indian banks - psu banks[1]

8/9/2019 Indian Banks - PSU Banks[1]

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abcGlobal Research

Risk-reward shifts into reward territory;

we see positives outweighing near-termconcerns as the credit cycle turns

We turn OW(V) on most PSU banks, as

we believe credit and earnings growth

surprises are just around the corner

We prefer Canara, PNB, Union in PSUs;

Axis, HDFC Bank in the private space

We change to a favourable PSU stanceprompted by the

recent turn in the credit cycle, a rise in short-term rates, and

our analysis of valuation metrics in an upcycle. Our scorecard

reveals that top-line growth, margins, profitability, valuations,

and shareholding patterns are now aligned to favour stock

outperformance in the banking sector over the next 12 months,

with a few exceptions.

Concerns remain on asset quality trends, rising bond yields,

and potential capital constraints, but these are fairly near

term, and we see the positives outweighing them over the

next two years as the credit cycle picks up steam.

Stocks that we favour to play the upcycle include relatively

small bank stocks with lower LDRs and higher CASA, as

well as those that have underperformed and now trade at a

discount to peers. In a nutshell, we prefer ‘tigers’ to ‘elephants’

at this point in the credit cycle.

PSU bank valuations likely to re-rate given that (1) FII

ownership is well below regulatory limits, with domestic

institutions taking up the slack, (2) the inverse correlation

with bond yields has broken down, and (3) ROEs of PSUsare likely to reach a range of 25-30% (ex-SBI) by FY12.

The most significant upside catalysts have historically

been credit and earnings growth surprises and, on the

downside, tightening liquidity. A combination of earnings

surprises and quickly expanding PE multiples in an upcycle

are likely to outweigh tightening liquidity-related concerns.

‘Tigers’ we like are Axis Bank, HDFC Bank, Canara Bank,

and Union Bank. We also foresee upside in PNB, BOB, and

ICICI. All are rated OW(V). We upgrade PNB and BOB to

OW(V) and SBI to N(V).

Banks

India Commercial Banks

Indian banksPSU banks: Potential to re-rate

Valuation summary

Bloombergticker

(IN)

Currentshareprice(INR)

Oldtargetprice(INR)

Newtargetprice(INR)

Pot’ltotal

return(%)

OldHSBCrating

NewHSBCrating

Bank of Baroda BOB 577 577 689 21 N(V) OW(V)Canara Bank CBK 382 445 534 43 OW(V) OW(V)Punjab Nat’l Bank PNB 891 901 1,163 33 N(V) OW(V)State Bank of India SBIN 1,957 2,038 2,033 5 UW(V) N(V)Union Bank of India UNBK 247 335 302 24 OW(V) OW(V)Axis Bank AXSB 1,067 1,389 1,389 31 OW(V) OW(V)HDFC Bank HDFCB 1,656 2,068 2,068 26 OW(V) OW(V)ICICI Bank ICICIBC 841 1,025 1,025 23 OW(V) OW(V)HDFC HDFC 2,457 2,657 2,657 10 N(V) N(V)

Source: Company data, HSBC; prices as of 17 February 2010

19 February 2010

Sachin Sheth*

Analyst

HSBC Securities & Capital Markets (India) Private Limited

+91 22 2268 1224 [email protected]

Todd Dunivant*

Head of Banks Research, Asia Pacific

The Hongkong and Shanghai Banking Corporation Limited

+852 2996 6599 [email protected]

View HSBC Global Research at: http://www.research.hsbc.com *Employed by a non-US affiliate of HSBC Securities (USA) Inc,and is not registered/qualified pursuant to NYSE and/or NASDregulations

Issuer of report: HSBC Securities and Capital Markets (India)Private Limited

Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it

http://www.research.hsbc.com/





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The score – net positive

At the current inflection point of the credit cycle,

we find that there are several positives to look

forward to in FY11, which we believe are being

partly ignored by the market given its near-term

focus on NPL and growth related issues. We

present our scorecard below, which summarises

the key positive and negative potential catalysts

likely to play out over the next 12 months within

our coverage universe.

Key takeaways are as follows:

1. A rising tide lifts many boats. When credit

cycles turn upward, it is not only loan volumes

that benefit, but also margins and asset quality.

2. Tigers vs elephants. We believe the best way

to play the cycle at its inflection point is to buy

shares in banks that are relatively small, with

relatively low loan-deposit ratios and relatively

high CASA deposits, so that they can leverage up

growth and margins more quickly.

Investment summary

Credit cycle’s turn offers entry point into bank stocks

Near-term risks of NPLs likely to be outweighed by many positives

Earnings and credit growth surprises are key potential catalysts

Table 1: Scorecard

Positive catalysts Comments Stock winners

Accelerating credit growth Credit growth, LDR leverage, CASA mix and marginswould improve

BOB, Union better placed on first three factors, Canaraand PNB on margins; HDBK and Axis from privatesegment

New base-rate based lending High mix of large corporate and lower mix of SME is

likely to be favourable to y ields

BOB and HDBK are the biggest beneficiaries; Canara,

Axis stand to benefit lessProfitability While PSU valuations have never matched the potentialof their ROE, we see more domestic institutions focusingon ROE trends to re-rate these stocks up over themedium term

Canara, PNB offer highest delta in ROA, ROE overthree years; ICICI in the private space

Valuations PE re-rating potential in a credit upcycle along withrecent underperformers is the key criteria

PNB, Canara in PSU and Axis, HDBK in privatesegment

FII shareholdings Greater the gap to 18% holdings, higher the potentialbuying power; However, domestic institutions have madeup for FIIs over the past three years

Canara has biggest opportunity at 11.5% FII holdings;However domestics have made up for the 3-year fall inFII holdings; SBI, BOB show a net reduction ininstitutional holdings along with FII selling

Negative catalysts Comments Stock losers

NPL overhang Extent of restructured loans, Existing coverage PNB, SBI, Union have highest proportion ofrestructured loans and SBI has lowest coverage;Canara’s coverage is also borderline per RBI definition

Capital constraints Low government holdings would be focus area, even

including quasi-government holders such as LIC

Union is most vulnerable from our coverage universe

followed by BOB

CONCLUSION Credit growth, NPLs likely to be most relevantparameters going ahead

Canara, PNB top picks in PSU space, Axis & HDBKin private space

Source: HSBC estimates



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3. Positive double whammy on valuations. In

addition to upwards earnings surprises, we

observe that PE multiples of bank stocks tend to

expand during credit upcycles and it becomes the

measure of choice over prict to book (PB),

particularly as asset quality risks fade.

4. The case for re-rating PSU banks appears to

be gaining momentum, particularly given that FII

holdings have fallen well below regulatory limits

and are no longer a constraint at many banks.Domestic institutional ownership has effectively

taken up that slack. Much of this domestic base

believes that the gap between PSU and private

bank multiples should narrow. Given the lack of

ownership constraints at their end, this credit

upcycle may well see a move towards this.

5. The NPL question. This remains an overhang

for much of the sector given the global

environment impacting SME exporters in India as

well as potential slippages in the restructured

portfolio, particularly for banks with relatively

lower coverage ratios like SBI.

6. Capital constraints and low government

shareholdings are a potentially worrying

combination for some banks with relatively low tier-

1 ratios along with government holdings near the

51% floor – e.g., Union and BOB. The solution

could be a combination of two things: more hybrid

issuance and the government holdings (including

quasi-government entity holdings) as part of total

holdings, in which case the holdings of Life

Insurance Corporation of India (LIC) in many of

these banks would provide a buffer.

In conclusion, we see the highest upsides to our

12-month target returns in Canara and PNB in the

PSU space and Axis and HDFC Bank in the

private space. In fact, we now have a majority of

OW(V) ratings in our universe of nine stocks.



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Accelerating credit growth

We believe we are at – or just past – the inflection

point in the current credit cycle – effectively near

the bottom of a cycle, which we think could peak

at 25% over the next few years. This not just a

low-base effect, as can be seen in Chart 2.

Recent industrial production data, along with our

economist’s forecast of GDP growth over the next

two years prompts us to peg FY11 credit growth

at 25% and FY12 at 22%. The historical

correlation of GDP and credit growth is fairly

robust, as is the correlation of industrialproduction and loan growth.

Recent industrial production data, along with our

economists’ forecast of GDP growth over the next

two years, prompt us to peg credit growth at 25%

for FY11 and 22% for FY12.

Chart 3:Nominal GDP growth vs system loan growth

-

2.0

4.0

6.0

8.0

10.012.0

14.0

16.0

18.0

20.0

A p r - 9 5

A p r - 9 6

A p r - 9 7

A p r - 9 8

A p r - 9 9

A p r - 0 0

A p r - 0 1

A p r - 0 2

A p r - 0 3

A p r - 0 4

A p r - 0 5

A p r - 0 6

A p r - 0 7

A p r - 0 8

A p r - 0 9

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

Nominal GDPgrowth Sy stem Loan Grow th

Source: CSO, HSBC

PSU Banks: Potential tore-rate

Accelerating loan growth benefits volumes, margins, asset quality

Valuations: PE expands quicker than PB in an upcycle

FII ownership is no longer a constraint

Chart 1: System loan, deposit growth, y-o-y

5%

10%

15%

20%

25%

30%

35%

M a r - 0 3

S e p - 0 3

M a r - 0 4

S e p - 0 4

M a r - 0 5

S e p - 0 5

M a r - 0 6

S e p - 0 6

M a r - 0 7

S e p - 0 7

M a r - 0 8

S e p - 0 8

M a r - 0 9

S e p - 0 9

Deposit growth Loan grow th

Source: RBI, HSBC

Chart 2: System loan growth, y-t-d

Loan growth, YTD

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

FY04 FY05 FY06 FY07 FY08 FY09 FY10

current trends

Nov08 liquidity crisis

Source: RBI, HSBC



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Chart 4:IIP growth vs system loan growth

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

A p r - 9 5

A p r - 9 6

A p r - 9 7

A p r - 9 8

A p r - 9 9

A p r - 0 0

A p r - 0 1

A p r - 0 2

A p r - 0 3

A p r - 0 4

A p r - 0 5

A p r - 0 6

A p r - 0 7

A p r - 0 8

A p r - 0 9

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

I IP gr ow th ( 3m ma) S ys tem Lo an Gr ow th

Source: CSO, HSBC

Initial signs of a credit pick-up have been

catalysed by tightening liquidity, which has led to

higher short-term rates, leading corporates to shift

towards bank funding vs CP-funding.

