34 0.38 0.21 ROA (ave) % 0.79 0.62 0.59 0.65 ROE (ave) % 5.5 6.8 7.6 4.2 ROE (ave) % 15.8 12.3 11.8 12.8 ROTE (ave) % 5.5 6.8 7.6 4.2 ROTE (ave) % 15.8 12.3 11.8 12.8

Growth rates 2011A 2012E 2013E 2014E Income Growth % 24.8 6.0 10.7 17.9 Cost Growth % 38.2 -8.2 15.3 15.1

Pre-Prov Profit Growth % 14.4 19.4 7.4 20.1 PBT Growth % 40.2 -2.3 16.8 28.5 Loan Growth % 26.5 18.0 17.0 17.0 Ave Int Earning Assets % 25.2 17.2 18.3 18.5 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 8.3 9.7 8.7 7.8 P/E (adj) x 8.3 9.7 8.7 7.8 P/B (wgted) x 1.2 1.1 1.0 0.9 P/TB (wgted) x 1.2 1.1 1.0 0.9 Dividend yield % 2.2 2.0 2.0 2.0 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 217,824 249,961 286,875 329,280 Net Loans to Customer m 2,130,962 2,514,535 2,942,006 3,442,147 Other Interest Earning Assets m 1,014,000 1,172,566 1,419,664 1,725,738 Other Assets m 148,940 238,326 245,893 250,666 Total Assets m 3,511,726 4,175,388 4,894,438 5,747,830 Customer Deposits m 2,988,858 3,607,165 4,274,687 5,034,201




20 March 2012 71

INDIA

CBK IN Underperform Close Price* 15 Mar 12 Rs506.05



Valuation Rs 385.00 - Gordon Growth methodology

GICS sector Banks






Year end 31 Mar 2011A 2012E 2013E 2014E Net interest Inc bn 78.2 78.0 95.4 117.0 Non interest Inc bn 27.0 28.1 29.0 31.0 PBT bn 50.3 42.0 46.3 57.0 PBT growth % 31.5 -16.4 10.2 23.0 Reported profit bn 40.3 33.2 36.6 45.0 EPS rep Rs 90.88 74.95 82.60 96.79 EPS rep growth % 23.3 -17.5 10.2 17.2 PER rep x 5.6 6.8 6.1 5.2 Total DPS Rs 11.00 10.00 10.00 10.00 Total div yield % 2.2 2.0 2.0 2.0 ROA % 1.3 0.9 0.8 0.9 ROE % 23.2 15.5 15.0 15.8 Equity to assets % 6.0 5.8 5.5 5.6 P/BV x 1.1 1.0 0.9 0.8

CBK IN rel BSE Sensex performance, & rec history





Canara Bank Asset quality to remain an overhang Event

Maintain Underperform: We expect Canara’s ROE to come down from 23%

seen in FY11 to 15-16% by FY14E driven by lower ROA and leverage. Maintain Underperform with a revised TP of Rs385

Impact

Asset quality can worsen further: Amongst our coverage, Canara has the largest exposure to the private power companies and SEBs; close to 12-13% of its loans are exposed to the power sector. We expect stressed assets as a % of net worth to double from 50% in FY11 to 100% in FY13E, driven by large restructurings in the power sector.

Falling loans to deposits to exert pressure on margins: In 3Q12, advances have grown only 15.5% YOY and deposit growth has been healthy at 20%. We expect the trend to continue going forward as deposits tend to be stickier than advances growth. We expect loans to grow at ~250bps higher than deposits over FY12-14E. This gap between deposit growth and credit growth is likely to exert pressure on margins, as investing term deposits in government securities is currently yielding a negative carry.

Poorest deposit franchise: Canara Bank’s CASA at sub-25% levels (fallen steeply by ~400bps in the last year) is the lowest amongst large banks, and the bank traditionally has relied on a large quantum of bulk deposits to fund growth. We believe that bulk deposits rates are unlikely to soften soon, putting further pressure on NIMs.

Grossly under-provisioned: The reported NPL coverage ratio in 3Q12 at 18% is perhaps the lowest in the sector. We are extremely concerned about the bank’s current state of under-provisioning. If we include restructured advances which stand at Rs96bn (4.4% of overall book), under-provisioning gets aggravated further. Due to this, we are factoring credit costs to increase by 60% YOY in FY13

Management change due in Sept-12: Management changes in PSU banks have caused a lot of uncertainty, as reflected by past experience, and the current Chairman is due for retirement in Sept-2012.


We reduce our FY13E and FY14E EPS by 12% and 11%, respectively, on account of higher credit costs and slower growth. We increase our TP by 4% to Rs385 on account of reduction in the cost of equity.

Price catalyst


Catalyst: Increased slippages and restructuring, margin pressures


Maintain Underperform with revised TP of Rs385


20 March 2012 72

Valuations and TP

We value CBK on a two stage Gordon growth model using


Fig 1 CBK – sum-of-parts methodology





20 March 2012 73

Fig 2 Select Ratios


GROWTH PROJECTIONS Growth in Net interest income 33.4 20.4 37.7 (0.3) 22.4 22.6 Growth in Operating profit (PPP) 33.9 27.7 20.7 (1.9) 16.6 20.2 Growth in Net profit 32.4 45.8 33.2 (17.5) 10.2 23.0 Growth in Total assets 21.7 20.5 26.9 17.9 18.1 17.3 Growth in Shareholder's Equity 16.3 20.2 36.6 13.9 13.7 19.5 ASSET ANALYSIS Net interest income / average assets 2.4 2.3 2.6 2.1 2.2 2.3 Earning assets to Total assets 89.2 90.3 88.1 88.8 89.6 91.3 Return on Avg Earning Assets 1.1 1.3 1.4 0.9 0.9 0.9 Loans to earning assets 65.0 65.5 65.0 64.2 63.1 61.7 LOAN ANALYSIS Loan growth 28.9 22.5 25.5 16.0 16.0 16.0 Corporate loan growth 31.7 22.5 25.5 16.0 16.0 16.0 Retail loan growth 12.1 22.5 25.5 16.0 16.0 16.0 DEPOSIT ANALYSIS Deposit growth 21.3 25.6 25.3 19.1 19.1 17.8 Current & savings to total deposit 30.1 29.1 28.3 28.9 29.6 30.7 Time deposit to total deposit 69.9 70.9 71.7 71.1 70.4 69.3 Deposits to Interest Bearing Liabilities 96.4 99.6 98.3 98.4 98.6 98.7 LIQUIDITY LDR 74.0 72.2 72.3 70.4 68.6 67.5 Loans to Assets 62.9 64.0 63.2 62.2 61.1 60.4 Customer Deposits to Earning Assets 87.9 90.7 89.9 91.2 92.1 91.5 ASSET QUALITY Gross NPA ratio 1.57 1.53 1.45 1.61 2.00 2.56 Loan loss coverage ratio 30.5 30.5 24.0 22.6 20.9 18.1 Provisions to Loans 0.73 0.93 0.52 0.46 0.74 0.74 Reserves to Loans 0.48 0.47 0.35 0.36 0.42 0.46 CAPITAL ADEQUACY Tier I CAR 8.01 8.54 10.87 10.30 10.00 10.20 Total CAR 14.10 13.43 15.38 15.03 14.00 13.59 Equity to assets 5.9 4.9 5.0 6.9 7.1 6.9 SPREAD ANALYSIS Yield on average assets 8.85 7.98 7.90 8.28 8.18 8.17 Average cost of funds 6.82 5.89 5.52 6.39 6.16 6.10 Spread 2.03 2.09 2.38 1.89 2.01 2.07 Net interest margin 2.78 2.80 3.12 2.44 2.54 2.63 OTHER INCOME Non interest income to total income 11.89 13.22 10.49 8.73 7.82 7.12 Fees to non interest income 27.64 25.33 27.96 30.95 33.02 35.49 Fees to total income 3.29 3.35 2.93 2.70 2.58 2.53 OPERATING EFFICIENCY Cost to income 43.6 40.7 42.0 43.5 43.9 43.3 Cost to assets 1.5 1.4 1.5 1.3 1.3 1.3 Interest bearing liabilities /Total liabilities 93.5 94.3 94.7 95.2 95.7 96.1 PROFITABILITY ROA 1.04 1.25 1.34 0.91 0.85 0.89 ROE 18.3 22.5 23.2 15.5 15.0 15.8 Pre provision ROE 34.9 37.7 35.2 27.9 28.6 29.5 Dividend yield 1.6 2.0 2.2 2.0 2.0 2.0 Basic EPS (Rs) 50.5 73.7 90.9 74.9 82.6 96.8 Diluted EPS (Rs) 50.5 73.7 90.9 74.9 82.6 96.8 VALUATIONS P/E 10.0 6.9 5.4 6.8 6.1 5.1 P/BV 2.1 1.7 1.2 1.1 0.9 0.8 PUP 5.2 4.1 3.7 3.7 3.2 2.8 Source: Company data, Macquarie Research, March 2012


20 March 2012 74

Fig 3 CBK: 1 yr fwd P/BV chart


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20 March 2012 75

Canara Bank (CBK IN, Underperform, Target Price: Rs385.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 25,548 16,833 16,496 27,047 Net Interest Income m 78,233 77,961 95,410 116,994 + Loan Fees m 2,848 1,877 1,653 2,710 + Loan Fees m 7,558 8,692 9,561 10,995 + Trading Income m 1,797 1,184 948 1,554 + Trading Income m 4,937 5,483 5,483 5,483 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 4,558 3,003 2,405 3,943 + Other Income m 14,536 13,908 13,908 14,504 Non Interest Income m 9,203 6,064 5,006 8,207 Non Interest Income m 27,031 28,083 28,952 30,982 Total Operating Inc m 34,751 22,896 21,502 35,254 Total Operating Inc m 105,264 106,044 124,363 147,976


Pre-Provision Profit m 19,624 12,929 12,073 19,795 Pre-Provision Profit m 61,071 59,881 69,827 83,930 Loan Provisions m 5,851 3,855 4,064 6,664 Loan Provisions m 10,811 17,854 23,507 26,943 Post Provision Profit m 13,773 9,074 8,009 13,131 Post Provision Profit m 50,260 42,027 46,320 56,988 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 13,773 9,074 8,009 13,131 Pre-Tax Profit m 50,260 42,027 46,320 56,988 - Taxation m 2,892 1,906 1,682 2,757 - Taxation m 10,000 8,826 9,727 11,967 Net Profit After Tax m 10,880 7,169 6,327 10,373 Net Profit After Tax m 40,260 33,201 36,593 45,020 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 10,880 7,169 6,327 10,373 Reported Profit m 40,260 33,201 36,593 45,020 Adjusted Profit m 10,880 7,169 6,327 10,373 Adjusted Profit m 40,259 33,201 36,593 45,020 Attributable Profit m 10,880 7,169 6,327 10,373 Attributable Profit m 40,260 33,201 36,593 45,020 EPS (rep) 24.56 16.18 14.28 23.42 EPS (rep) 90.88 74.95 82.60 96.79 EPS growth pcp (rep) % -17.5 4.6 10.2 10.2 EPS growth yoy (rep) % 23.3 -17.5 10.2 17.2 EPS (adj) 24.56 16.18 14.28 23.42 EPS (adj) 90.88 74.95 82.60 96.79 EPS growth pcp (adj) % -17.5 4.6 10.2 10.2 EPS growth yoy (adj) % 23.3 -17.5 10.2 17.2 DPS 2.50 2.50 2.50 2.50 DPS 11.00 10.00 10.00 10.00 Payout ratio % 12.1 13.3 12.1 10.3 Book Value p.s (wgted) 452.4 515.3 585.9 666.6 Tangible Book Value p.s (wgted) 452.4 515.3 585.9 666.6 Weighted average shares m 443 443 443 465




Pre-Prov Profit Growth % 13.9 -1.9 16.6 20.2 PBT Growth % 31.5 -16.4 10.2 23.0 Loan Growth % 25.5 16.0 16.0 16.0 Ave Int Earning Assets % 25.5 18.0 18.6 19.1 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 5.6 6.8 6.1 5.2 P/E (adj) x 5.6 6.8 6.1 5.2 P/B (wgted) x 1.1 1.0 0.9 0.8 P/TB (wgted) x 1.1 1.0 0.9 0.8 Dividend yield % 2.2 2.0 2.0 2.0 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 220,148 241,588 265,161 291,079 Net Loans to Customer m 2,124,672 2,464,619 2,858,958 3,316,392 Other Interest Earning Assets m 923,932 1,131,707 1,405,380 1,763,818 Other Assets m 92,036 124,587 149,589 118,769 Total Assets m 3,360,788 3,962,502 4,679,088 5,490,058 Customer Deposits m 2,939,727 3,499,973 4,169,941 4,913,032




20 March 2012 76

INDIA

HDFCB IN Outperform Close Price* 15 Mar 12 Rs510.95


Upside/Downside % 22.3

Valuation Rs 625.00 - Gordon growth

GICS sector Banks

Market cap Rsbn 1,197



Number shares on issue m 2,344



HDFCB IN rel BSE Sensex performance, & rec history





HDFC Bank Good things in life rarely come cheap Event

Our top pick and the only Outperform in the banking space: HDFC Bank is our top pick in the banking space. We reiterate our Outperform with a revised TP of Rs625.

Impact

Asset quality expected to remain exceptionally good: HDFC Bank’s

experience on loss rates in various retail product categories continues to be even better than what it had budgeted. Current credit costs of 1% are likely to stabilise more around 120bps over the longer term, according to management. It continues to judiciously make floating provisions which help it create a countercyclical buffer. The NPL coverage ratio, including floating provisions, is at ~125%+ – by far the best in the sector. It has largely avoided stressed sectors, exposure to infrastructure is largely in the form of working capital loans and is lower than its peers, and in the CV segment it isn’t

exposed much to the mining belts like Karnataka, Orissa etc. Overall we don’t

expect that credit costs will spike up, but will be around 120bps.