Chart 5:CP rates vs liquidity – inverse correlation

(15,000)

(10,000)

(5,000)

-

5,000

10,000

15,000

20,000

25,000

30,000

M a y - 0 5

S e p - 0 5

J a n - 0 6

M a y - 0 6

S e p - 0 6

J a n - 0 7

M a y - 0 7

S e p - 0 7

J a n - 0 8

M a y - 0 8

S e p - 0 8

J a n - 0 9

M a y - 0 9

S e p - 0 9

J a n - 1 0

-

2

4

6

8

10

12

14

16

RSP ORRPO I NDEX 3 M CP (RHS , in verse scale)

Source: Bloomberg, HSBC

This is evident in the shift during October-

December 2009, when a greater part of corporate

funding came from banks vs CPs.

In past credit upcycles, we have seen interest rates

increase with a lag. Typically, banks’ lending

portfolios reprice ahead of deposits leading to

margin expansion. In addition, NPL ratios tend to

reduce as does loan loss provisioning. All of this

leads to improving earnings growth and

profitability which we believe leads to expanding

valuation multiples (discussed in detail later).

Thus, banks which have a higher leverage to

growth (lower LDR ratios) benefit more in anupcycle, and those with higher CASA deposit mix

tend to see a quicker margin expansion

particularly in the first year of the upcycle. Banks

we believe can benefit in this upcycle include

Canara and Union Bank from the PSU space and

Axis, HDFC Bank in the private space.

Valuations: Positive double whammy

We observe that during credit upcycles, PE

multiples tend to expand quicker than PB

multiples for PSU bank stocks. We attempt to

factor this into our 12 month target prices and

arrive at OW(V) recommendations for all but 1 of

our 8 banks under coverage (ie. SBI).

Chart 6: BOB

4x

5x

6x

7x

8x

9x

10x

M a r - 9 7

M a r - 9 8

M a r - 9 9

M a r - 0 0

M a r - 0 1

M a r - 0 2

M a r - 0 3

M a r - 0 4

M a r - 0 5

M a r - 0 6

M a r - 0 7

M a r - 0 8

M a r - 0 9

-

5

10

15

20

25

30

35

40

PE/PB Sy stem Loan gr (%) RHS

Source: Company data, Bloomberg, HSBC

Table 2: Flow of resources to commercial sector – y-o-ycontribution to growth

Funding Source 1H10 3Q FY10

Bank credit 32% 49%Equity issues 4% 2%Pvt placements 10% 19%

CP issuance 15% -1%

HFC credit 2% 1%FI credit -1% 1%NBFC credit 5% -6%LIC credit 5% 7%ECB/FCCB 2% 7%ADR/GDR issues 4% 1%Overseas short-term credit -2% 5%

FDI 23% 17%Total 100% 100%

Source: RBI, HSBC



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Chart 7: Canara

3.0x

3.5x

4.0x

4.5x

5.0x

5.5x

6.0x

D e c - 0 2

J u n - 0 3

D e c - 0 3

J u n - 0 4

D e c - 0 4

J u n - 0 5

D e c - 0 5

J u n - 0 6

D e c - 0 6

J u n - 0 7

D e c - 0 7

J u n - 0 8

D e c - 0 8

J u n - 0 9

D e c - 0 9

-

5

10

15

20

25

30

35



Chart 8: PNB

3.0x

3.5x

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

7.0x

A p r - 0 2

A p r - 0 3

A p r - 0 4

A p r - 0 5

A p r - 0 6

A p r - 0 7

A p r - 0 8

A p r - 0 9

5

10

15

20

25

30

35



Chart 9: SBI

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

7.0x

7.5x

8.0x

M a r - 9 6

M a r - 9 7

M a r - 9 8

M a r - 9 9

M a r - 0 0

M a r - 0 1

M a r - 0 2

M a r - 0 3

M a r - 0 4

M a r - 0 5

M a r - 0 6

M a r - 0 7

M a r - 0 8

M a r - 0 9

-

5

10

15

20

25

30

35



Chart 10: Union

3.0x

3.5x

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

M a r - 0 0

M a r - 0 1

M a r - 0 2

M a r - 0 3

M a r - 0 4

M a r - 0 5

M a r - 0 6

M a r - 0 7

M a r - 0 8

M a r - 0 9

5

10

15

20

25

30

35

40

PE/PB System Loan gr (%) RHS


Our target prices are weighted 75% by PE, 15%

by PB and 10% by DCF/SOTP. Given the above

observations, we raise our target PE multiples forPSU banks to a range of 5.5-10.5x vs our earlier

range of 5.5-9.5x.

Alongwith the earnings changes we estimate for

these PSU banks (exhibited in detail in individual

company sections), we see 12-month potential

returns of 21-43% for our OW(V) rated stocks

and 5% for SBI. Accordingly, we upgrade BOB

and PNB to OW(V) from N(V) and SBI to N(V)

from UW(V).

Recent stock price behaviour shows that our PSU

bank index has underperformed the Sensex over

the last 1 and 3 months vs the private index,

which has outperformed. We see this as an

opportune entry point, as the balance appears to

be tilted in favour of these stocks per our

scorecard discussed earlier.

Table 3: Summary of earnings estimate and target price changes

Ticker New TP % chg ______ EPS change _______ _______ BV change________ _ PE multiple___ __PB multiple __FY10e FY11e FY12e FY10e FY11e FY12e New Old New Old

BOB IN 689 20% 3% -5% -5% 0% -2% -4% 8.0 6.7 1.2 1.0CBK IN 534 20% 21% 12% 2% 5% 6% 4% 5.6 5.5 1.2 1.1PNB IN 1,163 29% -1% 22% 25% 0% 5% 10% 7.5 7.0 1.3 1.3SBIN IN 2,033 0% -19% -13% -16% -4% -6% -9% 10.5 9.7 1.6 1.5UNBK IN 302 -10% -13% -8% -5% -1% -1% -1% 6.1 7.0 1.3 1.2

Source: HSBC



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Chart 11: PSU vs Pvt banks index relative to Sensex

-

50

100

150

200

250

300

350

400

450

J a n - 9 8

J a n - 9 9

J a n - 0 0

J a n - 0 1

J a n - 0 2

J a n - 0 3

J a n - 0 4

J a n - 0 5

J a n - 0 6

J a n - 0 7

J a n - 0 8

J a n - 0 9

J a n - 1 0

R elativ e PSU Index Relativ e Pv t Index

Source: Bloomberg, HSBC

The case for re-rating PSU banks

As discussed in our report of 10 September 2009,

Indian banks: Stock picks for an economic

recovery, we struggle to understand why PSU

banks trade at half or more of the multiples of

private banks despite superior and less volatile

ROEs. One of the reasons we have suggested is a

lack of autonomy, given the level of government

ownership at these banks.

Another issue we observe is that the lack of FII

shareholding limits available during 2005-08 led

to underperformance of these PSU bank stocks as

FII buying in these names tended to be stock

catalysts and lack of further buying led to

underperformance.

Chart 12: BOB

0

50

100

150

200

250

300

M a r - 0 1

J a n - 0 2

D e c - 0 2

O c t - 0 3

S e p - 0 4

J u l - 0 5

J u n - 0 6

M a y - 0 7

M a r - 0 8

F e b - 0 9

D e c - 0 9

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

B oB rel to sensex BoB F II%

Source: BSE, Bloomberg, HSBC

Chart 13: Canara

60

80

100

120

140

160

180

M a r - 0 3

N o v - 0 3

J u l - 0 4

M a r - 0 5

N o v - 0 5

J u l - 0 6

A p r - 0 7

D e c - 0 7

A u g - 0 8

A p r - 0 9

D e c - 0 9

0%

3%

6%

9%

12%

15%

18%

21%

Canar a r el to sensex Cana ra FII%


Chart 14: PNB

0

100

200

300

400

500

600

J u n - 0 2

M a r - 0 3

D e c - 0 3

S e p - 0 4

J u n - 0 5

M a r - 0 6

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S e p - 0 7

J u n - 0 8

M a r - 0 9

D e c - 0 9

0%

3%

6%

9%

12%

15%

18%

21%

P NB rel to s ens ex PNB F II%


Chart 15: SBI

80

100

120

140

160

180

200

220

240

M a r - 0 1

J a n - 0 2

D e c - 0 2

O c t - 0 3

S e p - 0 4

J u l - 0 5

J u n - 0 6

M a y - 0 7

M a r - 0 8

F e b - 0 9

D e c - 0 9

10%

12%

14%

16%

18%

20%

22%

S BI rel to sens ex SBI FII%


Chart 16: Union

50

100

150

200

250

M a r - 0 3

N o v - 0 3

J u l - 0 4

M a r - 0 5

N o v - 0 5

J u l - 0 6

A p r - 0 7

D e c - 0 7

A u g - 0 8

A p r - 0 9

D e c - 0 9

0%

3%

6%

9%

12%

15%

18%

21%

U ni on re l to sen sex U ni on FII%




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Starting 2008, most of these PSU banks saw their

FII shareholdings fall well below the holdings

limit, barring PNB. However, after an initial bout

of underperformance, many of these stocks have

seen their domestic institutional ownership

increase leading to outperformance (see Table 5).

Thus, if the fundamental factors such as

profitability, growth are improving for these

stocks, we believe we could be headed for a

structurally lower discount of these stocks vsprivate banking peers.

Chart 17: PSU discount to private banks

-75%

-70%

-65%

-60%

-55%

-50%

-45%

-40%

J a n - 0 4

J

u l - 0 4

J a n - 0 5

J

u l - 0 5

J a n - 0 6

J

u l - 0 6

J a n - 0 7

J

u l - 0 7

J a n - 0 8

J

u l - 0 8

J a n - 0 9

J

u l - 0 9

J a n - 1 0

P/ B - PSU dis ct to Pv t P /E - P SU dis ct to Pv t

Source: Bloomberg, Company data, HSBC

NPL overhang

Among the biggest concerns for investors is the

uncertainty of NPLs, particularly those potentially

emanating from the restructured loan books of

PSU banks, rather than private banks which have

a smaller proportion.

Table 4: Restructured loan trends (as % of loan book)

Mar-09 Jun-09 Sep-09 Dec-09

BOB 1.8 3.0 3.1 3.1Canara 1.5 3.7 3.7 3.8PNB 2.6 5.7 6.1 6.2SBI 2.4 3.9 4.4 4.2Union 3.1 4.8 4.6 4.4Axis 2.0 3.2 2.9 2.7HDFC Bank 0.1 0.6 0.6 0.4ICICI Bank 2.7 2.1 2.5 3.0

Source: Company data, HSBC

While a 10-15% slippage on this book is unlikely

to significantly lower economic value, banks with

lower coverage ratios are likely to be impacted

more adversely – e.g., SBI.

An economic recovery is likely to help their cause

through FY11.

Capital constraints

Given the credit upcycle, we expect banks to plan

their capital requirements ahead of time. However,

there are a few banks for which the 51% government

holdings floor is approaching fast and could be

breached if the bank were to issue a reasonable

amount of fresh equity to sustain growth through

this cycle. Examples are Union Bank and, to some

extent, BOB.

One way the government may tackle this (apart

from lowering the 51% floor, which would need

the approval of Parliament – unlikely to be obtained)

is to include quasi-government entities such as LIC

and other state-run institutions in the definition of

government holdings. In this event, the LIC can

subscribe to fresh issuance and maintain total

government holdings at 51%. A table showing the

combined holdings across banks follows.

Table 5: Insitutional ownership of PSU Banks

BOB BOB BOB Canara Canara Canara PNB PNB PNB SBI SBI SBI Union Union UnionTotal FII Local Total FII Local Total FII Local Total FII Local Total FII Local

Dec-06 35% 20% 15% 21% 17% 4% 34% 20% 14% 33% 20% 13% 29% 20% 9%Dec-09 33% 14% 19% 21% 12% 10% 37% 19% 18% 31% 15% 16% 30% 16% 14%Change -2% -6% 4% 0% -5% 6% 3% -1% 4% -2% -5% 3% 1% -4% 4%

Source: BSE, HSBC



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Thus we see that, within our coverage universe,

Union and BOB are at total government holdings

of about 60% giving them some breathing room.

Table 6: Government holdings in PSU banks, December 2009

_________________ Quasi-government __________________Govt LIC GIC Other General Ins. Cos. SIDBI

Andhra 51.6 51.6Dena 51.2 5.18 56.4Union 55.4 4.4 59.8BOB 53.8 7.3 61.1Vijaya 53.9 8.14 62.0IDBI Bank 52.7 11.8 1.2 2.1 64.5PNB 57.8 8.5 66.3OBC 51.1 15.4 1.1 66.5Allahabad 55.2 11.6 66.9SBI 59.4 9.5 68.9IOB 61.2 9.03 70.3UCO 63.6 7.19 70.8Synidcate 66.5 9.58 76.1Canara 73.2 4.6 77.8Indian bank 80.0 80.0Bank of Maharashtra 76.8 3.6 80.4Corporation 57.2 26.3 83.5Central bank 80.2 6.3 86.5

Source: BSE, HSBC

Table 7: Valuation summary (INR/sh)

_______HSBC PE _______ ______ HSBC PB________RIC code Company Mkt Price Target price Potential

total returnRating MCAP FY10e FY11e FY10e FY11e

BOB.BO BOB 577 689 21% Overweight (V) 4,518 7.4 6.2 1.5 1.3CNBK.BO Canara 382 534 43% Overweight (V) 3,436 4.6 3.9 1.2 1.0PNBK.BO PNB 891 1,163 33% Overweight (V) 6,085 7.54 5.19 1.75 1.37SBI.BO SBI 1,957 2,033 5% Neutral (V) 26,496 13.2 9.5 1.9 1.6UNBK.BO Union 247 302 24% Overweight (V) 2,697 6.76 4.81 1.5 1.1AXBK.BO Axis 1,067 1,389 31% Overweight (V) 9,008 16.7 12.8 2.7 2.3HDBK.BO HDBK 1,656 2,068 26% Overweight (V) 15,938 25.8 19.3 3.7 3.2

ICBK.BO ICBK 841 1,025 23% Overweight (V) 20,159 23.2 18.7 1.9 1.8HDFC.BO HDFC 2,457 2,657 10% Neutral (V) 15,105 24.4 19.7 4.8 4.2

Note: Under our research model, for stocks with a volatility indicator, the Neutral band is 10ppt above and below the hurdle rate of 10.5% for Indian stocks. Our target prices provided upside potential that is above, below, or within theNeutral band of our model; therefore, we rate t he stocks OW(V), UW(V), or N(V), as indicated in the “Rating” column abo ve.Source: Company data, HSBC estimates



10

Banks


19 February 2010

abc

Positive potential catalysts: Margin expansion in

FY11 as loan book reprices more quickly than

deposits. Higher proportion of corporate loans and

smaller proportion of SME loans likely to benefit

BOB vs peers after base rates come into play.

Negative potential catalysts: Does not enjoy

the same leeway as peers for raising further

capital without violating government holdingnorms, especially if the credit cycle is stronger

than expected.

Valuation: Not among the cheapest PSU bank

stocks, scope for re-rating is limited.

Earnings outlook: 25% CAGR in earnings over

the next three years up to FY12e, led by higher

loan growth and margins.

Key risks: (1) BOB’s relatively higher growth

vs peers has not yet resulted in visibly

deteriorating asset quality – which remains an

overhang in the uncertain environment. (2)

Slower-than-expected economic growth recovery

is a risk to stock outperformance.

Bank of Baroda (BOB)

Largest increase in CASA mix going ahead vs peer PSUs

New base rate norms favourable for BOB vs peers

12-mth potential return of 21%; upgrade to OW(V)



11

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19 February 2010

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Year to 3/2009a 3/2010e 3/2011e 3/2012e

P&L summary(INRm)

Net interest income 51,234 59,185 80,937 103,866Non-interest income 27,577 26,773 32,074 39,172Net fees/commissions 7,455 8,022 9,414 11,784Trading profits 9,324 6,734 8,037 9,901Other 10,798 12,017 14,623 17,487Total operating income 78,811 85,958 113,011 143,038Operating expense 35,761 39,812 46,288 54,322Staff costs 23,481 26,383 30,340 35,498Other oper expenese 12,279 13,430 15,948 18,824PPOP 43,050 46,146 66,723 88,716Provisions 9,621 6,656 17,760 20,434Bad debt 2,686 10,197 12,144 15,179Other 6,935 (3,540) 5,616 5,254

Other non-oper profit(loss)HSBC PBT 33,429 39,489 48,963 68,282Exceptionals - - - -Profit-before tax 33,429 39,489 48,963 68,282Taxation 11,157 11,057 14,689 23,899PAT 22,272 28,432 34,274 44,383Minorities + pref dividend - - - -Attributable profit 22,272 28,432 34,274 44,383HSBC attributable profit 22,272 28,432 34,274 44,383 Balance sheet summary (INRm)

Total assets 2,274,067 2,750,271 3,375,426 4,168,230Customer loans (net) 1,439,859 1,768,751 2,237,306 2,777,152Investment assets 524,459 632,729 744,275 884,520Other_assets 309,750 348,790 393,844 506,557Total liabilities 2,145,712 2,596,739 3,191,955 3,945,955

Customer deposits 1,923,970 2,359,235 2,908,283 3,593,887Debt securities issued 56,361 31,802 34,447 37,314Other liabilities 165,381 205,703 249,225 314,753Total capital 128,355 153,532 183,470 222,275Ordinary equity 128,355 153,532 183,470 222,275Minorities + other capitalIEA (avg) 1,952,925 2,414,464 2,941,297 3,631,098IBL (avg) 1,847,330 2,277,861 2,778,487 3,421,793 Capital adequacy (%)

RWA (INRm) 1,303,249 1,563,752 1,920,542 2,332,662Core tier 1 8.5% 8.1% 7.4% 7.7%Total t ier 1 8.5% 9.1% 8.2% 8.4%Total capital 14.1% 14.6% 13.5% 13.6%

ROAA deconstruction

Net interest income 2.52 2.36 2.64 2.75Total interest income 7.42 6.90 7.39 7.95Total interest expense 4.90 4.54 4.74 5.20Net fees and commissions 0.37 0.32 0.31 0.31Other income 0.99 0.75 0.74 0.73Operat ing income 3.87 3.42 3.69 3.79Operat ing expenses 1.76 1.58 1.51 1.44Staf f costs 1.15 1.05 0.99 0.94Other oper exp 0.60 0.53 0.52 0.50PPOP 2.12 1.84 2.18 2.35Provis ions 0.47 0.26 0.58 0.54Non-op items - - - -PBT 1.64 1.57 1.60 1.81Taxation 0.55 0.44 0.48 0.63PAT 1.09 1.13 1.12 1.18