Liquidity and capital position – pretty comfortable: Loan growth has broadly matched deposit growth and moreover HDFC doesn’t have a large

dependence on wholesale funding. The current Tier-1 ratio at 11.4% is very comfortable and its internal Basel-III analysis submitted to RBI also shows that the impact on capital ratios is minimal. It doesn’t have any hybrids in Tier-I and other issues like investment in subsidiaries, intangibles etc. are not there. So we don’t envisage any risk of equity dilution in the next 12-18 months.

Growth continues to surprise us: HDFC Bank for the past several years has grown at least 500bps faster than the system. Loan growth of 22% YoY in 3Q12 was much higher than system loan growth of 17%. Growth so far has been predominantly driven by retail assets. It is surprising that HDFC Bank continues to grow its retail portfolio like CVs, 2-Wheelers, personal loans and credit cards at impressive growth rates whereas other banks continue to struggle in these segments.


We have reduced EPS by 3% and 6% for FY13E and FY14E on account of slightly lower margins and higher opex. TP is marginally adjusted upwards by 2% owing to cost of equity changes.

Price catalyst


Catalyst: Strong earnings growth and return ratios


Expensive valuations to stay: HDFC Bank’s expensive valuations are

unlikely to come down owing to its strong fundamentals relative to its peers. We reiterate as our top pick with a TP of Rs625.


20 March 2012 77

So why is asset quality going to be far better than other banks?

It is predominantly a retail bank and exposure to corporates is mainly in the form of working capital loans where risk is lower.

Exposure to stressed sectors is relatively lower than peers.

It has one of the lowest exposures to the SME sector which has been affected by the current deteriorating macroeconomic scenario.

It has one of the lowest restructured assets ratios amongst its peers.

It has the highest NPL coverage ratio in the sector, including floating provisions at 125%+.

Fig 1 HDFC Bank: Asset quality stable


Fig 2 Credit costs drop despite increased lending to 2W and unsecured segment


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20 March 2012 78

Valuations and TP

We value HDFC Bank on a two-stage Gordon Growth method as the bank continues to be in a high growth stage and a single-stage Gordon Growth model cannot capture its high growth aspect.

P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)}, where g=growth rate for the first n (high-growth period) years, p=payout ratio in the first n years, gn=perpetual growth rate, pn=perpetual payout ratio.

Fig 3 HDFC Bank – Two stage Gordon growth model

Key Parameters Assumptions

RoE 22.0% g (initial growth) 19% r (CoE) 13% gn (perpetual growth rate) 4% n (initial growth period, yrs) 10 payout1 15% Payoutn 80% K1 3.05 K2 15.28 P/BV 4.03x Target price based on two stage Gordon growth model 625



20 March 2012 79

Fig 4 Select ratios

FY09 FY10 FY11 FY12E FY13E FY14E

GROWTH PROJECTIONS Growth in Net interest income 42.0 13.0 25.7 15.9 16.8 17.6 Growth in Operating profit (PPP) 37.5 24.2 20.2 17.9 23.0 20.4 Growth in Net profit 41.2 31.3 33.2 31.8 20.4 20.9 Growth in Total assets 37.6 21.4 24.7 18.5 17.6 17.9 Growth in Shareholder's Equity 30.9 43.0 17.9 17.6 18.3 19.2 ASSET ANALYSIS Net interest income / average assets 4.7 4.1 4.2 4.0 4.0 4.0 Earning assets to Total assets 95.6 96.4 94.0 94.2 94.5 94.8 Return on Avg Earning Assets 1.5 1.5 1.7 1.8 1.8 1.9 Loans to earning assets 56.4 58.7 61.4 63.1 64.1 65.0 LOAN ANALYSIS Loan growth 55.9 27.3 27.1 22.0 20.0 20.0 Retail loan growth 55.9 3.3 38.9 19.8 17.8 17.7 Non-retail loan growth 55.9 66.1 15.3 24.7 22.6 22.5 DEPOSIT ANALYSIS Deposits growth 41.7 17.2 24.6 19.9 19.9 19.9 Current & savings to total deposit 44.4 52.0 52.7 51.8 51.0 50.2 Time deposit to total deposit 55.6 48.0 47.3 48.2 49.0 49.8 Deposits to Interest Bearing Liabilities 98.2 92.8 93.5 94.2 94.8 95.3 LIQUIDITY LDR 69.2 75.2 76.7 78.1 78.2 78.2 Loans to Assets 54.0 56.6 57.7 59.4 60.6 61.7 Customer Deposits to Earning Assets 81.5 78.1 80.0 80.8 82.1 83.2 ASSET QUALITY Gross NPA ratio 2.01 1.44 1.06 0.77 0.55 0.36 Loan loss coverage ratio 68.4 78.4 82.5 87.2 92.5 101.8 Provisions to Loans 2.13 1.73 1.00 0.77 0.98 0.98 Reserves to Loans 1.38 1.13 0.87 0.67 0.51 0.36 CAPITAL ADEQUACY Tier I CAR 10.58 13.26 12.23 11.96 11.85 11.82 Total CAR 15.69 17.44 16.22 14.69 14.16 13.77 Equity to assets 8.2 9.7 9.2 9.1 9.1 9.2 SPREAD ANALYSIS Yield on average assets 10.88 8.39 8.49 9.23 9.06 9.01 Average cost of funds 6.85 4.84 4.78 5.76 5.59 5.50 Spread 4.02 3.55 3.71 3.47 3.47 3.51 Net interest margin 4.20 4.30 4.25 4.10 4.05 4.02 OTHER INCOME Non interest income to total income 16.77 19.76 17.87 16.91 18.13 18.56 Fees to non interest income 74.68 75.47 82.97 80.14 74.78 74.11 Fees to total income 12.52 14.91 14.82 13.55 13.55 13.75 OPERATING EFFICIENCY Cost to income 51.7 48.0 48.1 48.0 46.6 45.8 Cost to assets 3.5 2.9 2.9 2.8 2.7 2.7 Interest bearing liabilities /Total liabilities 86.5 89.7 88.5 88.8 90.0 91.2 PROFITABILITY ROA 1.42 1.45 1.57 1.71 1.74 1.79 ROE 16.9 16.1 16.7 18.7 19.1 19.5 Pre provision ROE 39.0 35.2 32.9 33.0 34.4 34.8 Dividend yield 0.4 0.5 0.6 0.5 0.6 0.6 Basic EPS (Rs) 10.6 13.6 17.0 22.3 26.8 32.4 Diluted EPS (Rs) 10.5 13.5 16.9 22.2 26.7 32.2 VALUATIONS (x) P/E 48.3 37.6 30.0 23.0 19.1 15.8 P/BV 7.2 5.4 4.7 4.0 3.4 2.8 PUP 21.0 18.2 15.4 13.1 10.6 8.8 Source: Company data, Macquarie Research, March 2012


20 March 2012 80

Fig 5 1 yr fwd P/BV chart


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20 March 2012 81

HDFC Bank (HDFCB IN, Outperform, Target Price: Rs625.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 34,079 34,281 29,469 33,424 Net Interest Income m 105,431 122,217 142,719 167,772 + Loan Fees m 11,834 11,904 10,341 11,729 + Loan Fees m 43,878 42,441 50,081 60,097 + Trading Income m 2,931 2,948 3,487 3,955 + Trading Income m -526 10,511 16,888 20,985 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 0 0 0 0 + Other Income m 0 0 0 0 Non Interest Income m 14,765 14,852 13,828 15,684 Non Interest Income m 43,352 52,952 66,969 81,082 Total Operating Inc m 48,843 49,133 43,297 49,108 Total Operating Inc m 148,783 175,169 209,688 248,854


Pre-Provision Profit m 25,386 25,537 23,118 26,221 Pre-Provision Profit m 77,254 91,043 111,963 134,765 Loan Provisions m 4,469 4,496 4,475 5,075 Loan Provisions m 19,061 16,028 21,671 25,591 Post Provision Profit m 20,917 21,041 18,644 21,146 Post Provision Profit m 58,193 75,016 90,292 109,175 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 20,917 21,041 18,644 21,146 Pre-Tax Profit m 58,193 75,016 90,292 109,175 - Taxation m 6,485 6,523 5,780 6,556 - Taxation m 18,929 23,256 27,992 33,846 Net Profit After Tax m 14,432 14,518 12,864 14,590 Net Profit After Tax m 39,264 51,759 62,300 75,329 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 14,432 14,518 12,864 14,590 Reported Profit m 39,264 51,759 62,300 75,329 Adjusted Profit m 14,432 14,518 12,864 14,590 Adjusted Profit m 39,264 51,759 62,300 75,329 Attributable Profit m 14,432 14,518 12,864 14,590 Attributable Profit m 39,264 51,759 62,300 75,329 EPS (rep) 6.20 6.24 5.53 6.27 EPS (rep) 16.88 22.25 26.78 32.38 EPS growth pcp (rep) % 2.0 56.0 20.4 20.4 EPS growth yoy (rep) % 31.0 31.8 20.4 20.9 EPS (adj) 6.20 6.24 5.53 6.27 EPS (adj) 16.88 22.25 26.78 32.38 EPS growth pcp (adj) % 2.0 56.0 20.4 20.4 EPS growth yoy (adj) % 31.0 31.8 20.4 20.9 DPS 0.76 0.76 0.82 0.82 DPS 3.85 3.04 3.26 3.26 Payout ratio % 22.8 13.7 12.2 10.1 Book Value p.s (wgted) 109.1 128.3 151.8 181.0 Tangible Book Value p.s (wgted) 109.1 128.3 151.8 181.0 Weighted average shares m 2,326 2,326 2,326 2,326




Pre-Prov Profit Growth % 20.2 17.8 23.0 20.4 PBT Growth % 35.7 28.9 20.4 20.9 Loan Growth % 27.1 22.0 20.0 20.0 Ave Int Earning Assets % 18.4 20.6 19.4 19.6 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 30.3 23.0 19.1 15.8 P/E (adj) x 30.3 23.0 19.1 15.8 P/B (wgted) x 4.7 4.0 3.4 2.8 P/TB (wgted) x 4.7 4.0 3.4 2.8 Dividend yield % 0.8 0.6 0.6 0.6 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 251,008 254,607 259,419 264,461 Net Loans to Customer m 1,599,827 1,951,789 2,342,146 2,810,575 Other Interest Earning Assets m 754,974 888,739 1,050,685 1,245,748 Other Assets m 167,717 191,292 211,729 235,181 Total Assets m 2,773,526 3,286,427 3,863,980 4,555,966 Customer Deposits m 2,085,864 2,499,976 2,996,882 3,593,653




20 March 2012 82

INDIA

ICICIBC IN Neutral Close Price* 15 Mar 12 Rs930.25



Valuation Rs 855.00 - Sum of Parts

GICS sector Banks




Number shares on issue m 1,153



ICICIBC IN rel BSE Sensex performance, & rec history





ICICI Bank Where is the upside? Downgrade to Neutral Event

Downgrade to Neutral on valuations, TP unchanged: After the sharp rally recently, valuations look stretched. Downgrade to Neutral from Outperform.

Impact

Restructuring to pick up, negative surprises can’t be ruled out: Going ahead, the quantum of restructured assets is expected to pick up. We don’t

expect asset quality to deteriorate to the extent seen in the previous cycle. However there is stress in certain mid-corporate and power sector exposures that ICICI has put on its books and are likely to be restructured over the course of the next few years.

Aggressive guidance on credit costs: Management guidance on FY13E credit costs (provisions on NPLs as a percentage of advances) to be around 75bps marginally higher than FY12E is aggressive in our view. If ICICI manages to deliver these credit cost numbers on the back of higher restructuring, we believe the market is not going to take it well. We have conservatively built in 110bps of credit costs into our numbers. If we build in 75bps into our model, our earnings estimates would be roughly 11% higher for FY13E.

Growth remains a worry: Management continues to be a bit cautious on growth. Performance with respect to the retail segment has been very unsatisfactory and much of the growth in the past two years has come from the corporate segment, particularly infrastructure. The bank has been struggling to grow its retail book compared to some of its peers who have done very well.

Risk of equity dilution is less: The proposed Basel-III norm is unlikely to result in equity dilution for ICICI, at least in the early years of implementation as ICICI is sufficiently capitalised. That isn’t the case with most of its peers who

would come to the market over the course of next two years to raise capital. Hence the risk of equity dilution is also pretty low over the next two years in our view. By that time we believe there could be some repatriation of capital from the Canada business further giving some cushion. Management has guided that, according to their internal calculations, they don’t need to raise any equity

capital for the next three years.


We marginally increase FY13E and FY14E EPS by 3% and 1 % due to slightly lower credit costs. No change in TP.

Price catalyst

12-month price target: Rs855.00 based on a Sum of Parts methodology.

Catalyst: Increase in restructured assets quantum


See limited upside from current levels: ICICI Bank now trades at 1.5x FY13E P/BV which is inline with its historic averages. Neutral.


20 March 2012 83

Asset quality – What is the difference between this cycle vs. previous cycle?

If one looks at the historical cycle of NPLs and credit cost trends, we see that credit costs have peaked around 200-250bps. The FY02/03 spike in NPLs/credit costs was mainly on account of the reverse merger with its beleaguered parent ICICI Ltd whereas in FY09/10 NPLs were driven by unsecured loans and 2W loans during the retail cycle.