Year to 3/2009a 3/2010e 3/2011e 3/2012eGrowth (y-o-y %)

Net interes t income 31.0 15.5 36.8 28.3Non-interest income 34.5 (2.9) 19.8 22.1Operat ing expense 21.9 11.3 16.3 17.4PPOP 42.1 7.2 44.6 33.0Provisions 17.1 (30.8) 166.8 15.1PBT 51.5 18.1 24.0 39.5PAT 55.1 27.7 20.5 29.5 Customer loans (net) 34.9 22.8 26.5 24.1Total assets 26.6 20.9 22.7 23.5RWA 17.2 20.0 22.8 21.5Customer depos its 26.5 22.6 23.3 23.6

Ratios (%)

NIM 2.62 2.45 2.75 2.86Gross yield 7.73 7.18 7.69 8.26Cost of funds 5.40 5.01 5.23 5.73Spread 2.33 2.17 2.46 2.53

NPL/gross loans 1.27 1.43 1.29 1.17Credit cost 0.2 0.6 0.6 0.6Coverage 43.9 79.2 73.6 73.0NPL/RWA 1.4 1.6 1.5 1.4Provsion/RWA 0.6 1.3 1.1 1.0Net write-off/RWA - - - -NPL/NTE 14.4 16.7 15.9 14.7Net loans/total assets 63.3 64.3 66.3 66.6RWA/total assets 57.3 56.9 56.9 56.0Loans/deposits 74.8 75.0 76.9 77.3Avg IEA/avg total assets 96.0 96.1 96.0 96.3Avg IBL/avg total liab 96.4 96.1 96.0 95.9

Cost/income 45.4 46.3 41.0 38.0Non-int income/total income 35.0 17.3 17.4 17.9ROAA (including goodwill) 1.09 1.13 1.12 1.18ROAE (including goodwill) 21.1 22.6 22.5 23.9Return on avg tier 1 22.8 22.5 22.9 25.1Leverage (x) 19.3 20.0 20.1 20.3

Valuation data

PE (diluted EPS) 9.5 7.4 6.2 4.8P/PPOP 4.9 4.6 3.2 2.4PB 1.9 1.5 1.3 1.0P/NTE 1.9 1.5 1.3 1.0Dividend yield (x) 1.8 1.9 2.1 2.6P/deposits 0.1 0.1 0.1 0.1

P/assets 0.1 0.1 0.1 0.1

*Based on HSBC EPS (diluted)

Price relative

114

214

314

414

514

614

714

814

2008 2009 2010 2011

114

214

314

414

514

614

714

814

Bank of Baroda Rel to BOMBAY SE SENSITIVE INDEX

Source: HSBC

Financials & valuation

Bank of Baroda – BOB IN – Overweight (V) Target price INR689

Per share data (INR)

EPS reported (diluted) 60.9 77.8 93.8 121.4HSBC EPS (diluted) 60.9 77.8 93.8 121.4DPS 10.5 11.0 12.0 15.0NAV 311.5 376.4 456.2 560.0NAV (including goodwill) 311.5 376.4 456.2 560.0



12

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19 February 2010

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Chart 18: PE/PB vs system loan growth

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Chart 19: Rolling PE Chart 20: Rolling PB

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Average 10 year

Source: Company data, HSBC Source: Company data, HSBC



13

Banks


19 February 2010

abc

Table 8: 3Q FY10 highlights

3Q FY10

Loans growth (y-o-y) 23.5%Deposit growth (y-o-y) 27.6%LDR 72.6%Incremental LDR 63.9%CASA 31.0%Loan mix:

International advances 25.7%Domestic advances 74.3%Retail advances 14.3%SME advances 13.0%Farm credit 12.0%Corporate advances 35.0%

Margins 3.0%FII Holding 14.2%Domestic institutional and government (incl LIC) s/h 19.0%Gross NPLs 1.4%Coverage ratio 78.4%


Table 9: Old vs new estimates

2010e (new) Change 2011e (new) Change 2012e (new) Change

Whats ChangedTotal interest income 173,316 -3.1% 226,214 4.3% 299,896 13.3%Interest expenses 114,131 -0.7% 145,277 4.8% 196,030 18.4%Net interest income (NII) 59,185 -7.5% 80,937 3.4% 103,866 4.7%P/(L) on sale of investments 6,365 -45.1% 7,574 -42.2% 9,366 -42.0%P/(L) on exchange transactions 4,813 -33.5% 6,009 -40.1% 7,522 -34.6%Fee and other income 15,595 -9.1% 18,491 -11.7% 22,285 -11.0%Non-interest income ex-treasury 20,408 -16.3% 24,500 -20.9% 29,807 -18.4%Total non-interest income 26,773 -25.6% 32,074 -27.3% 39,172 -25.6%Total income 85,958 -14.0% 113,011 -7.7% 143,038 -5.8%Operating expenses 39,812 -1.2% 46,288 3.4% 54,322 7.1%Pre-provisioning profits 46,146 -22.7% 66,723 -14.0% 88,716 -12.3%Core PPP 39,781 -17.2% 59,149 -8.3% 79,350 -6.6%Provisions for NPAs 10,197 -21.3% 12,144 -29.4% 15,179 -34.7%Provisions for std. assets 1,504 -46.4% 1,691 -45.3% 1,955 -54.8%Provisions on investments (5,846) -1009.1% 2,923 405.1% 2,046 292.8%

Other provisions 802 1,002 1,254Total provisions 6,656 -61.3% 17,760 -18.8% 20,434 -30.4%PBT 39,489 -7.0% 48,963 -12.1% 68,282 -4.9%Tax 11,057 -25.6% 14,689 -24.7% 23,899 -4.9%PAT 28,432 3.0% 34,274 -5.4% 44,383 -4.9%

Balance sheetDeposits 2,359,235 -0.4% 2,908,283 0.1% 3,593,887 -3.1%Net advances 1,768,751 -0.4% 2,237,306 0.0% 2,777,152 -3.3%Total assets 2,750,271 0.2% 3,375,426 0.5% 4,168,230 -2.5%

Net interest margin 2.44% -0.19% 2.73% 0.09% 2.84% 0.17%Book value 376.44 -0.33% 456.17 -2.41% 560.04 -4.38%EPS 77.78 3.02% 93.77 -5.39% 121.42 -4.86%ROA 1.13% 0.03% 1.12% -0.07% 1.18% -0.05%ROE 22.6% 0.70% 22.5% -0.93% 23.9% -0.34%

Tax rate 28.0% -7.00% 30.0% -5.00% 35.0% 0.00%Cost income 46.3% 6.01% 41.0% 4.38% 38.0% 4.57%Core cost income 50.0% 4.42% 43.9% 2.93% 40.6% 3.25%




14

Banks


19 February 2010

abc

Valuation and risksWe have lowered our loan growth assumptions for

FY12e by 3.3% and also deposits by 3.1%. We

have revised NIM estimate by -19bp in 2010, +9

in FY11 and +17bp in FY12. Also, Non interest

income estimate has been lowered by 25.6%,

27.3% and 25.6% I n FY10, FY11 and FY12,

respectively. As a result, we are revising our net

profit forecast by +3% in 2010, -5.4% in 2011,

and +4.9% in 2012, respectively.

We value BOB using a combination of economic

profit model (EPM), PE, and PB methodologies.

We assign a 75% weight to the PE and 15% to

P/B and 10% to DCF components. The three-

stage EPM uses explicit forecasts until FY12e

followed by 10 years of semi-explicit forecasts,

where we assume 8% loan CAGR and a 20%

dividend payout. The final stage of 12 years (fadeperiod) assumes convergence of ROE and COE.

We assume a risk free rate of 8%, beta of 1, and

equity risk premium of 6%, translating into a cost

of equity of 14%. Our EPM value is INR536.

Under our research model, for stocks with a

volatility indicator, the Neutral band is 10ppt

above and below the hurdle rate of 10.5% for

India. Our target price of INR689 (INR577

earlier) suggests a 21% potential total return,

including prospective dividend yield, which is

above the Neutral band of 0.5-20.5% around the

current share price. We therefore upgrade BOB

shares from Neutral (V) to Overweight (V).

Table 10: Earnings outlook (% y-o-y)

FY10 FY11 FY12

Income statementInterest income 15% 31% 33%Interest expense 14% 27% 35%Net interest income 16% 37% 28%Other income – ex treasury 10% 20% 22%Treasury gain -23% 19% 24%Total other income 0% 20% 22%Operating income 10% 31% 27%Core operating income 14% 32% 27%Operating expense 18% 16% 17%Operating profit 4% 45% 33%Core operating profit 11% 49% 34%Loan loss provisions 365% 19% 25%Other provisions -141% -259% -6%Total provisions -38% 167% 15%Pre tax profit 18% 24% 39%Tax -1% 33% 63%Net profit 28% 21% 29%Core PBT 32% 25% 42%Balance sheetAdvances 23% 26% 24%Deposits 23% 23% 24%Gross NPLs 39% 14% 12%Net NPLs 18% 44% 14%Total assets 21% 23% 23%


Table 11: Valuation summary

PE-based TP PB-based TP DCF value Weighted TP Potential total return

New 739 539 536 689 21%Old 611 438 525 577




15

Banks


19 February 2010

abc

Positive potential catalysts: Significant

improvement in margins, led by robust balance

sheet growth; enjoys among the biggest expansion

in ROA, ROE within our PSU universe; lowest FII

holdings of 11.5% offers highest scope vs peers.