Fig 1 Trends in NPL and credit costs over the years


Since then ICICI has largely reduced the dependence on 2W and unsecured portfolio.

Fig 2 Negligible exposure to 2W and unsecured loans now


In the previous cycle Gross NPLs had touched a high of 5.2% with retail NPLs at 8.2% and retail contributed to 65% of NPLs and loans.

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20 March 2012 84

Fig 3 Retail NPL ratios have started to moderate


Another important aspect is that the bank has beefed up its NPL coverage ratio now to 79% levels which is impressive,

Fig 4 Coverage ratio is now very healthy compared to the earlier cycle


SME exposure is much lower than most other banks

ICICI Bank’s exposure to the SME sector is much lower than peers. The SME sector is more

vulnerable to a slowdown in demand and rise in interest rates as it operates on lower margins and has high gearing. ICICI Bank traditionally has avoided relying on the SME sector for its growth in asset book. The SME sector is tapped more generally for the liabilities business by ICICI.

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20 March 2012 85

Fig 5 SME exposure of banks as % of advances Fig 6 SME exposure as a % of net worth

Source: Company data, Macquarie Research, March 2012 Source: Company data, Macquarie Research, March 2012

Valuations and TP

We value ICICI Bank on a sum-of-parts basis in which the core banking business is valued using a single stage Gordon growth model and the life insurance business is valued using an appraisal value method which is the sum of the embedded value and new business value. Other businesses are valued either as a % of AUM or a multiple of book value.

Fig 7 ICICI Bank: Sum-of-parts valuation

(INR m except per share data) Total value % Stake Value attributable

to ICICI Bank Per Share

value Comments

Core business 750,010 100% 750,010 673 1.6x FY13E adjusted book value ICICI Securities including PD 9,960 100% 9,960 9 10x FY13E Profits ICICI Venture 11,582 100% 11,582 10 10% of FY13E AUM ICICI Prudential Life 128,574 74% 95,145 85 Appraisal value, New business margin 12%. NBAP

multiple 12x ICICI Lombard General Insurance 10,784 74% 7,980 7 0.8x Capital Infused Prudential ICICI AMC 40,462 51% 20,635 19 5% of FY13E AUM ICICI Home Finance 23,261 100% 23,261 21 1.5x FY13E NW International banking subs 33,570 100% 33,570 30 10.0x FY13E profits Final target price 822,614 855


The core banking business is valued using a two stage Gordon growth model where P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)}, where g=growth rate for the first n (high-growth period) years, p=payout ratio in the first n years, gn=perpetual growth rate, pn=perpetual payout ratio.

Fig 8 Valuation of core business using a two stage Gordon growth model

RoE 17.2% g (initial growth) 14% r (CoE) 14% gn (perpetual growth rate) 4% n (initial growth period, yrs) 10 Target P/BV 1.63x


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20 March 2012 86

Fig 9 Select ratios


GROWTH PROJECTIONS Growth in Net interest income 14.5 (3.0) 11.1 18.7 23.7 16.4 Growth in Operating profit (PPP) 12.1 9.0 (7.0) 11.5 26.1 17.3 Growth in Net profit (9.6) 7.1 28.0 22.6 10.2 12.6 Growth in Total assets (5.1) (4.2) 11.8 11.2 15.2 15.6 Growth in Shareholder's Equity 6.6 4.2 6.6 7.8 8.1 8.7 ASSET ANALYSIS Net interest income / average assets 2.1 2.2 2.3 2.5 2.7 2.7 Earning assets to Total assets 92.6 93.9 94.8 96.9 95.6 95.8 Return on Avg Earning Assets 1.0 1.2 1.4 1.5 1.5 1.5 Loans to earning assets 62.1 53.1 56.2 58.1 59.4 61.0 LOAN ANALYSIS Loan growth (3.2) (17.0) 19.4 17.6 16.0 19.0 Domestic Corp loan growth 8.5 15.2 37.1 17.6 16.0 19.0 Retail loan growth (19.3) (23.2) 16.7 17.6 16.0 19.0 International loan growth 14.5 (23.7) 9.0 17.6 16.0 19.0 Agri loan growth 51.1 (17.0) 19.4 17.6 16.0 19.0 DEPOSIT ANALYSIS Deposits growth (10.7) (7.5) 11.8 16.0 17.1 17.2 Current & savings to total deposit 28.7 41.7 45.1 42.7 41.3 39.9 Time deposit to total deposit 71.3 58.3 54.9 57.3 58.7 60.1 Deposits to Interest Bearing Liabilities 76.4 71.7 74.6 74.1 73.7 73.2 LIQUIDITY LDR 100.0 89.7 95.9 97.2 96.2 97.7 Loans to Assets 57.6 49.9 53.3 56.3 56.7 58.4 Customer Deposits to Earning Assets 62.1 59.2 58.6 59.8 61.7 62.4 ASSET QUALITY Gross NPA ratio 4.32 5.07 4.48 4.21 4.14 3.97 Loan loss coverage ratio 52.8 59.5 76.0 75.2 75.7 77.4 Provisions to Average Loans 1.72 2.20 1.15 0.66 1.21 1.34 Reserves to Loans 2.33 3.11 3.52 3.27 3.23 3.17 CAPITAL ADEQUACY Tier I CAR 11.80 13.96 13.17 11.58 10.29 9.15 Total CAR 15.50 19.41 19.54 17.03 14.98 13.20 Equity to assets 13.2 14.3 13.6 13.2 12.4 11.7 SPREAD ANALYSIS Yield on average assets 9.44 8.22 7.93 8.05 8.45 8.50 Average cost of funds 7.38 5.99 5.61 5.86 5.95 5.91 Spread 2.07 2.23 2.32 2.20 2.50 2.59 Net interest margin 2.43 2.49 2.64 2.57 2.77 2.78 OTHER INCOME Non-interest income to total income 19.6 22.5 20.4 19.3 19.0 18.9 Fees to non interest income 74.0 64.6 83.0 83.1 80.7 81.8 Fees to total income 14.5 14.6 16.9 16.1 15.4 15.5 OPERATING EFFICIENCY Cost to income ratio 44.1 37.6 42.2 43.9 41.9 41.2 Cost to assets 1.8 1.6 1.7 1.8 1.9 1.9 Interest bearing liabilities /Total liabilities 86.7 90.4 86.2 90.1 91.3 92.4 PROFITABILITY ROA 0.96 1.08 1.34 1.47 1.43 1.40 ROE 7.8 8.0 9.6 11.0 11.3 11.7 Pre provision ROE 18.5 19.1 16.8 17.5 20.5 22.1 Dividend yield 1.2 1.3 1.5 1.6 1.7 1.8 Basic EPS (Rs) 33.8 36.1 45.4 54.8 60.4 68.1 Diluted EPS (Rs) 33.7 36.1 45.4 54.7 60.3 67.9 VALUATION RATIOS (x) P/E 27.6 25.8 20.5 17.0 15.4 13.7 P/BV 2.1 2.0 1.9 1.8 1.7 1.5 PUP 11.6 10.7 11.8 10.6 8.4 7.2 Source: Company data, Macquarie Research, March 2012


20 March 2012 87

Fig 10 ICICI Bank: 1 yr fwd P/BV chart


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20 March 2012 88

ICICI Bank (ICICIBC IN, Neutral, Target Price: Rs855.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 29,317 26,610 28,880 34,205 Net Interest Income m 90,169 107,007 132,361 154,053 + Loan Fees m 16,620 15,085 15,221 18,027 + Loan Fees m 68,912 60,661 69,760 81,619 + Trading Income m 2,111 1,916 2,526 2,991 + Trading Income m -2,434 7,705 11,575 12,533 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 1,264 1,147 1,107 1,311 + Other Income m 1 4,612 5,073 5,580 Non Interest Income m 19,994 18,148 18,854 22,330 Non Interest Income m 66,479 72,978 86,409 99,733 Total Operating Inc m 49,312 44,758 47,734 56,534 Total Operating Inc m 156,648 179,984 218,770 253,785


Pre-Provision Profit m 27,644 25,091 27,751 32,867 Pre-Provision Profit m 90,475 100,899 127,187 149,217 Loan Provisions m 4,256 3,863 7,228 8,561 Loan Provisions m 22,875 15,534 33,128 43,260 Post Provision Profit m 23,388 21,228 20,523 24,307 Post Provision Profit m 67,600 85,365 94,059 105,958 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 23,388 21,228 20,523 24,307 Pre-Tax Profit m 67,600 85,365 94,059 105,958 - Taxation m 6,081 5,519 5,336 6,320 - Taxation m 16,093 22,195 24,455 27,549 Net Profit After Tax m 17,307 15,709 15,187 17,987 Net Profit After Tax m 51,507 63,170 69,604 78,409 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 17,307 15,709 15,187 17,987 Reported Profit m 51,507 63,170 69,604 78,409 Adjusted Profit m 17,307 15,709 15,187 17,987 Adjusted Profit m 51,507 63,170 69,604 78,409 Attributable Profit m 17,307 15,709 15,187 17,987 Attributable Profit m 51,507 63,170 69,604 78,409 EPS (rep) 15.03 13.64 13.19 15.62 EPS (rep) 44.72 54.84 60.43 68.07 EPS growth pcp (rep) % 67.4 -15.3 10.0 10.0 EPS growth yoy (rep) % 23.9 22.6 10.2 12.6 EPS (adj) 15.03 13.64 13.19 15.62 EPS (adj) 44.72 54.84 60.43 68.07 EPS growth pcp (adj) % 67.4 -15.3 10.0 10.0 EPS growth yoy (adj) % 23.9 22.6 10.2 12.6 DPS 3.75 3.75 4.00 4.00 DPS 14.00 15.00 16.00 17.00 Payout ratio % 31.3 27.4 26.5 25.0 Book Value p.s (wgted) 481.3 518.9 561.0 609.5 Tangible Book Value p.s (wgted) 481.3 518.9 561.0 609.5 Weighted average shares m 1,152 1,152 1,152 1,152




Pre-Prov Profit Growth % -7.0 11.5 26.1 17.3 PBT Growth % 26.5 26.3 10.2 12.6 Loan Growth % 19.4 17.6 16.0 19.0 Ave Int Earning Assets % 12.9 13.8 13.7 16.0 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 20.8 17.0 15.4 13.7 P/E (adj) x 20.8 17.0 15.4 13.7 P/B (wgted) x 1.9 1.8 1.7 1.5 P/TB (wgted) x 1.9 1.8 1.7 1.5 Dividend yield % 1.5 1.6 1.7 1.8 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 37,844 37,844 37,844 37,844 Net Loans to Customer m 2,163,659 2,544,132 2,951,193 3,511,920 Other Interest Earning Assets m 1,649,917 1,795,061 1,983,271 2,209,789 Other Assets m 210,918 139,116 228,537 254,210 Total Assets m 4,062,337 4,516,153 5,200,845 6,013,763 Customer Deposits m 2,256,021 2,617,974 3,066,536 3,595,468

Other Int Bearing Liab m 768,265 913,547 1,093,721 1,313,909 Other Liabilities m 483,641 386,918 394,464 402,370 Total Liabilities m 3,507,927 3,918,440 4,554,721 5,311,747 Ordinary Equity m 11,518 11,518 11,518 11,518 Retained Earnings m 0 0 0 0 Reserves m 542,891 586,195 634,606 690,498 Minority Interests m 0 0 0 0 Total S/H's Funds m 554,409 597,713 646,124 702,016



20 March 2012 89

INDIA

KMB IN Neutral Close Price* 15 Mar 12 Rs557.65



Valuation Rs 535.00 - Sum of Parts

GICS sector Diversified Financials







KMB IN rel BSE Sensex performance, & rec history





Kotak Mahindra Bank You aren’t Mr. Perfect, Downgrade to Neutral Event

Very expensive at 2.8x FY13E P/BV, little margin of safety, Downgrade to

Neutral: Though Kotak’s fundamentals relative to its peers is expected to be robust, at 2.8x FY13E P/BV the stock is pricey and there is very little room for comfort at these valuations. We downgrade the stock to Neutral with TP of Rs535. The downgrade is purely on account of its expensive valuations. Fundamentals are expected to remain solid.

Impact

We are enthused by the financing business: Over the past 12 months the share of thfinancing business has gone up from 73% on an average to 80% now. These businesses have been registering excellent growth in profits and are more stable compared to the capital markets piece, which is very volatile. Hence the earnings stream going ahead is likely to be strong and steady and less subjecd to the vagaries of the market. Risk of equity dilution is also the least, as Kotak is well capitalised. We don’t envisage any capital raising for at least the next three years.

Excellent asset quality: Asset quality continues to hold up extremely well, with NPLs well under control. Gross NPLs including stressed assets have been declining and gel in line with our thesis that retail-focused banks should continue to do very well.

CASA ratio – positive effect of savings rate de-regulation: CASA has gone up from 26% to 28% QoQ in 3Q12, and KMB have managed to add close to 0.15mn customers this quarter compared to 0.1mn a quarter before. So there has been a good 50% increase, which is encouraging. The management articulated that they are seeing good traction in savings deposits post the de-regulation.

Capital market businesses – facing the brunt: Though only 7% of profits are constituted by non-banking/financing and non-insurance streams, they still tend to swing earnings a bit. The numbers posted by the investment banking business and international subsidiaries (predominantly asset management) were quite dismal this quarter, reflecting the current turmoil in capital markets


We are fine tuning earnings and our TP. Changes to EPS have been minimal and TP is reduced by 3% to Rs535.

Price catalyst

12-month price target: Rs535.00 based on a Sum of Parts methodology.

Catalyst: Strong growth and improvement in return ratios


Good stock to own from a long term perspective: Though near-term upside looks limited due to expensive valuations, we believe Kotak is a good stock to own from a long-term perspective owing to its sound fundamentals.


20 March 2012 90

Valuations and target price

We value Kotak on a sum-of-parts basis where the banking business is valued on a two-stage Gordon growth model to capture the high growth phase. The life insurance business is valued on an appraisal value method, whereas other businesses are valued either on a P/E methodology or % of AUM.

Fig 1 Kotak - Target price calculation

Sum of Parts Per share value Remarks

Standalone bank 354 Two stage Gordon growth model - 3.0x P/BV - FY13E Life insurance 21 Appraisal value = EV + new business value Asset management 27 5% of FY13E AUM International subsidiaries 10 15.0x FY13E net profit Investment company 5 15.0x FY13E net profit Securities 29 15.0x FY13E net profit Investment banking 8 15.0x FY13E net profit Auto finance 83 3.0x FY13E book value Alternate assets 7 10% of AUM Less further investment in subsidiaries (10) Target Price (Rounded off) 535



20 March 2012 91

Fig 2 Select Ratios


GROWTH PROJECTIONS Growth in Net interest income 29.6 19.1 24.0 12.3 19.2 23.9 Growth in Operating profit (PPP) (24.0) 79.3 (0.8) 18.0 22.6 23.3 Growth in Net profit (34.2) 100.3 19.9 19.4 21.1 21.7 Growth in Total assets (0.9) 37.0 33.7 18.2 19.4 20.2 Growth in Shareholder's Equity 12.0 21.3 38.6 16.7 17.4 18.1 ASSET ANALYSIS Net interest income / average assets 5.9 5.9 5.4 4.9 4.9 5.1 Earning assets to Total assets 92.6 93.8 95.4 97.3 100.0 103.0 Return on Avg. Earning Assets 1.7 3.0 2.6 2.4 2.4 2.4 Loans to earning assets 60.4 57.5 58.7 63.3 67.0 70.3 LOAN ANALYSIS Loan growth 2.3 32.1 38.7 30.0 30.0 30.0 Corporate loan growth 16.2 221.5 48.0 38.1 37.6 37.2 Retail loan growth (3.2) 10.9 38.7 30.0 30.0 30.0 Other loan growth 10.5 (6.7) 24.1 14.7 12.7 10.0 DEPOSIT ANALYSIS Deposits growth 1.0 57.8 25.2 26.7 26.7 26.7 Current & savings to total deposit 36.1 31.9 31.3 31.1 30.9 30.8 Time deposit to total deposit 63.9 68.1 68.7 68.9 69.1 69.2 Deposits to Interest Bearing Liabilities 55.6 62.7 56.4 60.7 64.5 68.1 LIQUIDITY LDR 162.8 136.2 151.0 155.0 159.0 163.2 Loans to Assets 34.4 39.6 37.1 39.7 42.2 44.4 Customer Deposits to Earning Assets 37.1 42.2 38.9 40.8 42.2 43.1 ASSET QUALITY Gross NPA ratio 3.7 3.1 1.6 1.3 1.1 1.1 Loan loss coverage ratio 45.4 51.9 65.0 73.5 73.8 72.5 Provisions to Average Loans 1.5 2.1 0.3 0.3 0.4 0.4 Reserves to Loans 1.5 1.4 1.0 0.9 0.8 0.7 CAPITAL ADEQUACY Tier I CAR 18.8 15.4 18.0 16.0 14.4 13.2 Total CAR 22.8 18.4 19.9 17.4 15.6 14.0 Equity to assets 16.2 14.4 14.9 14.7 14.4 14.2 SPREAD ANALYSIS Yield on average assets 11.7 10.4 10.2 10.0 9.8 9.7 Average cost of funds 7.5 5.8 6.2 7.0 7.2 7.2 Spread 4.2 4.7 4.0 3.0 2.7 2.5 Net interest margin 6.0 6.1 5.6 4.9 4.8 4.8 OTHER INCOME Non interest income to total income 55.2 65.8 58.2 58.7 58.2 56.4 Fees to non interest income 115.5 36.7 59.9 89.0 97.1 111.6 Fees to total income 20.2 16.3 16.1 17.0 17.3 17.5 OPERATING EFFICIENCY Cost to income 74.6 70.9 71.5 70.4 69.1 68.0 Cost to assets 9.8 12.3 9.3 8.3 8.1 7.9 Interest bearing liabilities /Total liabilities 73.8 73.7 77.3 76.8 76.4 76.0 PROFITABILITY ROA 1.6 2.7 2.4 2.3 2.4 2.4 ROE 10.7 18.3 16.8 15.9 16.5 17.0 Pre provision ROE 21.8 33.4 25.4 23.8 24.9 26.1 Dividend yield 0.1 0.1 0.1 0.1 0.1 0.1 Basic EPS (Rs) 9.5 18.8 21.9 25.4 30.8 37.4 Diluted EPS (Rs) 9.3 18.6 21.6 25.0 30.3 36.9 VALUATIONS (x) P/E 59.9 30.0 25.9 22.3 18.4 15.1 P/BV 6.0 5.0 3.8 3.2 2.8 2.3 PUP 14.3 8.0 8.6 7.3 5.9 4.8 Source: Company data, Macquarie Research, March 2012


20 March 2012 92

Fig 3 Kotak Bank: 1yr fwd - P/BV chart


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20 March 2012 93

Kotak Mahindra Bank (KMB IN, Neutral, Target Price: Rs535.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 10,875 9,931 10,607 11,515 Net Interest Income m 35,069 39,371 46,913 58,140 + Loan Fees m 4,470 4,082 4,391 4,767 + Loan Fees m 13,487 16,184 19,421 23,306 + Trading Income m 977 892 1,024 1,112 + Trading Income m 4,204 3,538 4,530 4,525 + Insurance Income m 9,338 8,528 8,791 9,543 + Insurance Income m 29,399 33,809 38,880 44,712 + Other Income m 669 611 569 618 + Other Income m 1,789 2,421 2,516 2,616 Non Interest Income m 15,455 14,114 14,775 16,040 Non Interest Income m 48,878 55,952 65,348 75,159 Total Operating Inc m 26,329 24,045 25,382 27,555 Total Operating Inc m 83,947 95,324 112,261 133,299


Pre-Provision Profit m 7,803 7,126 7,830 8,501 Pre-Provision Profit m 23,949 28,251 34,633 42,692 Loan Provisions m 437 399 524 569 Loan Provisions m 1,476 1,583 2,319 3,368 Post Provision Profit m 7,366 6,727 7,306 7,932 Post Provision Profit m 22,473 26,668 32,314 39,324 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 7,366 6,727 7,306 7,932 Pre-Tax Profit m 22,473 26,668 32,314 39,324 - Taxation m 2,210 2,018 2,192 2,379 - Taxation m 6,782 8,001 9,694 11,797 Net Profit After Tax m 5,156 4,709 5,114 5,552 Net Profit After Tax m 15,691 18,668 22,620 27,527 - Minority Interests m 0 0 0 0 - Minority Interests m 1 0 0 0 Reported Profit m 5,156 4,709 5,114 5,552 Reported Profit m 15,690 18,668 22,620 27,527 Adjusted Profit m 5,156 4,709 5,114 5,552 Adjusted Profit m 15,690 18,668 22,620 27,527 Attributable Profit m 5,156 4,709 5,114 5,552 Attributable Profit m 15,690 18,668 22,620 27,527 EPS (rep) 7.00 6.39 6.94 7.53 EPS (rep) 21.35 25.33 30.70 37.36 EPS growth pcp (rep) % 19.0 4.0 21.2 21.2 EPS growth yoy (rep) % 12.0 18.7 21.2 21.7 EPS (adj) 7.00 6.39 6.94 7.53 EPS (adj) 21.34 25.33 30.70 37.36 EPS growth pcp (adj) % 19.0 4.0 21.2 21.2 EPS growth yoy (adj) % 11.9 18.7 21.2 21.7 DPS 0.25 0.25 0.25 0.25 DPS 0.88 1.00 1.00 1.00 Payout ratio % 4.1 3.9 3.3 2.7 Book Value p.s (wgted) 149.2 173.6 203.8 240.7 Tangible Book Value p.s (wgted) 149.2 173.6 203.8 240.7 Weighted average shares m 735 737 737 737




Pre-Prov Profit Growth % -1.8 18.0 22.6 23.3 PBT Growth % 18.1 18.7 21.2 21.7 Loan Growth % 38.7 30.0 30.0 30.0 Ave Int Earning Assets % 37.4 20.0 22.3 23.3 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 26.1 22.0 18.2 14.9 P/E (adj) x 26.1 22.0 18.2 14.9 P/B (wgted) x 3.7 3.2 2.7 2.3 P/TB (wgted) x 3.7 3.2 2.7 2.3 Dividend yield % 0.2 0.2 0.2 0.2 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 21,149 28,725 39,288 54,030 Net Loans to Customer m 412,420 536,145 696,989 906,086 Other Interest Earning Assets m 269,284 282,179 303,530 327,984 Other Assets m 33,959 23,689 4 -37,888 Total Assets m 736,811 870,739 1,039,811 1,250,211 Customer Deposits m 273,130 345,994 438,303 555,247

Other Int Bearing Liab m 211,448 224,451 241,307 259,793 Other Liabilities m 141,532 171,084 208,485 255,989 Total Liabilities m 626,110 741,529 888,096 1,071,030 Ordinary Equity m 3,684 3,684 3,684 3,684 Retained Earnings m 0 0 0 0 Reserves m 105,944 124,239 146,487 173,644 Minority Interests m 1,072 1,287 1,544 1,853 Total S/H's Funds m 110,700 129,210 151,716 179,181



20 March 2012 94

INDIA

PNB IN Underperform Close Price* 15 Mar 12 Rs997.15



Valuation Rs 790.00 - Gordon Growth Model Gordon Growth Model

GICS sector Banks







PNB IN rel BSE Sensex performance, & rec history





Punjab National Bank Gone awry! Event

Structural de-rating in the making: We expect PNB’s ROE to come down

from the 23% seen in FY11 to 17% by FY14E driven by lower ROA and leverage. Maintain Underperform with a revised TP of Rs790.

Impact

Asset quality – the pain point, expect stressed assets to net-worth to

shoot up: Quantum of slippages as well as restructuring is expected to remain high. We believe PNB, in its quest for high margins, has gone into high risk lending and that has resulted in asset quality being consistently bad quarter after quarter. We expect stressed assets as a proportion of net-worth to increase to 92% by the end of FY13E from a level of 50% seen two years ago. More large restructurings like Air India and Rajasthan SEBs are due over the course of the next few quarters.

Book value grossly overstated due to large restructuring: We believe

looking at FY13E book value and arguing that valuations look cheap is meaningless in the context of a large restructured book which constitutes 6% of overall loans. Many restructured exposures like the TNSEB exposure don’t

even carry any meaningful provisions as they have been done on a zero NPV loss basis.

Steady deterioration of franchise worries us: The CASA ratio has steadily declined over the past ten quarters, going down from a whopping 470bps since June-2010 to 36.2% in 3Q12. The bank has been utilising bulk deposits to fund growth which leaves it vulnerable to sudden tightness, in our view. Despite such a sharp deterioration of quality of its franchise, PNB’s NIMs

have hardly declined and have been maintained at around 3.9%.

Expect frequent equity dilution: The bank has already diluted its equity base by 9% in FY12E and we expect equity dilution again to happen in the next 12 months as the bank gears up for Basel-III capital requirements.


We reduce our FY13E and FY14E EPS by 7% and 14%, respectively, on account of higher credit costs and equity dilution. We reduce our TP by 10% to Rs790 on account of lower ROE and lower adjusted book value.

Price catalyst

12-month price target: Rs790.00 based on a Gordon Growth Model methodology.

Catalyst: Increase in slippages and restructured assets quantum.


Reiterate Underperform: Historically PNB has traded at a premium to its peers owing to its superior returns. However with those superior return ratios unlikely to be seen going ahead, the stock is expected to de-rate further. Reiterate Underperform with a new TP of Rs790.


20 March 2012 95

Expect slippages and stressed assets to remain high

Slippages have been stubbornly high for PNB for the past several quarters and we expect that to continue. The quantum of restructured assets at 6% is the highest amongst large PSU banks.

Fig 1 PNB – slippages have been persistently high


We expect stressed assets as a proportion of net-worth to increase to 92% by the end of FY13E from a level of 50% seen two years ago. More large restructurings like Air India and Rajasthan SEBs are due over the course of the next few quarters.