Negative potential catalysts: Low coverage ratio

(per earlier definition) likely to put pressure on

earnings given higher provisioning requirements;

higher proportion of SME and relatively low

proportion of corporate loans vs peers likely to

place it at a relative disadvantage after base rate is

implemented.

Valuations: At 3.9x PE, it trades at a large

discount of 24% to its five-year average, offering

the highest potential 12-month return (43%) in our

coverage universe.

Earnings outlook: A 33% CAGR in earnings

over the next three years up to FY12e, led by

higher loan growth and margins, but partlyneutralised by higher provisioning.

Key risks: (1) Higher-than-expected slippage

likely to pressurise earnings via higher provisioning

given low coverage. (2) Retirement of chairman in

July 2010 may introduce uncertainties on several

policy fronts in investors’ perception.

Canara Bank (CBK)

Among the best margin accretion prospects vs peers

Also has among the best & highest improvement in ROE

Largest discount to peer multiples offers highest 12-month

potential returns of 43%; Reiterate OW(V)



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19 February 2010

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Year to 3/2009a 3/2010e 3/2011e 3/2012e

P&L summary(INRm)

Net interest income 47,178 56,463 75,347 98,718Non-interest income 23,112 31,573 32,864 38,283Net fees/commissions 6,388 9,287 11,514 12,965Trading profits 7,125 9,759 7,048 8,245Other 9,599 12,527 14,303 17,073Total operating income 70,290 88,036 108,211 137,001Operating expense 30,652 32,727 38,333 44,260Staff costs 18,772 19,894 22,618 26,157Other oper expenese 11,881 12,833 15,715 18,103PPOP 39,638 55,309 69,878 92,742Provisions 13,914 12,430 16,858 25,601Bad debt 9,000 11,666 15,430 23,703Other 4,914 764 1,428 1,898






Net interes t income 33.4 19.7 33.4 31.0Non-interest income 4.4 36.6 4.1 16.5Operat ing expense 9.8 6.8 17.1 15.5PPOP 33.9 39.5 26.3 32.7Provisions 32.0 (10.7) 35.6 51.9PBT 35.0 66.7 23.7 26.6PAT 32.4 64.6 19.0 21.7 Customer loans (net) 28.9 24.0 24.0 21.9Total assets 21.7 24.6 22.9 18.0RWA 7.7 15.7 20.5 19.4Customer depos its 21.3 25.1 22.7 18.2

Ratios (%)

NIM 2.45 2.38 2.56 2.78Gross yield 8.89 8.39 8.77 9.16Cost of funds 6.76 6.28 6.49 6.70Spread 2.13 2.11 2.28 2.46 NPL/gross loans 1.6 1.7 1.5 1.4Credit cost 0.7 0.8 0.8 1.0Coverage 30.4 29.8 34.6 42.6NPL/RWA 1.7 2.0 1.8 1.7Provsion/RWA 0.5 0.6 0.6 0.7Net write-off/RWA - - - -NPL/NTE 17.8 20.5 17.9 15.3Net loans/ total assets 62.9 62.6 63.2 65.3RWA/total assets 57.0 52.9 51.9 52.5Loans/deposits 74.0 73.3 74.1 76.4Avg IEA/avg total assets 96.2 96.4 96.6 96.7Avg IBL/avg total liab 97.2 97.5 97.5 97.5 Cost/income 43.6 37.2 35.4 32.3Non-int income/total income 32.9 17.3 17.4 17.9ROAA (inc luding goodwill ) 1.04 1.38 1.33 1.35ROAE (inc luding goodwill ) 22.6 29.7 27.7 26.7Return on avg tier 1 22.8 30.3 28.6 27.5Leverage (x) 21.8 21.5 20.8 19.8

Valuation data

PE (diluted EPS) 7.6 4.6 3.9 3.2P/PPOP 4.0 2.8 2.2 1.7PB 1.6 1.2 1.0 0.8P/NTE 1.6 1.2 1.0 0.8Dividend yield (x) 2.1 2.9 3.4 3.9P/deposits 0.08 0.07 0.05 0.05P/assets 0.07 0.06 0.05 0.04


Price relative

100

150

200

250

300

350

400

450

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550

2008 2009 2010 2011

100

150

200

250

300

350

400

450

500

550

Canara Bank Rel to BOMBAY SE SENSITIVE INDEX

Source: HSBC


Canara Bank – CBK IN – Overweight (V) Target price INR534



ROAA deconstruction

Net interest income 2.36 2.29 2.47 2.69Total interest income 8.56 8.08 8.47 8.86Total interest expense 6.20 5.80 6.00 6.16Net fees and commissions 0.32 0.38 0.38 0.35Other income 0.84 0.90 0.70 0.69Operat ing income 3.51 3.57 3.55 3.74Operat ing expenses 1.53 1.33 1.26 1.21Staf f costs 0.94 0.81 0.74 0.71Other oper exp 0.59 0.52 0.52 0.49

PPOP 1.98 2.24 2.29 2.53Provis ions 0.70 0.50 0.55 0.70Non-op items - - - -PBT 1.29 1.74 1.74 1.83Taxation 0.25 0.36 0.41 0.48PAT 1.04 1.38 1.33 1.35



17

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19 February 2010

abc


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19 February 2010

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3Q FY10

Productivity:Loans growth (y-o-y) 14.3%Deposit growth (y-o-y) 19.5%LDR 70.6%Incremental LDR 54.3%CASA 28.7%Loan mix:Retail advances 14.6%SME advances 19.3%Farm credit 15.5%Corporate advances 50.6%

Assets quality:Gross NPLs 1.8%Coverage ratio 24.5%

Margins:NIM 2.7%Shareholdings:

FII Holding 11.5%Domestic institutional and government (incl LIC) 9.7%

Source: [HSBC, Company data]



Total interest income 199,377 -3.6% 258,200 4.0% 324,626 7.7%Interest expenses 142,914 -2.4% 182,853 6.0% 225,908 11.0%Net interest income (NII) 56,463 -6.4% 75,347 -0.7% 98,718 0.7%P/(L) on sale of investments 9,402 115.5% 6,650 29.9% 7,775 19.5%P/(L) on revaluation of investments - - -P/(L) on exchange transactions 4,254 0.0% 4,193 0.0% 4,822 0.0%Fee and other income 17,917 0.9% 22,021 1.6% 25,686 -0.2%Non-interest income ex-treasury 22,171 0.7% 26,214 1.3% 30,508 -0.2%Total non-interest income 31,573 19.7% 32,864 6.0% 38,283 3.3%Total income 88,036 1.5% 108,211 1.3% 137,001 1.4%Operating expenses 32,727 0.3% 38,333 3.0% 44,260 8.7%Pre-provisioning profits 55,309 2.3% 69,878 0.3% 92,742 -1.7%Provisions for NPAs 11,666 -15.9% 15,430 -4.3% 23,703 24.8%Provisions for std. assets 1,409 -42.1% 1,636 -45.1% 1,862 -53.6%Provisions on investments (799) -200.0% (400) -200.0% (200) -200.0%

Other provisions 155 0.9% 192 1.7% 236 -0.2%Total provisions 12,430 -28.0% 16,858 -14.4% 25,601 9.2%PBT 42,879 16.4% 53,020 6.1% 67,140 -5.4%Tax 8,763 1.5% 12,426 -9.4% 17,750 -20.4%PAT 34,116 21.0% 40,594 11.9% 49,390 1.5%

Balance sheetDeposits 2,337,669 1.3% 2,867,604 1.2% 3,388,262 -1.9%Net advances 1,713,570 1.7% 2,124,317 1.7% 2,590,177 -1.6%Total assets 2,735,738 1.3% 3,362,258 1.3% 3,967,745 -1.4%

Net interest margin 2.36% -0.18% 2.55% -0.05% 2.77% 0.02%Book value 315.21 4.80% 399.01 5.95% 501.92 4.01%EPS 83.21 20.98% 99.01 11.95% 120.46 1.54%ROA 1.38% 0.23% 1.33% 0.13% 1.35% 0.02%ROE 29.7% 4.50% 27.7% 1.61% 26.7% -0.88%

Tax rate 20.4% -3.00% 23.4% -4.00% 26.4% -5.00%Cost income 37.2% -0.46% 35.4% 0.62% 32.3% 2.17%Core cost income 41.6% 1.99% 37.7% 1.18% 34.2% 2.59%




19

Banks


19 February 2010

abc

Valuation and risksWe have revised our loan growth assumptions for

FY10-12e by +1.7%, +1.7% and -1.6% to 24%,

24% and 21.9%. Also, deposits estimates for

FY10-12e have been revised to 25.1%,22.7% and

18.2% from 23.4%, 22.8% and 21.9%. We have

raised estimate for P& L on investments by

115.5%, 29.9% and 19.5% to INR9.4bn,

INR6.65bn and INR7.8bn during FY10-12e. As a

result, we are revising our net profit forecast by

+21% in 2010, +11.9% in 2011, and +1.5% in

2012, respectively.

We value Canara bank using a combination of

economic profit model (EPM), PE, and PB

methodologies. We assign a 75% weight to the PE

and 15% to P/B and 10% to DCF components.

The three-stage EPM uses explicit forecasts untilFY12e followed by 10 years of semi-explicit

forecasts, where we assume 8% loan CAGR and a

20% dividend payout. The final stage of 12 years

(fade period) assumes convergence of ROE and

COE. We assume a risk free rate of 8%, beta of 1,

and equity risk premium of 6%, translating into a

cost of equity of 14%. Our EPM value is INR530.


volatility indicator, the Neutral band is 10ppt above

and below the hurdle rate of 10.5% for India. Our

target price of INR534 (INR445 earlier) suggests a

43% potential total return, including prospective

dividend yield, which is above the Neutral band of

0.5-20.5% around the current share price. We

therefore reiterate our Overweight (V) rating.