Fig 2 Stressed assets to net-worth to increase substantially


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20 March 2012 96

Valuations and TP

We value PNB on a two stage Gordon Growth Model using


Fig 3 PNB – sum-of-parts methodology

Cost of equity 13.5% RoE 14.8% g (initial growth) 11% n(initial growth period) 5 Steady growth 4% Theoretical P/BV – using two stage Gordon growth model 1.22x FY13E adjusted book value (INR) – Adjusted for Net NPLs (Rs/sh) 826 Assumed restructuring hit at 20% to gross book value (Rs/sh) 179 Book value used in calculation of fair value (Rs/sh) 647

Target Price (Rounded off) (Rs/sh) 790



20 March 2012 97

Fig 4 Select ratios


GROWTH PROJECTIONS Growth in Net interest income 27.0 20.6 39.3 15.5 15.3 16.1 Growth in Operating profit 43.4 27.5 23.6 15.7 13.3 13.9 Growth in Net profit 50.9 26.4 13.5 7.0 14.8 14.4 Growth in Total assets 24.1 20.1 27.5 19.1 17.3 18.1 Growth in Shareholder's Equity 19.0 20.9 21.4 29.2 16.7 27.1 ASSET ANALYSIS Net interest income / average assets 3.2 3.1 3.5 3.3 3.2 3.2 Earning assets to Total assets 88.3 89.1 89.1 88.3 88.6 88.3 Return on Avg Earning Assets 1.4 1.5 1.4 1.2 1.2 1.1 Loans to earning assets 70.9 70.6 71.8 71.8 71.4 70.9 LOAN ANALYSIS Loan growth 29.5 20.6 29.7 18.0 17.0 17.0 Corporate loan growth 28.5 20.6 29.7 18.0 17.0 17.0 Retail loan growth 34.4 20.6 29.7 18.0 17.0 17.0 DEPOSIT ANALYSIS Deposits growth 26.0 18.9 25.5 20.5 18.9 18.9 Current & savings to total deposit 38.8 40.8 38.5 37.7 38.2 38.6 Time deposit to total deposit 61.2 59.2 61.5 62.3 61.8 61.4 Deposits to Interest Bearing Liabilities 98.0 96.7 93.9 94.8 95.6 96.2 LIQUIDITY LDR 73.8 74.8 77.4 75.8 74.6 73.4 Loans to Assets 62.7 62.9 64.0 63.4 63.3 62.7 Customer Deposits to Earning Assets 87.6 86.6 85.3 87.2 88.3 89.2 ASSET QUALITY Gross NPA ratio 1.79 1.72 1.81 2.11 2.55 3.12 Loan loss coverage ratio 90.5 69.5 53.4 62.7 71.1 72.9 Provisions to Loans 0.82 0.59 0.93 0.75 1.00 1.00 Reserves to Loans 1.62 1.20 0.97 1.32 1.82 2.28 CAPITAL ADEQUACY Tier I ratio 8.98 9.15 8.44 9.10 8.71 9.09 Total capital ratio 14.03 14.16 12.42 12.68 11.92 11.97 Equity to assets 5.9 6.0 5.7 6.2 6.1 6.6 SPREAD ANALYSIS Yield on average assets 9.02 8.17 8.28 9.38 9.20 9.09 Average cost of funds 6.14 5.28 4.96 6.29 6.16 6.08 Spread 2.87 2.89 3.32 3.09 3.05 3.01 Net interest margin 3.62 3.57 3.96 3.76 3.68 3.63 OTHER INCOME Non interest income to total income 13.1 14.4 11.8 9.5 9.6 9.5 Fees to non interest income 47.2 46.6 56.6 60.1 61.7 64.1 Fees to total income 6.2 6.7 6.7 5.7 5.9 6.1 OPERATING EFFICIENCY Cost to income 42.3 39.4 41.3 40.3 41.5 42.5 Cost to assets 1.9 1.8 1.9 1.7 1.7 1.7 Interest bearing liabilities /Total liabilities 92.2 92.5 93.4 94.1 94.6 95.1 PROFITABILITY ROA 1.4 1.4 1.3 1.1 1.1 1.1 ROE 22.9 24.1 22.6 19.2 18.1 16.9 Pre provision ROE 42.6 45.3 46.2 42.5 39.4 36.7 Dividend yield 2.0 1.2 2.2 2.0 2.0 2.0 Basic EPS (Rs) 98.0 123.9 140.3 143.2 157.7 171.8 Diluted EPS (Rs) 98.0 123.9 140.3 143.2 157.7 171.8 VALUATIONS (x) P/E 10.2 8.1 7.1 7.0 6.3 5.8 P/BV 2.4 1.9 1.6 1.3 1.1 1.0 PUP 5.5 4.3 3.5 3.3 2.9 2.8 Source: Company data, Macquarie Research, March 2012


20 March 2012 98

Fig 5 PNB: 1 yr fwd P/BV chart


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20 March 2012 99

Punjab National Bank (PNB IN, Underperform, Target Price: Rs790.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 36,676 35,876 34,797 38,766 Net Interest Income m 118,073 136,344 157,230 182,473 + Loan Fees m 9,763 9,550 9,355 10,422 + Loan Fees m 33,134 36,295 42,271 49,315 + Trading Income m 765 748 775 863 + Trading Income m 2,992 2,842 3,500 3,500 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 0 0 0 0 + Other Income m 0 0 0 0 Non Interest Income m 10,528 10,298 10,130 11,285 Non Interest Income m 36,126 39,137 45,771 52,815 Total Operating Inc m 47,204 46,175 44,927 50,052 Total Operating Inc m 154,199 175,481 203,001 235,289


Pre-Provision Profit m 28,175 27,561 26,266 29,262 Pre-Provision Profit m 90,557 104,742 118,683 135,233 Loan Provisions m 9,132 8,933 8,001 8,914 Loan Provisions m 24,920 33,949 36,153 42,225 Post Provision Profit m 19,043 18,628 18,265 20,349 Post Provision Profit m 65,637 70,793 82,530 93,009 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 19,043 18,628 18,265 20,349 Pre-Tax Profit m 65,637 70,793 82,530 93,009 - Taxation m 6,284 6,147 6,210 6,919 - Taxation m 21,302 23,362 28,060 30,693 Net Profit After Tax m 12,759 12,481 12,055 13,430 Net Profit After Tax m 44,335 47,431 54,470 62,316 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 12,759 12,481 12,055 13,430 Reported Profit m 44,335 47,431 54,470 62,316 Adjusted Profit m 12,759 12,481 12,055 13,430 Adjusted Profit m 44,335 47,431 54,470 62,316 Attributable Profit m 12,759 12,481 12,055 13,430 Attributable Profit m 44,335 47,431 54,470 62,316 EPS (rep) 38.53 37.69 34.90 38.88 EPS (rep) 140.27 143.24 157.68 171.80 EPS growth pcp (rep) % 2.1 -0.4 10.1 10.1 EPS growth yoy (rep) % 13.3 2.1 10.1 9.0 EPS (adj) 38.53 37.69 34.90 38.88 EPS (adj) 140.27 143.24 157.68 171.80 EPS growth pcp (adj) % 2.1 -0.4 10.1 10.1 EPS growth yoy (adj) % 13.3 2.1 10.1 9.0 DPS 5.00 5.00 5.00 5.00 DPS 22.00 20.00 20.00 20.00 Payout ratio % 15.7 14.0 12.7 11.6 Book Value p.s (wgted) 680.5 839.4 938.7 1,136.4 Tangible Book Value p.s (wgted) 680.5 839.4 938.7 1,136.4 Weighted average shares m 316 331 345 363




Pre-Prov Profit Growth % 23.6 15.7 13.3 13.9 PBT Growth % 11.2 7.9 16.6 12.7 Loan Growth % 29.7 18.0 17.0 17.0 Ave Int Earning Assets % 27.4 17.7 17.4 17.6 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 7.1 7.0 6.3 5.8 P/E (adj) x 7.1 7.0 6.3 5.8 P/B (wgted) x 1.5 1.2 1.1 0.9 P/TB (wgted) x 1.5 1.2 1.1 0.9 Dividend yield % 2.2 2.0 2.0 2.0 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 237,769 282,737 336,570 401,033 Net Loans to Customer m 2,421,067 2,856,859 3,342,525 3,910,754 Other Interest Earning Assets m 1,010,767 1,180,876 1,399,141 1,664,485 Other Assets m 113,650 184,391 205,917 265,746 Total Assets m 3,783,252 4,504,863 5,284,153 6,242,018 Customer Deposits m 3,128,987 3,769,234 4,482,427 5,331,194




20 March 2012 100

INDIA

SBIN IN Underperform Close Price* 15 Mar 12 Rs2,299.45

12-month target Rs 1,700.00


Valuation Rs 1,700.00 - Sum of Parts

GICS sector Banks






Year end 31 Mar 2011A 2012E 2013E 2014E Net interest Inc bn 455.5 540.3 618.5 710.8 Non interest Inc bn 342.1 404.1 464.4 535.9 PBT bn 199.2 268.3 276.3 335.1 PBT growth % 6.6 34.7 3.0 21.3 Reported profit bn 111.8 161.0 174.1 211.1 EPS rep Rs 176.06 238.65 258.09 284.57 EPS rep growth % -7.0 35.5 8.1 10.3 PER rep x 13.1 9.6 8.9 8.1 Total DPS Rs 30.00 37.00 37.00 37.00 Total div yield % 1.3 1.6 1.6 1.6 ROA % 0.7 0.9 0.8 0.9 ROE % 13.4 17.2 15.7 16.0 Equity to assets % 5.1 5.4 5.2 5.6 P/BV x 1.7 1.5 1.3 1.2

SBIN IN rel BSE Sensex performance, & rec history





State Bank of India Size doesn’t matter Event

Maintain Underperform with TP of Rs1,700: We remain bearish on SBI mainly due to asset quality issues which are unlikely to abate in the near future. Maintain Underperform.

Impact

Asset quality – the biggest worry: The key worry continues to be asset quality and slippages have been stubbornly high at 4% of advances for quite some time. Management recently clarified at our conference that sectors like aviation, metals, sugar, those companies dependent on state utilities like cable, and transformer companies have contributed to the NPLs. The key worry is the large level of NPLs seen in agri, SME and the mid-corporate sector where Gross NPL ratios are at 9.5%, 7.9% and 5.5%, respectively.

Agri sector – recoveries hold the key and they have been unsatisfactory:

Agri NPLs have risen rapidly from less than 3% in FY09 to 9.5% as of Dec-2011. The moral hazard issue due to the debt waiver has resulted in farmers defaulting on agri loans. SBI also doesn’t have a choice but to lend to this

segment in order to meet the priority sector obligations and government diktats. The issue has also been the level of recoveries in the agri segment, which continues to be quite disappointing.

Expect stressed assets to net-worth to increase to 76% by FY13E: We expect stressed assets to net-worth to increase to 76% by FY13E from the 54% seen in FY11. We expect restructuring to pick up in 4QFY12 and FY13. However the level of restructured assets will be lower for SBI compared to its peers owing to its lower exposures to various stressed sectors like power, aviation etc.

Margins have peaked and opex to increase: SBI’s 3Q12 NIMs at 4% plus

are close to all-time highs, and we think NIMs have peaked and could come down as rate cuts begin given that nearly 70-75% of loans are at floating rates. Also we expect pressure on opex due to impending wage negotiations due from Nov-2012 which could result in higher salary costs and employee benefits like pensions. Cost-income ratio should inch up by 200bps by FY14E.


We increase our FY13E and FY14E earnings by 8% and 1% on account of an increase in margins, which have been maintained at high levels. TP remains unchanged at Rs1,700.

Price catalyst

12-month price target: Rs1,700.00 based on a Sum of Parts methodology.

Catalyst: High slippages and increase in restructured assets


Frequent equity dilution imminent, Maintain Underperform: The expected capital infusion of Rs79bn from the government is insufficient and we expect more equity dilution over the course of the next five years driven mainly by Basel-III requirements.


20 March 2012 101

Asset quality the biggest worry

Slippages have remained consistently high for SBI for several quarters in a row.

Fig 1 Slippages remain persistently high


Slippages from restructured assets have also increased and close to 26% of loans from restructured assets category have slipped into NPLs.

Fig 2 Slippages from restructured portfolio rise significantly


Another major worry has been the rise in agri and SME NPLs seen over several quarters.

Fig 3 Agri and SME NPLs rising at an alarming rate

Gross NPL ratios of sectors 4QFY11 1QFY12 2QFY12 3QFY12

Retail 2.65% 2.58% 2.89% 2.84% Agri 6.37% 7.17% 8.92% 9.45% SME 3.66% 4.19% 4.99% 7.90% International 2.06% 2.06% 1.95% 2.20% Mid Corporate 3.16% 3.38% 4.25% 5.54% Source: Company data, Macquarie Research, March 2012

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20 March 2012 102

Fig 4 Agri and SME NPLs are rising at an alarming rate


We expect stressed assets to net-worth to increase substantially for SBI in FY13 driven by larger restructuring. Note that stressed assets are defined as net NPLs (i.e. NPLs not provided for) plus restructured assets where provisioning done is minimal.

Fig 5 Stressed assets to net-worth to increase substantially


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SBI


20 March 2012 103

Valuations

We value SBI on a sum-of-parts basis, and we value the core banking business using a two-stage Gordon Growth Model. The life insurance business is valued using the appraisal value method, which is embedded value plus new business value.

Fig 6 SBI – sum-of-parts methodology

Cost of equity 13.0% RoE 14.8% g (initial growth) 12% n(initial growth period) 10 Steady growth 4% Theoretical P/BV – using two stage Gordon growth model 1.3x FY13E adjusted book value (INR) – Adjusted for Net NPLs 1,413 Assumed restructuring hit at 15% to gross book value 253 Book value used in calculation of fair value 1,160

Fair value based on BV (INR) 1,520

Valuation of life insurance (INR) 163 Target Price (Rounded off) 1,700



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Fig 7 Select ratios (Consolidated)


GROWTH PROJECTIONS Growth in Net interest income 23.3 15.2 36.2 18.6 14.5 14.9 Growth in Operating profit (PPP) 30.4 3.8 34.0 33.9 8.0 16.2 Growth in Net profit 22.3 7.1 (8.9) 48.1 8.1 21.5 Growth in Assets 27.0 11.1 13.6 17.1 16.7 17.5 Growth in Shareholder's Equity 18.2 14.8 0.4 24.7 12.7 25.5 ASSET ANALYSIS Net interest income / average assets 2.5 2.4 2.9 3.0 3.0 2.9 Earning assets to Total assets 95.6 96.1 95.9 94.7 94.3 93.4 Return on Avg Earning Assets 1.0 0.9 0.8 0.9 0.9 0.9 Loans to earning assets 60.1 62.4 63.7 63.9 63.8 63.5 LOAN ANALYSIS Loan growth 24.4 15.9 15.7 16.0 16.0 16.0 DEPOSIT ANALYSIS Deposits growth 30.3 10.3 12.5 18.6 18.6 18.7 Current & savings to total deposit 38.4 42.7 44.9 45.6 46.4 47.1 Time deposit to total deposit 61.6 57.3 55.1 54.4 53.6 52.9 Deposits to Interest Bearing Liabilities 94.0 93.5 93.2 93.9 94.6 95.2 LIQUIDITY LDR 74.1 77.9 80.2 78.4 76.7 75.0 Loans to Assets 57.5 60.0 61.1 60.5 60.1 59.4 Customer Deposits to Earning Assets 81.1 80.1 79.4 81.5 83.2 84.8 ASSET QUALITY Gross NPA ratio 2.66 2.85 3.09 3.31 4.10 5.09 Loan loss coverage ratio 36.8 41.4 52.1 66.3 66.7 63.6 Provisions to Loans 0.53 0.77 1.16 1.26 1.30 1.30 Reserves to Loans 0.98 1.18 1.61 2.19 2.74 3.24 CAPITAL ADEQUACY Total capital ratio 14.25 13.39 11.98 13.66 12.84 12.95 Equity to assets 5.5 5.7 5.1 5.4 5.2 5.6 SPREAD ANALYSIS Yield on average assets 8.32 7.62 7.69 8.22 8.10 8.04 Average cost of funds 6.15 5.54 5.06 5.51 5.35 5.26 Spread 2.17 2.08 2.62 2.71 2.76 2.78 Net interest margin 2.63 2.55 3.08 3.19 3.15 3.11 OTHER INCOME Non interest income / total income 9.59 14.80 11.44 10.66 9.94 9.12 Fees to non interest income 45.38 35.11 40.81 39.72 38.02 36.24 Fees to total income 8.60 8.86 9.44 8.93 8.59 8.18 OPERATING EFFICIENCY Cost to income 52.7 63.1 58.3 52.9 55.6 55.2 Cost to assets 2.3 3.1 3.0 2.8 2.9 2.8 Interest bearing liabilities /Total liabilities 87.5 87.6 86.3 87.0 87.6 88.2 PROFITABILITY ROA 0.9 0.9 0.7 0.9 0.8 0.8 ROE 16.9 15.6 13.3 17.4 15.9 16.2 Pre provision ROE 35.8 31.9 39.9 47.5 43.4 42.3 Dividend yield 1.2 1.2 1.2 1.6 1.9 2.0 Basic EPS (Rs) 176.9 189.2 176.1 238.7 258.1 284.6 Diluted EPS (Rs) 176.9 189.2 176.1 238.7 258.1 284.6 VALUATIONS (x) P/E 13.9 13.0 14.4 10.0 9.5 8.2 P/BV 2.2 1.9 1.9 1.6 1.4 1.3 PUP 6.4 6.2 4.6 3.7 3.4 3.2 Source: Company data, Macquarie Research, March 2012


20 March 2012 105

Fig 8 SBIN: 1 yr fwd P/BV chart


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20 March 2012 106

State Bank of India (SBIN IN, Underperform, Target Price: Rs1,700.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 150,849 120,282 146,835 161,285 Net Interest Income m 455,500 540,265 618,529 710,818 + Loan Fees m 44,822 35,739 41,919 46,044 + Loan Fees m 139,589 160,528 176,581 194,239 + Trading Income m 14,548 11,600 12,631 13,874 + Trading Income m 47,114 52,102 53,209 52,674 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 53,464 42,631 55,703 61,185 + Other Income m 155,371 191,481 234,643 289,004 Non Interest Income m 112,833 89,970 110,254 121,104 Non Interest Income m 342,075 404,111 464,433 535,917 Total Operating Inc m 263,683 210,252 257,089 282,389 Total Operating Inc m 797,575 944,376 1,082,962 1,246,734


Pre-Provision Profit m 124,299 99,112 114,122 125,353 Pre-Provision Profit m 332,395 445,176 480,727 558,543 Loan Provisions m 49,391 39,383 48,525 53,301 Loan Provisions m 133,198 176,894 204,408 223,408 Post Provision Profit m 74,908 59,729 65,596 72,052 Post Provision Profit m 199,198 268,282 276,319 335,136 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 74,908 59,729 65,596 72,052 Pre-Tax Profit m 199,198 268,282 276,319 335,136 - Taxation m 29,963 23,892 24,271 26,659 - Taxation m 87,398 107,313 102,238 124,000 Net Profit After Tax m 44,945 35,838 41,326 45,393 Net Profit After Tax m 111,799 160,969 174,081 211,135 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 44,945 35,838 41,326 45,393 Reported Profit m 111,799 160,969 174,081 211,135 Adjusted Profit m 44,945 35,838 41,326 45,393 Adjusted Profit m 111,799 160,969 174,081 211,135 Attributable Profit m 44,945 35,838 41,326 45,393 Attributable Profit m 111,799 160,969 174,081 211,135 EPS (rep) 66.63 53.13 61.27 67.30 EPS (rep) 176.06 238.65 258.09 284.57 EPS growth pcp (rep) % 35.5 35.5 8.1 8.1 EPS growth yoy (rep) % -7.0 35.5 8.1 10.3 EPS (adj) 66.63 53.13 61.27 67.30 EPS (adj) 176.06 238.65 258.09 284.57 EPS growth pcp (adj) % 35.5 35.5 8.1 8.1 EPS growth yoy (adj) % -7.0 35.5 8.1 10.3 DPS 9.25 9.25 9.25 9.25 DPS 30.00 37.00 37.00 37.00 Payout ratio % 17.0 15.5 14.3 13.0 Book Value p.s (wgted) 1,314.5 1,542.9 1,738.1 1,982.6 Tangible Book Value p.s (wgted) 1,314.5 1,542.9 1,738.1 1,982.6 Weighted average shares m 635 674 674 742




Pre-Prov Profit Growth % 34.0 33.9 8.0 16.2 PBT Growth % 6.6 34.7 3.0 21.3 Loan Growth % 15.7 16.0 16.0 16.0 Ave Int Earning Assets % 11.4 16.5 16.9 17.2 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 13.1 9.6 8.9 8.1 P/E (adj) x 13.1 9.6 8.9 8.1 P/B (wgted) x 1.7 1.5 1.3 1.2 P/TB (wgted) x 1.7 1.5 1.3 1.2 Dividend yield % 1.3 1.6 1.6 1.6 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 1,193,498 1,254,062 1,317,734 1,384,649 Net Loans to Customer m 10,064,016 11,674,258 13,542,139 15,708,882 Other Interest Earning Assets m 4,550,441 5,351,881 6,369,281 7,634,520 Other Assets m 672,228 1,018,547 1,288,167 1,736,405 Total Assets m 16,480,183 19,298,748 22,517,322 26,464,455 Customer Deposits m 12,555,625 14,890,054 17,662,873 20,957,254

Other Int Bearing Liab m 920,357 965,931 1,014,133 1,065,121 Other Liabilities m 2,168,288 2,402,109 2,667,996 2,971,112 Total Liabilities m 15,644,270 18,258,094 21,345,003 24,993,487 Ordinary Equity m 6,350 6,745 6,745 7,419 Retained Earnings m 0 0 0 0 Reserves m 828,363 1,033,909 1,165,574 1,463,549 Minority Interests m 0 0 0 0 Total S/H's Funds m 834,713 1,040,654 1,172,319 1,470,968



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INDIA

UNBK IN Underperform Close Price* 15 Mar 12 Rs240.15



Valuation Rs 185.00 - Gordon Growth

GICS sector Banks






Year end 31 Mar 2011A 2012E 2013E 2014E Net interest Inc bn 62.2 70.6 80.4 93.7 Non interest Inc bn 20.4 22.5 23.9 25.5 PBT bn 29.6 24.8 30.2 33.9 PBT growth % 4.3 -16.1 21.6 12.5 Reported profit bn 20.8 15.6 21.1 23.8 EPS rep Rs 39.71 29.15 35.80 36.62 EPS rep growth % -3.3 -26.6 22.8 2.3 PER rep x 6.0 8.2 6.7 6.6 Total DPS Rs 8.00 6.00 6.00 6.00 Total div yield % 3.3 2.5 2.5 2.5 ROA % 1.0 0.6 0.7 0.7 ROE % 18.0 11.6 13.4 12.5 Equity to assets % 5.4 5.2 5.4 5.5 P/BV x 1.0 0.9 0.8 0.8

UNBK IN rel BSE Sensex performance, & rec history





Union Bank of India Cheap can remain cheap Event

Downgrade to Underperform: We expect Union Bank’s ROE to witness severe pressure and fall from the 18-20% seen in FY08-11 to 12-13% by FY14E given slower growth and asset quality issues. Downgrade to Underperform with a revised TP of Rs185.

Impact

Asset quality to overhang the performance: Once known for superior asset quality, Union Bank has steadily disappointed, with net NPA rising close to 2% in 3Q12. This has led to a continued de-rating of the stock over the past 1.5 years. Restructured assets in 3Q12 grew by a steep 3x sequentially to Rs86bn (stood at 5.5% of loan book). We expect the slippage ratio to remain close to 2% compared to the 1.5% seen in FY07-10. With poor reported provision coverage of 45%, we expect credit costs to pile up over FY12-14E.

Business growth slowing down: In 3Q12, domestic advances grew YoY by 15% and domestic deposits increased by just 10%, indicating a sharp slowdown. These growth rates are particularly poor compared to industry averages. We expect credit growth to come off over FY11-14E and record a 16% CAGR against +25% seen in FY09-11.

Franchise remains weak, fee traction disappointing: Union Bank has invested heavily in technology, re-branding and infrastructure/systems in order to lift the CASA ratio above 33-35% and fee income growth. However, the bank has failed to show any sustained meaningful improvement in CASA (remains at 30-31%) and non-interest income.

Management change in April 2012. The current CMD, Mr. Nair, is expected to superannuate/retire in April 2012. Management changes at PSU banks tend to cause significant uncertainty, due to past experience. This makes us additionally cautious on the stock.


We cut our earnings by 21% for FY13E and by 31% for FY14E, mainly due to higher credit costs, lower growth and equity dilution. We cut our TP by 18% to Rs185 mainly due to a lower ROE and lower projected earnings growth.

Price catalyst


Catalyst: Pressure on asset quality – increase in NPLs and restructured assets.


Downgrade to Underperform: Lower loan growth, asset quality issues and a weakening franchise, along with a management change, are likely to overhang stock performance in the medium term. We downgrade Union Bank to Underperform with a revised TP of Rs185.


20 March 2012 108

Valuations and TP

We value UNBK on a two stage Gordon growth model using


Fig 1 UNBK – sum-of-parts methodology





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Fig 2 Select Ratios


GROWTH PROJECTIONS Growth in Net interest income 33.6 9.9 48.3 13.5 13.9 16.6 Growth in Operating profit 19.4 18.7 17.6 21.8 10.2 12.3 Growth in Net profit 24.5 20.2 0.3 (25.0) 35.1 12.5 Growth in Total assets 29.7 21.2 20.9 16.7 16.5 16.6 Growth in Shareholders’ Equity 19.0 19.3 22.5 11.9 21.1 19.5 ASSET ANALYSIS Net interest income / average assets 2.7 2.4 2.9 2.8 2.7 2.7 Earning assets to Total assets 96.7 97.1 97.3 97.2 97.5 98.0 Return on Avg Earning Assets 1.3 1.2 1.0 0.6 0.7 0.7 Loans to earning assets 62.1 63.0 65.8 65.4 65.0 64.3 LOAN ANALYSIS Loan growth 29.8 23.6 26.5 16.0 16.0 16.0 Corporate loan growth 32.5 19.5 25.7 15.2 15.2 15.2 Retail loan growth 28.8 29.5 32.3 21.1 20.9 20.7 Agri Loan growth 17.8 41.3 26.5 16.0 16.0 16.0 DEPOSIT ANALYSIS Deposits growth 33.5 22.6 19.1 16.8 17.1 17.1 Current & savings to total deposit 30.1 31.7 31.8 32.8 33.4 34.0 Time deposit to total deposit 69.9 68.3 68.2 67.2 66.6 66.0 Deposits to Interest Bearing Liabilities 97.3 98.2 96.6 96.5 96.5 96.4 LIQUIDITY LDR 69.6 70.2 74.6 74.1 73.4 72.7 Loans to Assets 60.0 61.1 64.0 63.6 63.3 63.0 Customer Deposits to Earning Assets 89.2 89.7 88.2 88.3 88.5 88.5 ASSET QUALITY Gross NPA ratio 1.99 2.24 2.40 3.10 3.17 3.42 Loan loss coverage ratio 80.5 63.8 50.2 45.9 57.9 63.9 Provisions to Loans 0.64 0.65 0.88 1.10 1.00 1.00 Reserves to Loans 1.60 1.43 1.20 1.42 1.83 2.19 CAPITAL ADEQUACY Tier I ratio 8.19 7.91 8.69 8.74 8.93 9.01 Total capital ratio 8.19 7.91 8.69 8.74 8.93 9.01 Equity to assets 9.1 8.7 8.5 8.2 8.5 8.8 SPREAD ANALYSIS Yield on average assets 8.71 7.73 7.87 8.59 8.32 8.26 Average cost of funds 6.17 5.54 5.14 6.06 5.86 5.83 Spread 2.54 2.19 2.73 2.53 2.46 2.43 Net interest margin 3.24 2.71 3.33 3.19 3.12 3.11 OTHER INCOME Non interest income to total income 11.1 12.9 11.0 9.6 9.0 8.3 Fees to non interest income 21.1 17.8 17.9 18.6 20.2 21.8 Fees to total income 2.3 2.3 2.0 1.8 1.8 1.8 OPERATING EFFICIENCY Cost to income 41.8 40.7 47.8 43.7 44.6 45.5 Cost to assets 1.6 1.4 1.8 1.6 1.6 1.6 Interest bearing liabilities /Total liabilities 93.7 93.7 93.9 93.8 94.5 95.1 PROFITABILITY ROA 1.2 1.2 1.0 0.6 0.7 0.7 ROE 21.5 21.7 18.0 11.6 13.4 12.5 Pre provision ROE 38.3 38.2 37.1 38.8 36.6 34.2 Dividend yield 2.1 2.3 3.3 2.5 2.5 2.5 Basic EPS (Rs) 34.2 41.1 39.7 29.2 35.8 36.6 Diluted EPS (Rs) 34.2 41.1 39.7 29.2 35.8 36.6 VALUATIONS (x) P/E 7.0 5.8 6.0 8.2 6.7 6.6 P/BV 1.7 1.4 1.0 0.9 0.9 0.8 PUP 3.9 3.3 3.5 3.0 2.9 2.8 Source: Company data, Macquarie Research, March 2012