FY10e FY11e FY12e

Income statementInterest income 16% 30% 26%Interest expense 15% 28% 24%Net interest income 20% 33% 31%Other income – ex treasury 41% 18% 16%Treasury gain 27% -29% 17%Total other income 37% 4% 16%Operating income 25% 23% 27%Core operating income 25% 29% 27%Operating expense 7% 17% 15%Operating profit 40% 26% 33%Core operating profit 42% 38% 34%Loan loss provisions 30% 32% 54%Other provisions -84% 87% 33%Total provisions -11% 36% 52%Pre tax profit 67% 24% 27%Tax 75% 42% 43%Net profit 65% 19% 22%Core PBT 83% 39% 28%Balance sheetAdvances 24% 24% 22%Deposits 25% 23% 18%

Gross NPLs 32% 12% 10%Net NPLs 33% 4% -3%Total assets 25% 23% 18%




New 547 470 530 534 43%Old 450 386 491 445




20

Banks


19 February 2010

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Positive potential catalysts: Margin expansion in

FY11 as loan book reprices quicker than deposits;

superior coverage ratio likely to put lower pressure

on provisioning costs going ahead; thus, PNB

enjoys among the biggest expansion in ROA and

ROE within our PSU universe.

Negative potential catalysts: PNB has the

highest proportion of restructured loans on its

book; this is partially offset by a superior

coverage ratio.

Valuations: On PE basis, it trades at among the

largest discounts of 21% to its five-year average

offering significant upside to a potential re-rating.

Earnings outlook: 30% CAGR in earnings overthe next three years up to FY12e, led by higher loan

growth and margins and lower provisions growth.

Key risks: (1) Higher-than-expected slippage in

its restructured book, (2) Lower CASA mix of

deposits leading to lower margins improvement.

Punjab National Bank (PNB)

Significant margin improvement prospects

Among the highest improvement in profitability vs peers

Potential total stock returns of 33% over 12 months; upgrade to

OW(V) from N(V)



21

Banks


19 February 2010

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Year to 3/2009a 3/2010e 3/2011e 3/2012e

P&L summary(INRm)

Net interest income 70,309 86,431 116,078 139,709Non-interest income 29,197 30,684 36,741 44,585Net fees/commissions 13,766 13,695 17,309 21,427Trading profits 6,940 7,878 8,615 10,278Other 8,491 9,111 10,816 12,880Total operating income 99,505 117,116 152,819 184,294Operating expense 42,062 48,205 56,176 66,225Staff costs 29,244 32,861 38,431 45,339Other oper expenese 12,818 15,344 17,745 20,886PPOP 57,443 68,910 96,643 118,069Provisions 9,774 13,031 15,603 16,036Bad debt 8,211 10,424 11,341 11,918Other 1,563 2,607 4,119






Net interes t income 27.0 22.9 34.3 20.4Non-interest income 46.2 5.1 19.7 21.3Operat ing expense 19.3 14.6 16.5 17.9PPOP 43.4 20.0 40.2 22.2Provisions 37.6 33.3 19.7 2.8PBT 44.6 17.2 45.0 25.9PAT 50.9 20.5 45.2 25.9 Customer loans (net) 29.5 21.3 24.9 22.9Total assets 24.1 19.4 16.8 19.6RWA 20.3 19.9 21.1 19.9Customer depos its 26.0 20.7 17.4 20.4

Ratios (%)


Valuation data

PE (diluted EPS) 9.09 7.54 5.19 4.12P/PPOP 4.89 4.08 2.91 2.38PB 2.14 1.75 1.37 1.07P/NTE 2.14 1.75 1.37 1.07Div idend y ield (x ) 2.25 2.47 3.03 3.37P/deposits 0.13 0.11 0.09 0.08P/assets 0.11 0.10 0.08 0.07


Price relative

186

386

586

786

986

1186

2008 2009 2010 2011

186

386

586

786

986

1186

Punjab National Bank Rel to BOMBAY SE SENSITIVE INDEX

Source: HSBC


Punjab National Bank – PNB IN – Overweight (V) Target price INR1,163



ROAA deconstruction





22

Banks


19 February 2010

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3.0x

3.5x

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

7.0x

A p

r - 0 2

F e

b - 0 3

N o v - 0 3

S e

p - 0 4

J u

n - 0 5

M a

r - 0 6

J a

n - 0 7

O c t - 0 7

A u

g - 0 8

M a y - 0 9

F e

b - 1 0

5

10

15

20

25

30

35




0x

2x

4x

6x

8x

10x

A p r - 0 2

F e

b - 0 3

N o

v - 0 3

S e

p - 0 4

J u

n - 0 5

M a

r - 0 6

J a

n - 0 7

O c t - 0 7

A u

g - 0 8

M a

y - 0 9

F e

b - 1 0


0.0x

0.5x

1.0x

1.5x

2.0x

A p r - 0 2

F e

b - 0 3

N o

v - 0 3

S e

p - 0 4

J u

n - 0 5

M a

r - 0 6

J a

n - 0 7

O c t - 0 7

A u

g - 0 8

M a

y - 0 9

F e

b - 1 0





23

Banks


19 February 2010

abc


3Q FY10Productivity:

Loans growth (y-o-y) 20.3%Deposit growth (y-o-y) 18.7%LDR 72.8%Incremental LDR 78.0%CASA 39.5%

Loan mix:Retail advances 10.5%SME advances 19.2%Farm credit 16.0%Corporate advances 54.4%

Assets Quality:Gross NPLs 1.8%

Coverage ratio 74.3%Margins:NIM 3.8%

Shareholdings:FII Holding 19.1%Domestic institutional and government (incl LIC) 18.3%




Total interest income 219,826 -4.0% 280,601 3.3% 348,067 5.7%Interest expenses 133,394 -7.2% 164,523 -2.8% 208,358 1 .9%Net interest income (NI I) 86,431 1.4% 116,078 13.4% 139,709 11.8%P/ (L) on sale of investments 7,522 -15.4% 8,197 0.3% 9,790 22.1%P/(L) on revaluation of investments – – –P/ (L) on exchange transact ions 3,104 -16.7% 3,570 0.0% 4,105 11.1%Fee and other income 20,058 -3.7% 24,974 -2.8% 30,690 -3.2%Non- interest income ex-t reasury 23,162 -5.7% 28,544 -2.5% 34,795 -1.7%Total non-interest income 30,684 -8.3% 36,741 -1.9% 44,585 2.7%Total income 117,116 -1.3% 152,819 9.3% 184,294 9.5%Operating expenses 48,205 -6.3% 56,176 -5.1% 66,225 -2.7%Pre-provis ioning prof its 68,910 2.5% 96,643 19.9% 118,069 17.8%Provis ions for NPAs 10,424 50.0% 11,341 27.3% 11,918 0.6%Provis ions for std. assets 1,265 -46.7% 1,840 -41.7% 2,096 -50.7%Provisions on investments 1,000 0.0% 2,000 33.3% 1,500 -25.0%

Other provisions 342 0.1% 422 0.9% 523 0.5%Total provis ions 13,031 22.2% 15,603 11.6% 16,036 -13.9%PBT 55,879 -1.2% 81,040 21.6% 102,032 25.0%Tax 18,620 -1.2% 26,953 21.4% 33,918 24.8%PAT 37,259 -1.2% 54,087 21.7% 68,114 25.1%

Balance sheetDeposi ts 2,531,289 -0.2% 2,970,796 1.1% 3,575,835 -1.2%Net advances 1,876,839 0.1% 2,344,929 1.5% 2,881,136 -0.4%Total assets 2,948,876 -0.1% 3,445,691 1.2% 4,122,304 -0.5%

Net interest margin 3.30% 0.05% 3.75% 0.42% 3.81% 0.39%Book value 509.17 0.18% 649.12 5.11% 830.05 9.91%EPS 118.17 -1.18% 171.54 21.72% 216.03 25.06%ROA 1.38% -0.02% 1.69% 0.29% 1.80% 0.36%ROE 25.5% -0.33% 29.6% 4.58% 29.2% 4.04%

Tax rate 33.3% 0.00% 33.3% -0.05% 33.2% -0.05%Cost income 41.2% -2.20% 36.8% -5.58% 35.9% -4.51%Core cost income 44.0% -2.89% 38.8% -6.12% 38.0% -4.51%




24

Banks


19 February 2010

abc

Valuation and risks

We have revised our loan and deposit growth

assumptions for FY11 from 23.2% and 15.9% to

17.4% and 24.9%. Also, we have raised NIM

estimate by 42bps and 39bp in FY11& FY12

respectively..As a result, we are revising our net

profit forecast by +21.7% in 2011 and 25.1% in

2012, respectively.

We value PNB using a combination of economicprofit model (EPM), PE, and PB methodologies.


P/B and 10% to DCF components. We value

PNBK using a combination of economic profit

model (EPM), PE, and PB methodologies. The

three-stage EPM uses explicit forecasts until

FY12e followed by 10 years of semi-explicit

forecasts, where we assume 11% loan CAGR and

a 20% dividend payout. The final stage of 12

years (fade period) assumes convergence of ROE

and COE. We assume a risk free rate of 8%, beta

of 1, and equity risk premium of 6%, translating

into a cost of equity of 14%. Our EPM value is

INR987.



above and below the hurdle rate of 10.5% for

India. Our target price of INR1,163 (INR901




current share price. We therefore upgrade PNB

from Neutral (V) to Overweight (V) rating.