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Fig 3 UNBK: 1 yr fwd P/BV chart


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20 March 2012 111

Union Bank of India (UNBK IN, Underperform, Target Price: Rs185.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 19,154 17,429 18,060 20,630 Net Interest Income m 62,162 70,552 80,357 93,664 + Loan Fees m 1,139 1,037 1,085 1,239 + Loan Fees m 3,649 4,197 4,826 5,550 + Trading Income m 2,538 2,309 2,237 2,556 + Trading Income m 8,934 9,348 9,955 10,603 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 2,438 2,218 2,058 2,351 + Other Income m 7,808 8,979 9,159 9,342 Non Interest Income m 6,115 5,564 5,381 6,146 Non Interest Income m 20,391 22,524 23,940 25,495 Total Operating Inc m 25,269 22,993 23,441 26,776 Total Operating Inc m 82,553 93,076 104,297 119,159


Pre-Provision Profit m 14,235 12,954 12,982 14,829 Pre-Provision Profit m 43,053 52,436 57,761 64,883 Loan Provisions m 7,502 6,827 6,204 7,087 Loan Provisions m 13,496 27,634 27,604 30,949 Post Provision Profit m 6,733 6,127 6,778 7,742 Post Provision Profit m 29,558 24,801 30,157 33,933 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 6,733 6,127 6,778 7,742 Pre-Tax Profit m 29,558 24,801 30,157 33,933 - Taxation m 2,491 2,267 2,033 2,323 - Taxation m 8,735 9,177 9,047 10,180 Net Profit After Tax m 4,242 3,860 4,744 5,419 Net Profit After Tax m 20,823 15,625 21,110 23,753 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 4,242 3,860 4,744 5,419 Reported Profit m 20,823 15,625 21,110 23,753 Adjusted Profit m 4,242 3,860 4,744 5,419 Adjusted Profit m 20,823 15,625 21,110 23,753 Attributable Profit m 4,242 3,860 4,744 5,419 Attributable Profit m 20,823 15,625 21,110 23,753 EPS (rep) 7.91 7.20 8.05 9.19 EPS (rep) 39.71 29.15 35.80 36.62 EPS growth pcp (rep) % -26.6 -26.6 22.8 22.8 EPS growth yoy (rep) % -3.3 -26.6 22.8 2.3 EPS (adj) 7.91 7.20 8.05 9.19 EPS (adj) 39.71 29.15 35.80 36.62 EPS growth pcp (adj) % -26.6 -26.6 22.8 22.8 EPS growth yoy (adj) % -3.3 -26.6 22.8 2.3 DPS 1.50 1.50 1.50 1.50 DPS 8.00 6.00 6.00 6.00 Payout ratio % 20.1 20.6 16.8 16.4 Book Value p.s (wgted) 243.4 266.5 293.4 318.6 Tangible Book Value p.s (wgted) 243.4 266.5 293.4 318.6 Weighted average shares m 524 536 590 649




Pre-Prov Profit Growth % 17.7 21.8 10.2 12.3 PBT Growth % 4.3 -16.1 21.6 12.5 Loan Growth % 26.5 16.0 16.0 16.0 Ave Int Earning Assets % 19.7 17.2 17.4 17.6 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 6.0 8.2 6.7 6.6 P/E (adj) x 6.0 8.2 6.7 6.6 P/B (wgted) x 1.0 0.9 0.8 0.8 P/TB (wgted) x 1.0 0.9 0.8 0.8 Dividend yield % 3.3 2.5 2.5 2.5 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 176,105 193,635 212,911 234,109 Net Loans to Customer m 1,509,861 1,751,439 2,031,669 2,356,736 Other Interest Earning Assets m 608,871 731,139 883,150 1,072,228 Other Assets m 64,418 76,761 80,228 76,632 Total Assets m 2,359,255 2,752,974 3,207,959 3,739,704 Customer Deposits m 2,024,613 2,364,382 2,767,769 3,240,788




20 March 2012 112

INDIA

YES IN Neutral Close Price* 15 Mar 12 Rs374.75


Upside/Downside % 1.4

Valuation Rs 380.00 - Gordon growth

GICS sector Banks





Year end 31 Mar 2011A 2012E 2013E 2014E Net interest Inc m 12,469 16,510 21,651 27,356 Non interest Inc m 6,233 7,964 9,841 11,743 PBT m 10,922 14,410 17,732 20,903 PBT growth % 50.3 31.9 23.1 17.9 Reported profit m 7,271 9,655 11,880 14,005 EPS rep Rs 21.12 27.81 31.84 35.08 EPS adj growth % 35.0 31.7 14.5 10.2 PER rep x 17.7 13.5 11.8 10.7 PER adj x 17.7 13.5 11.8 10.7 Total DPS Rs 2.52 4.17 4.78 5.26 Total div yield % 0.7 1.1 1.3 1.4 ROA % 1.5 1.5 1.5 1.4 ROE % 21.1 23.4 20.5 18.2 Equity to assets % 6.4 6.2 7.9 7.4 EV/EBITDA x 8.4 6.5 5.8 5.4 P/BV x 3.4 2.9 2.0 1.8

YES IN rel BSE Sensex performance, & rec history





Yes Bank YES is a ―NO‖ for the time being Event

Sharp rally since the beginning of the year leaves with limited upside,

Downgrade to Neutral: We downgrade YES Bank to Neutral from Outperform. The stock is up 60%+ since the beginning of the year and we see limited upside after such a sharp rally. Unless there are very aggressive rate cuts by RBI and/or wholesale rates plummet, we don’t see material re-rating from current levels.

Impact

Expect pick-up in restructured assets over the next 4 quarters: Though YES Bank’s quality of book is likely to be much better than most other corporate-focused banks, we expect some deterioration in asset quality and a pick-up in restructured assets in the next 12 months. NPLs at 20bps and credit costs at 10bps currently are unsustainable, in our view.

Priority sector guidelines could be painful: The proposed draft priority sector guidelines, which suggest 9% credit to small and marginal farmers is bound to exert pressure on overall profitability – margins, opex and asset quality. On a ceterus paribus basis according to our analysis, the impact on NIMs could be 30bps.

Savings rate de-regulation is proving beneficial: There has been a sharp accretion in savings deposits after they rose 44% QoQ in 3QFY12. Traction on savings accounts (leads, account openings etc) is 3-4x better than the traction before savings deposit rate were de-regulated, according to management.

Pace of branch addition very healthy: Over the past 12 months, YES Bank added 146 branches, which is encouraging. The reliance on retail deposits has risen rapidly, with branch banking plus CASA deposits constituting nearly 31% of overall deposit base as of 3QFY12—up 700bps YoY.


We cut our earnings by 11% and 17% for FY13E and FY14E on account of equity dilution and higher opex. TP is unchanged at Rs380, owing to the cost of equity changes which prompt a slightly higher target multiple.

Price catalyst


Catalyst: Increase in restructured assets


Stock trading at 2.0x P/BV – inline with historical valuations: Growth this cycle is going to be much lower than the previous cycle, and we don’t think

the previous high valuations are likely to be reached. Downgrade to Neutral with TP of Rs380.


20 March 2012 113

Valuation

We value YES Bank on a two-stage Gordon growth model using:

P/BV = RoE * {(p(1+g) * (1- (1+g)n/(1+r)n)) + (pn(1+g)n(1+gn))/((r-gn)(1+r)n)} where g=growth rate for the first n (high-growth period) years, p= dividend payout ratio in the first n years, gn=perpetual growth rate, pn=perpetual dividend payout ratio

Fig 1 YES Bank – Valuation methodology

Components of two stage model Our assumption

Sustainable ROE 18.9% Initial no of years 10 Growth rate for the first 10 years 15% Payout ratio for the first 10 years 20% Perpetual growth rate 4% Perpetual payout ratio 80% Target Price to Book Ratio – two stage Gordon growth model 2.0x FY13E Book Value per Share (Rs) 190 Target price (Rs; rounded up) 380

Source: Company data, Macquarie Research, January 2012


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Fig 2 Select ratios


GROWTH PROJECTIONS Growth in Net interest income 54.1 54.7 58.2 32.4 31.1 26.4 Growth in Operating profit (PPP) 50.7 63.6 37.9 28.5 25.9 20.9 Growth in Net profit 51.9 57.2 52.2 32.8 23.1 17.9 Growth in Assets 34.8 58.9 157.7 22.8 25.3 23.9 Growth in Shareholder's Equity 23.1 90.2 22.8 17.8 59.7 16.1 ASSET ANALYSIS Net interest income / average assets 2.6 2.7 2.6 2.5 2.7 2.7 Earning assets / Total assets 93.6 96.4 96.1 97.2 95.9 94.8 Return on Avg Earning Assets 1.4 1.4 1.3 1.4 1.4 1.3 Loans / earning assets 57.8 63.3 60.6 58.5 56.8 55.7 LOAN ANALYSIS Loan growth 31.5 78.9 54.8 20.0 20.0 20.0 DEPOSIT ANALYSIS Deposits growth 21.8 65.7 71.4 20.0 20.0 20.0 Current & savings to total deposit 8.7 10.5 10.3 15.2 21.2 28.5 Time deposit to total deposit 91.3 89.5 89.7 84.8 78.8 71.5 Deposits to Interest Bearing Liabilities 81.4 84.9 87.3 86.4 86.4 86.4 LIQUIDITY LDR 76.7 82.8 74.8 74.8 74.8 74.8 Loans to Assets 54.2 61.0 58.2 56.9 54.5 52.8 Customer Deposits to Earning Assets 75.4 76.4 81.0 78.3 76.0 74.5 ASSET QUALITY Gross NPA ratio 0.68 0.27 0.23 0.31 0.42 0.55 Loan loss coverage ratio 51.5 78.4 88.6 84.9 81.5 80.1 Provisions to Loans 0.52 0.51 0.14 0.10 0.20 0.30 Reserves to Loans 0.35 0.21 0.21 0.26 0.34 0.44 CAPITAL ADEQUACY Tier I ratio 9.50 12.90 9.70 9.25 11.73 11.08 Total Capital ratio 16.63 20.60 16.50 15.94 18.31 17.55 Equity to assets 7.1 8.5 6.4 6.2 7.9 7.4 SPREAD ANALYSIS Yield on average assets 10.66 8.40 8.82 10.33 9.83 9.46 Average cost of funds 8.80 6.46 6.96 8.84 8.31 7.98 Spread 1.86 1.94 1.85 1.49 1.51 1.48 Net interest margin 2.90 3.10 2.90 2.89 2.87 2.89 OTHER INCOME Non-interest income/ total income 46.2 42.2 33.3 32.5 31.2 30.0 Fees / non interest income 51.7 65.9 94.2 84.8 82.3 82.8 Fees / total income 23.9 27.8 31.4 27.6 25.7 24.9 OPERATING EFFICIENCY Cost / income 44.2 36.7 36.3 37.5 38.8 40.4 Cost / assets 2.1 1.7 1.4 1.4 1.5 1.6 Interest bearing liabilities / Total liabilities 93.4 94.8 95.3 93.8 91.5 88.2 PROFITABILITY ROA 1.52 1.61 1.52 1.47 1.46 1.38 ROE 20.6 20.3 21.1 23.4 20.5 18.2 Pre provision ROE 35.9 36.6 34.6 37.0 33.2 30.2 Dividend yield - 0.4 0.7 1.1 1.3 1.4 Basic EPS (Rs) 10.2 15.6 21.1 27.8 31.8 35.1 Diluted EPS (Rs) 10.1 14.9 20.3 26.9 33.1 39.0 VALUATIONS (x) P/E 36.6 23.9 17.7 13.5 11.8 10.7 P/BV 6.8 3.7 3.4 2.9 2.0 1.8 PUP 21.1 13.3 10.8 8.5 7.3 6.4 Source: Company data, Macquarie Research, March 2012


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Fig 3 YES Bank: 1 yr fwd P/BV band chart


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Yes Bank (YES IN, Neutral, Target Price: Rs380.00) Quarterly Results 3Q/12A 4Q/12E 1Q/13E 2Q/13E Profit & Loss 2011A 2012E 2013E 2014E

Net Interest Income m 4,340 4,618 4,656 5,248 Net Interest Income m 12,469 16,510 21,651 27,356 + Loan Fees m 1,774 1,888 1,742 1,964 + Loan Fees m 5,215 6,750 8,100 9,720 + Trading Income m 278 296 338 381 + Trading Income m 1,018 1,057 1,571 1,839 + Insurance Income m 0 0 0 0 + Insurance Income m 0 0 0 0 + Other Income m 41 44 36 41 + Other Income m -0 157 169 183 Non Interest Income m 2,093 2,228 2,116 2,386 Non Interest Income m 6,233 7,964 9,841 11,743 Total Operating Inc m 6,433 6,846 6,772 7,634 Total Operating Inc m 18,702 24,474 31,492 39,099


Pre-Provision Profit m 4,022 4,280 4,144 4,671 Pre-Provision Profit m 11,904 15,302 19,270 23,304 Loan Provisions m 235 250 331 373 Loan Provisions m 982 892 1,538 2,401 Post Provision Profit m 3,788 4,031 3,813 4,298 Post Provision Profit m 10,922 14,410 17,732 20,903 Other Profit m 0 0 0 0 Other Profit m 0 0 0 0 - Amortisation m 0 0 0 0 - Amortisation m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Non Recurring Items m 0 0 0 0 - Associates m 0 0 0 0 - Associates m 0 0 0 0 Pre-Tax Profit m 3,788 4,031 3,813 4,298 Pre-Tax Profit m 10,922 14,410 17,732 20,903 - Taxation m 1,250 1,330 1,258 1,418 - Taxation m 3,650 4,755 5,852 6,898 Net Profit After Tax m 2,538 2,700 2,555 2,880 Net Profit After Tax m 7,271 9,655 11,880 14,005 - Minority Interests m 0 0 0 0 - Minority Interests m 0 0 0 0 Reported Profit m 2,538 2,700 2,555 2,880 Reported Profit m 7,271 9,655 11,880 14,005 Adjusted Profit m 2,538 2,700 2,555 2,880 Adjusted Profit m 7,271 9,655 11,880 14,005 Attributable Profit m 2,538 2,700 2,555 2,880 Attributable Profit m 7,271 9,655 11,880 14,005 EPS (rep) 7.31 7.78 6.85 7.72 EPS (rep) 21.12 27.81 31.84 35.08 EPS growth pcp (rep) % 31.7 31.7 14.5 14.5 EPS growth yoy (rep) % 35.0 31.7 14.5 10.2 EPS (adj) 7.31 7.78 6.85 7.72 EPS (adj) 21.12 27.81 31.84 35.08 EPS growth pcp (adj) % 31.7 31.7 14.5 14.5 EPS growth yoy (adj) % 35.0 31.7 14.5 10.2 DPS 1.04 1.04 1.19 1.19 DPS 2.52 4.17 4.78 5.26 Payout ratio % 11.9 15.0 15.0 15.0 Book Value p.s (wgted) 110.2 128.7 191.2 207.5 Tangible Book Value p.s (wgted) 110.2 128.7 191.2 207.5 Weighted average shares m 344 347 373 399




Pre-Prov Profit Growth % 37.9 28.6 25.9 20.9 PBT Growth % 50.3 31.9 23.1 17.9 Loan Growth % 54.8 20.0 20.0 20.0 Ave Int Earning Assets % 62.1 24.5 23.8 22.5 Valuation data 2011A 2012E 2013E 2014E P/E (rep) x 17.7 13.5 11.8 10.7 P/E (adj) x 17.7 13.5 11.8 10.7 P/B (wgted) x 3.4 2.9 2.0 1.8 P/TB (wgted) x 3.4 2.9 2.0 1.8 Dividend yield % 0.7 1.1 1.3 1.4 Balance Sheet 2011A 2012E 2013E 2014E Cash & Equivalent m 30,760 36,823 44,093 52,814 Net Loans to Customer m 343,636 412,364 494,836 593,804 Other Interest Earning Assets m 192,488 255,199 331,865 419,100 Other Assets m 23,185 20,401 37,023 58,639 Total Assets m 590,070 724,787 907,818 1,124,357 Customer Deposits m 459,389 551,267 661,521 793,825

Other Int Bearing Liab m 66,909 86,948 104,273 125,287 Other Liabilities m 25,831 41,891 70,690 122,416 Total Liabilities m 552,129 680,106 836,484 1,041,527 Ordinary Equity m 3,471 3,471 3,992 3,992 Retained Earnings m 0 0 0 0 Reserves m 34,469 41,210 67,342 78,837 Minority Interests m 0 0 0 0 Total S/H's Funds m 37,941 44,681 71,334 82,830



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Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform – return >3% in excess of benchmark return Neutral – return within 3% of benchmark return Underperform – return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie – Asia/Europe Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10% Macquarie First South - South Africa Outperform – expected return >+10% Neutral – expected return from -10% to +10% Underperform – expected return <-10% Macquarie - Canada Outperform – return >5% in excess of benchmark return Neutral – return within 5% of benchmark return Underperform – return >5% below benchmark return Macquarie - USA Outperform (Buy) – return >5% in excess of Russell 3000 index return Neutral (Hold) – return within 5% of Russell 3000 index return Underperform (Sell)– return >5% below Russell 3000 index return

Volatility index definition* This is calculated from the volatility of historical price movements. Very high–highest risk – Stock should be expected to move up or down 60–100% in a year – investors should be aware this stock is highly speculative. High – stock should be expected to move up or down at least 40–60% in a year – investors should be aware this stock could be speculative. Medium – stock should be expected to move up or down at least 30–40% in a year. Low–medium – stock should be expected to move up or down at least 25–30% in a year. Low – stock should be expected to move up or down at least 15–25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations – 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations

Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards).

Recommendation proportions – For quarter ending 31 December 2011 AU/NZ Asia RSA USA CA EUR Outperform 56.59% 65.60% 54.55% 44.53% 75.28% 49.46% (for US coverage by MCUSA, 10.53% of stocks covered are investment banking clients) Neutral 33.45% 20.55% 38.96% 50.20% 22.47% 32.36% (for US coverage by MCUSA, 10.96% of stocks covered are investment banking clients) Underperform 9.96% 13.85% 6.49% 5.27% 2.25% 18.18% (for US coverage by MCUSA, 0.44% of stocks covered are investment banking clients)

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Media and Internet Jiong Shao (China, Hong Kong) (852) 3922 3566 Steve Zhang (China, Hong Kong) (852) 3922 3578 Nitin Mohta (India) (9122) 6720 4090 Prem Jearajasingam (Malaysia) (603) 2059 8989 Alex Pomento (Philippines) (632) 857 0899

Oil, Gas and Petrochemicals James Hubbard (Asia) (852) 3922 1226 Jal Irani (India) (9122) 6720 4080 Polina Diyachkina (Japan) (813) 3512 7886 Brandon Lee (Korea) (822) 3705 8669 Sunaina Dhanuka (Malaysia) (603) 2059 8993 Trevor Buchinski (Thailand) (662) 694 7829 Pharmaceuticals and Healthcare Abhishek Singhal (India) (9122) 6720 4086 Eunice Bu (Korea) (822) 2095 7223 Property Callum Bramah (Asia) (852) 3922 4731 David Ng (China, Hong Kong) (852) 3922 1291 Jeffrey Gao (China) (8621) 2412 9026 Unmesh Sharma (India) (9122) 6720 4092 Felicia Barus (Indonesia) (6221) 2598 8480 Sunaina Dhanuka (Malaysia) (603) 2059 8993 Alex Pomento (Philippines) (632) 857 0899 Tuck Yin Soong (Singapore) (65) 6601 0838 Corinne Jian (Taiwan) (8862) 2734 7522 Patti Tomaitrichitr (Thailand) (662) 694 7727 Resources / Metals and Mining Andrew Dale (Asia) (852) 3922 3587 Graeme Train (China) (8621) 2412 9035 Matty Zhao (Hong Kong) (852) 3922 1293 Pelen Ji (China, Hong Kong) (852) 3922 4741 Christina Lee (Hong Kong) (852) 3922 3571 Rakesh Arora (India) (9122) 6720 4093 Adam Worthington (Indonesia) (852) 3922 4626 Polina Diyachkina (Japan) (813) 3512 7886 Chak Reungsinpinya (Thailand) (662) 694 7982 Technology Jeffrey Su (Asia, Taiwan) (8862) 2734 7512 Lisa Soh (China) (852) 3922 1401 Nitin Mohta (India) (9122) 6720 4090 Damian Thong (Japan) (813) 3512 7877 David Gibson (Japan) (813) 3512 7880 George Chang (Japan) (813) 3512 7854 Jeff Loff (Japan) (813) 3512 7851 Daniel Kim (Korea) (822) 3705 8641 Soyun Shin (Korea) (822) 3705 8659 Andrew Chang (Taiwan) (8862) 2734 7526 Daniel Chang (Taiwan) (8862) 2734 7516 Kylie Huang (Taiwan) (8862) 2734 7528 Telecoms Nathan Ramler (Asia) (813) 3512 7875 Lisa Soh (China, Hong Kong) (852) 3922 1401 Riaz Hyder (Indonesia) (6221) 2598 8486 Prem Jearajasingam (Malaysia, Singapore) (603) 2059 8989 Alex Pomento (Philippines) (632) 857 0899 Joseph Quinn (Taiwan) (8862) 2734 7519

Transport & Infrastructure Janet Lewis (Asia, Japan) (852) 3922 5417 Bonnie Chan (Hong Kong) (852) 3922 3898 Nicholas Cunningham (Japan) (813) 3512 6044 Sunaina Dhanuka (Malaysia) (603) 2059 8993 Corinne Jian (Taiwan) (8862) 2734 7522 Utilities & Renewables Adam Worthington (Asia) (852) 3922 4626 Inderjeetsingh Bhatia (India) (9122) 6720 4087 Prem Jearajasingam (Malaysia) (603) 2059 8989 Alex Pomento (Philippines) (632) 857 0899 Commodities Jim Lennon (4420) 3037 4271 Duncan Hobbs (4420) 3037 4497 Bonnie Liu (65) 6601 0144 Graeme Train (8621) 2412 9035 Rakesh Arora (9122) 6720 4093 Data Services Josh Holcroft (852) 3922 1279 Economics Peter Eadon-Clarke (Asia, Japan) (813) 3512 7850 Richard Gibbs (Australia) (612) 8232 3935 Paul Cavey (China) (852) 3922 3570 Tanvee Gupta (India) (9122) 6720 3455 Quantitative / CPG Gurvinder Brar (Global) (4420) 3037 4036 Burke Lau (Asia) (852) 3922 5494 Simon Rigney (Asia) (852) 3922 4719 Eric Yeung (Asia) (852) 3922 4077 Patrick Hansen (Japan) (813) 3512 7876 Ayumu Kuroda (Japan) (813) 3512 7569 Strategy/Country Emil Wolter (Asia) (65) 6601 0538 Peter Eadon-Clarke (Japan) (813) 3512 7850 Chris Hunt (China, Hong Kong) (852) 3922 1119 Jiong Shao (China) (852) 3922 3566 Rakesh Arora (India) (9122) 6720 4093 Nicolaos Oentung (Indonesia) (6121) 2598 8366 David Gibson (Japan) (813) 3512 7880 Chan Hwang (Korea) (822) 3705 8643 Yeonzon Yeow (Malaysia) (603) 2059 8982 Alex Pomento (Philippines) (632) 857 0899 Conrad Werner (Singapore) (65) 6601 0182 Daniel Chang (Taiwan) (8862) 2734 7516 David Gambrill (Thailand) (662) 694 7753 Find our research at Macquarie: www.macquarie.com.au/research Thomson: www.thomson.com/financial Reuters: www.knowledge.reuters.com Bloomberg: MAC GO Factset: http://www.factset.com/home.aspx CapitalIQ www.capitaliq.com TheMarkets.com www.themarkets.com Email [email protected] for access

Asia Sales Regional Heads of Sales Robin Black (Asia) (852) 3922 2074 Chris Gray (ASEAN) (65) 6601 0288 Peter Slater (Boston) (1 617) 598 2502 Jeffrey Shiu (China & Hong Kong) (852) 3922 2061 Thomas Renz (Geneva) (41) 22 818 7712 Andrew Mouat (India) (9122) 6720 4100 JJ Kim (Korea) (822) 3705 8799 Chris Gould (Malaysia) (603) 2059 8888 Gino C Rojas (Philippines) (632) 857 0861 Eric Roles (New York) (1 212) 231 2559 Luke Sullivan (New York) (1 212) 231 2507 Paul Colaco (New York) (1 212) 231 2496 Sheila Schroeder (San Francisco) (1 415) 762 5001 Miki Edelman (Taiwan) (8862) 2734 7580

Regional Heads of Sales cont’d Angus Kent (Thailand) (662) 694 7601 Michael Newman (Tokyo) (813) 3512 7920 Angus Innes (UK/Europe) (44) 20 3037 4841 Rob Fabbro (UK/Europe) (44) 20 3037 4865 Sean Alexander (Generalist) (852) 3922 2101

Regional Head of Distribution Justin Crawford (Asia) (852) 3922 2065

Sales Trading Adam Zaki (Asia) (852) 3922 2002 Phil Sellaroli (Japan) (813) 3512 7837 Grace Lee (Korea) (822) 3705 8601 Jonathan Seymour (Singapore) (65) 6601 0202

Sales Trading cont’d Mike Keen (Europe) (44) 20 3037 4905 Chris Reale (New York) (1 212) 231 2555 Marc Rosa (New York) (1 212) 231 2555 Stanley Dunda (Indonesia) (6221) 515 1555 Kenneth Cheung (Malaysia) (603) 2059 8888 Michael Santos (Philippines) (632) 857 0813 Isaac Huang (Taiwan) (8862) 2734 7582 Dominic Shore (Thailand) (662) 694 7707

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