FY10e FY11e FY12e

Income statementInterest income 14% 28% 24%Interest expense 8% 23% 27%Net interest income 23% 34% 20%Other income – ex treasury 3% 23% 22%Treasury gain 13% 9% 19%Total other income 5% 20% 21%Operating income 18% 30% 21%Core operating income 18% 32% 21%Operating expense 15% 17% 18%Operating profit 20% 40% 22%Core operating profit 21% 44% 22%Loan loss provisions -32% 9% 5%Other provisions -146% 63% -3%Total provisions 34% 20% 3%Pre tax profit 17% 45% 26%Tax 11% 45% 26%Net profit 21% 45% 26%Core PBT 18% 51% 27%Balance sheetAdvances 21% 25% 23%Deposits 21% 17% 20%CASA mixGross NPLs 37% 17% 18%Net NPLs 231% -13% 15%Total assets 19% 17% 20%




New 1,253 829 987 1,163 33%Old 937 755 855 901




25

Banks


19 February 2010

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Positive potential catalysts: SBI’s large balance

sheet would get a significant leg-up from the

credit upcycle as growth and margins improve.

Negative potential catalysts: Cost increasesgiven its branch expansion plans likely to put

pressure on earnings in FY12e capping growth

and profitability prospects; Likely to face more

pressures vs peers on repricing its loan book

upwards during the credit upcycle; Lower-than-

peers coverage ratio likely to put more pressure

on provisioning.

Valuations: Most expensive PSU bank stock, at

9.5x PE, offering little room for re-rating given

lower-than-peers growth and ROE prospects.

Earnings outlook: 18% CAGR in earnings over the

next three years up to FY12e, led by higher loan

growth and margins partially dampened by higher

costs; ROE, too, is increasing, to 18.5% by FY12e.

Key risks: (1) On the upside, aggressive market

share expansion likely to result in higher-than-

anticipated earnings growth. (2) On the downside,

higher than expected slippage in restructured

loans likely to put pressure on earnings given low

coverage vs peers.

State Bank of India(SBIN)

Big beneficiary of improving growth and margins

But high cost increases dampens growth and profitability outlook

Most expensive PSU bank stock; recent underperformance offers

scope to upgrade to N(V); entry point at INR1,700



26

Banks


19 February 2010

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Year to 3/2009a 3/2010e 3/2011e 3/2012e

P&L summary(INRm)

Net interest income 208,731 224,571 311,046 363,273Non-interest income 126,908 145,585 180,790 225,501Net fees/commissions 76,172 98,385 123,748 153,127Trading profits 29,769 24,924 21,669 26,684Other 20,967 22,276 35,373 45,689Total operating income 335,639 370,156 491,836 588,774Operating expense 156,487 193,871 239,396 297,176Staff costs 97,473 123,097 156,538 200,855Other oper expenese 59,014 70,774 82,858 96,321PPOP 179,152 176,285 252,439 291,598Provisions 37,346 32,366 53,614 58,445Bad debt 24,750 33,186 44,234 49,606Other 12,596 (820) 9,381 8,839


Total assets 9,644,321 11,171,150 13,381,489 15,247,335Customer loans (net) 5,425,032 6,500,465 8,058,125 9,747,379Investment assets 2,759,540 3,109,862 3,486,975 3,380,555Other_assets 1,459,749 1,560,823 1,836,390 2,119,400Total liabilities 9,064,844 10,523,783 12,616,737 14,341,013Customer deposits 7,420,731 8,659,826 10,522,693 13,095,211Debt securities issued 537,137 590,302 616,570 644,152Other liabilities 1,106,976 1,273,655 1,477,473 601,649Total capital 579,477 652,026 760,101 890,528Ordinary equity 579,477 652,026 760,101 890,528Minorities + other capitalIEA (avg) 7,900,602 9,881,152 11,647,979 13,563,235IBL (avg) 7,360,671 9,134,850 10,807,470 12,985,851 Capital adequacy (%)

RWA (INRm) 7,719,190 8,920,061 10,591,757 12,361,693Core tier 1 9.4% 8.2% 7.8% 7.7%Total ti er 1 9.4% 8.2% 7.8% 7.7%Total capital 14.3% 13.1% 12.0% 11.3%

ROAA deconstruction

Net interest income 2.48 2.16 2.53 2.54Total interest income 7.57 7.03 7.52 7.82Total interest expense 5.09 4.88 4.99 5.28Net fees and commissions 0.90 0.95 1.01 1.07Other income 0.60 0.45 0.46 0.51Operat ing income 3.98 3.56 4.01 4.11Operat ing expenses 1.86 1.86 1.95 2.08Staf f costs 1.16 1.18 1.28 1.40Other oper exp 0.70 0.68 0.67 0.67PPOP 2.13 1.69 2.06 2.04

Provis ions 0.44 0.31 0.44 0.41Non-op items - - - -PBT 1.68 1.38 1.62 1.63Taxation 0.60 0.48 0.56 0.56PAT 1.08 0.90 1.06 1.07


Net interes t income 22.6 7 .6 38.5 16.8Non-interest income 46.0 14.7 24.2 24.7Operat ing expense 24.1 23.9 23.5 24.1PPOP 36.7 (1.6) 43.2 15.5Provisions 39.9 (13.3) 65.7 9.0PBT 35.8 1.5 38.2 17.3PAT 35.5 3.2 38.5 17.1Customer loans (net) 30.2 19.8 24.0 21.0Total assets 33.7 15.8 19.8 13.9RWA (0.0) 15.6 18.7 16.7Customer depos its 38.1 16.7 21.5 24.4

Ratios (%)


Valuation data

PE (diluted EPS) 13.6 13.2 9.5 8.1P/PPOP 6.9 7.0 4.9 4.3PB 2.1 1.9 1.6 1.4P/NTE 2.1 1.9 1.6 1.4Dividend yield (x) 1.5 1.5 1.5 1.5P/deposits 0.17 0.14 0.12 0.09P/assets 0.13 0.11 0.09 0.08


Price relative

634

1134

1634

2134

2634

3134

2008 2009 2010 2011

634

1134

1634

2134

2634

3134

State Bank of India Rel to BOMBAY SE SENSITIVE INDEX

Source: HSBC


State Bank of India – SBIN IN – Neutral (V) Target price INR2,033


EPS reported (diluted) 143.7 148.2 205.3 240.5

HSBC EPS (diluted) 143.7 148.2 205.3 240.5DPS 29.0 29.0 30.0 30.0NAV 912.7 1,027.0 1,197.2 1,402.7NAV (including goodwill) 912.7 1,027.0 1,197.2 1,402.7



27

Banks


19 February 2010

abc


4.0x

5.0x

6.0x

7.0x

8.0x

9.0x

10.0x

11.0x

12.0x

M a r - 9 6

A u

g - 9 7

J a

n - 9 9

J u

n - 0 0

O

c t - 0 1

M a r - 0 3

A u

g - 0 4

D e c - 0 5

M a

y - 0 7

O

c t - 0 8

F e

b - 1 0

-

5

10

15

20

25

30

35




0x

3x

6x9x

12x

15x

18x

M a r - 9 6

A u g - 9 7

J a n - 9 9

J u n - 0 0

O c t - 0 1

M a r - 0 3

A u g - 0 4

D e c - 0 5

M a y - 0 7

O c t - 0 8

F e b - 1 0


Average 10 year

0.0x0.3x0.6x0.9x1.2x1.5x1.8x2.1x2.4x2.7x

M a r - 9 6

A u g - 9 7

J a n - 9 9

J u n - 0 0

O c t - 0 1

M a r - 0 3

A u g - 0 4

D e c - 0 5

M a y - 0 7

O c t - 0 8

F e b - 1 0


Average 10 year




28

Banks


19 February 2010

abc


3Q FY10

Productivity:Loans growth (y-o-y) 18.9%

Deposit growth (y-o-y) 11.3%LDR 77.7%Incremental LDR 122.0%CASA 42.7%Loan mix:

International Advances 15.7%Domestic AdvancesRetail Advances 21.8%SME Advances 17.2%Farm credit 10.2%Corporate Advances 35.2%Assets Quality:Gross NPLs 3.1%Coverage ratio 40.2%Margins:NIM 2.8%Shareholdings:FII Holding 15.0%

Domestic institutional and government (incl LIC) 15.8%




Total interest income 732,015 -7.4% 923,390 -5.8% 1,119,519 -7.1%Interest expenses 507,444 -4.0% 612,344 -2.8% 756,246 -2.3%Net interest income (NII) 224,571 -14.4% 311,046 -11.0% 363,273 -15.8%P/(L) on sale of investments 20,543 -37.0% 16,492 -56.5% 20,603 -47.8%P/(L) on Revaluationa of Investments (5) 0.0% (5) 0.0% (4) 0.0%P/(L) on exchange transactions 12,619 14.3% 26,058 75.0% 37,338 88.9%Fee and other income 112,423 -4.4% 138,239 -8.3% 167,560 -8.6%Non-interest income ex-treasury 125,042 -2.8% 164,298 -0.8% 204,898 0.9%Total non-interest income 145,585 -9.7% 180,790 -11.2% 225,501 -7.0%Total income 370,156 -12.6% 491,836 -11.1% 588,774 -12.7%Operating expenses 193,871 -0.5% 239,396 -4.7% 297,176 -6.2%Pre-provisioning profits 176,285 -23.0% 252,439 -16.4% 291,598 -18.4%Provis ions for NPAs 33,186 -36.4% 44,234 -41.9% 49,606 -47.5%Provis ions for std. assets 3,642 -54.5% 5,331 -46.4% 5,585 -53.7%Provis ions on investments (5,655) -350.0% 2,594 -11.0% 1,474 -58.9%

Other provisions 1,193 1,456 1,781Total provis ions 32,366 -49.2% 53,614 -40.8% 58,445 -47.8%PBT 143,919 -12.9% 198,825 -5.9% 233,153 -4.9%Tax 49,824 -12.4% 68,462 -5.9% 80,437 -5.0%PAT 94,096 -13.1% 130,363 -6.0% 152,716 -4.9%

Balance sheetDeposits 8,659,826 -6.3% 10,522,693 -8.6% 13,095,211 -10.7%Net advances 6,500,465 -3.4% 8,058,125 -3.4% 9,747,379 -5.7%Total assets 11,171,150 -5.5% 13,381,489 -7.5% 15,247,335 -9.5%

Net interest margin 2.25% -0.30% 2.65% -0.13% 2.66% -0.23%Book value 1,027.01 -2.79% 1,197.23 -4.06% 1,402.67 -4.84%EPS 148.20 -13.13% 205.33 -5.96% 240.54 -4.92%ROA 0.90% -0.11% 1.06% 0.01% 1.07% 0.04%ROE 15.3% -2.05% 18.5% -0.49% 18.5% -0.09%

Tax rate 34.6% 0.20% 34.4% 0.02% 34.5% -0.01%Cost income 52.4% 6.39% 48.7% 3.26% 50.5% 3.47%Core cost income 55.5% 5.63% 50.4% 1.60% 52.3% 2.37%




29

Banks


19 February 2010

abc

Valuation and risks

We have revised our loan growth assumptions for

FY10-12e to 19.8%,24% and 21% from 24%

earlier. Also, deposit forecasts have been changed

to 16.7%, 21.5% and 24.4% from 24.5%, 24.6%

and 27.4%, respectively. Also, NIM forecasts

have been lowered by 30bp, 13bp and 23bp for

FY10-12e.In addition, provision expenses forecast

have been increased by 49.2%, 40.8% and 47.8%

for FY10-12, respectively. As a result, we arelowering our net profit forecast by -13.1% in

2010, -6% in 2011 and -4.9% in 2012,

respectively.

We value SBI using a combination of economic

profit model (EPM), PE, and PB methodologies.


P/B and 10% to DCF components. The three-

stage EPM uses explicit forecasts until FY12e

followed by 10 years of semi-explicit forecasts,

where we assume 8% loan CAGR and a 20%

dividend payout. The final stage of 12 years (fade

period) assumes convergence of ROE and COE.

We assume a risk free rate of 8%, beta of 1, and

equity risk premium of 6%, translating into a cost

of equity of 14%. Our EPM value is INR1,698


volatility indicator, the Neutral band is 10pptabove and below the hurdle rate of 10.5% for

India. Our target price of INR2,033 (INR2,038



within the Neutral band of 0.5-20.5% around the

current share price. We therefore raise our rating

to Neutral (V) from Underweight (V).


(INRbn) FY10e FY11e FY12e

Income statementInterest income 15% 26% 21%Interest expense 18% 21% 24%Net interest income 8% 39% 17%Other income – ex treasury 24% 31% 25%Treasury gain -20% -20% 25%Total other income 15% 24% 25%Operating income 10% 33% 20%Core operating income 13% 36% 20%Operating expense 24% 23% 24%Operating profit -2% 43% 16%Core operating profit 2% 51% 15%Loan loss provisions 41% 33% 12%Other provisions -106% -1243% -6%Total provisions -13% 66% 9%Pre tax profit 1% 38% 17%Tax -2% 37% 17%Net profit 3% 39% 17%Core PBT 6% 48% 17%Balance sheetAdvances 20% 24% 21%Deposits 17% 22% 24%CASA mixGross NPLs 30% 16% 9%Net NPLs 26% 9% -3%Total assets 16% 20% 14%




New 2,106 1,893 1,698 2,033 5%Old 2,115 1,811 1,802 2,038




30

Banks


19 February 2010

abc

Positive potential catalysts: Union’s historically

lower balance sheet growth now positions it for a

significant leverage up the credit cycle; accordingly,

margin and ROE expansion likely to be significant;

enjoys among the biggest expansion in ROA, ROE

within our PSU universe.

Negative potential catalysts: Second-highest

proportion of restructured loans on its book in ouruniverse; relatively low scope to raise fresh equity

given low government shareholdings.

Valuations: On a PE basis, it trades at significant

discounts of 17% to its five-year average offering

24% upside to a potential re-rating.

Earnings outlook: 25% CAGR in earnings over

the next three years up to FY12e, led by higher

loan growth and margins.

Key risks: (1) Higher-than-expected slippage in

its restructured book. (2) May not be able to ramp

up growth levels given equity raising constraints

because of lower government holdings.

Union Bank (UNBK)

Among the most leveraged PSU Banks to a credit upcycle

Significant ROE expansion expected up to 27% by FY12e

24% potential returns over 12 mths; Reiterate OW(V)



31

Banks


19 February 2010

abc

Year to 3/2009a 3/2010e 3/2011e 3/2012e

P&L summary(INRm)

Net interest income 38,136 39,653 59,823 76,580Non-interest income 14,826 20,261 23,372 29,360Net fees/commissions 3,133 4,109 5,273 6,825Trading profits 3,215 6,684 6,126 7,277Other 8,478 9,467 11,973 15,258Total operating income 52,961 59,913 83,195 105,941Operating expense 22,141 24,463 28,487 33,431Staff costs 11,519 12,564 14,788 17,446Other oper expenese 10,622 11,899 13,699 15,985PPOP 30,820 35,451 54,708 72,509Provisions 7,255 10,140 16,534 20,086Bad debt 5,465 7,487 11,073 14,786Other 1,790 2,652 5,461 5,300


Total assets 1,609,755 1,997,766 2,441,394 3,011,466Customer loans (net) 965,342 1,141,979 1,430,360 1,819,691Investment assets 429,970 560,299 664,940 790,448Other_assets 214,443 295,487 346,093 401,327Total liabilities 1,522,352 1,894,840 2,315,465 2,854,417


RWA (INRm) 953,840 1,140,756 1,570,413 1,917,944Core tier 1 8.2% 8.3% 7.5% 7.7%Total t ier 1 8.2% 8.3% 7.5% 7.7%Total capital 13.3% 14.0% 12.4% 12.5%


Net interes t income 33.6 4 .0 50.9 28.0Non-interest income 12.3 36.7 15.4 25.6Operat ing expense 39.0 10.5 16.4 17.4PPOP 19.4 15.0 54.3 32.5Provisions 0.8 39.8 63.1 21.5PBT 26.7 7.4 50.8 37.3PAT 24.5 7.0 40.5 31.3 Customer loans (net) 30.0 18.3 25.3 27.2Total assets 29.8 24.1 22.2 23.4RWA 8.6 19.6 37.7 22.1Customer depos its 33.5 20.3 24.8 23.4

Ratios (%)


Valuation data

PE (diluted EPS) 7.23 6.75 4.81 3.66P/PPOP 4.05 3.52 2.28 1.72PB 1.77 1.45 1.14 0.89P/NTE 1.77 1.45 1.14 0.89Div idend y ield (x ) 2.02 2.02 2.02 2.02P/deposits 0.09 0.07 0.06 0.05P/assets 0.08 0.06 0.05 0.04


Price relative

67

117

167

217

267

317

367

2008 2009 2010 2011

67

117

167

217

267

317

367

Union Bank Of India Rel to BOMBAY SE SENSITIVE INDEX

Source: HSBC


Union Bank of India – UNBK IN – Overweight (V) Target price INR302



ROAA deconstruction





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3.0x

3.5x

4.0x

4.5x

5.0x

5.5x

6.0x

6.5x

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p - 0 2

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y - 0 3

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b - 0 4

N o

v - 0 4

A u

g - 0 5

M a

y - 0 6

F e

b - 0 7

N o

v - 0 7

A u

g - 0 8

M a

y - 0 9

F e

b - 1 0

5

10

15

20

25

30

35

40




0x

2x

4x

6x

8x

10x

S

e p - 0 2

J

u n - 0 3

M

a r - 0 4

D

e c - 0 4

S

e p - 0 5

M

a y - 0 6

F

e b - 0 7

N

o v - 0 7

A

u g - 0 8

A

p r - 0 9

J

a n - 1 0

Rolling P/E Av erage 5 y earAverage 7 year

0.0x

0.5x

1.0x

1.5x

2.0x

S e p - 0 2

J u n - 0 3

M a r - 0 4

D e c - 0 4

S e p - 0 5

J u n - 0 6

M a r - 0 7

D e c - 0 7

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F e b - 1 0


Av erage 7 year




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3Q FY10

Productivity:Loans growth (y-o-y) 14.6%Deposit growth (y-o-y) 16.5%LDR 70.5%Incremental LDR 63.2%CASA 32.3%

Loan mix:Retail Advances 11.1%SME Advances 19.4%Farm credit 16.5%Corporate Advances 53.1%

Assets quality:Gross NPLs 2.0%Coverage ratio 70.7%

Margins:NIM 2.7%

Shareholdings:FII Holding 16.2%Domestic institutional and government (incl LIC) 13.5%




Total interest income 132,368 -11.8% 174,562 -4.3% 228,835 2.2%Interest expenses 92,715 -9.3% 114,739 -4.8% 152,254 3.3%Net interest income (NI I) 39,653 -17.2% 59,823 -3.4% 76,580 0.2%P/ (L) on sale of investments 6,684 40.5% 6,126 7.1% 7,277 6.7%P/(L) on Revaluationa of Investments – #DIV/0! – #DIV/0! – #DIV/0!P/(L) on exchange t ransactions 3,161 -34.4% 4,244 -28.7% 5,688 -24.3%Fee and other income 10,415 -14.6% 13,001 -13.3% 16,396 -16.2%Non-interest income ex-treasury 13,576 -20.2% 17,246 -17.7% 22,083 -18.5%Total non-interest income 20,261 -6.9% 23,372 -12.4% 29,360 -13.4%Total income 59,913 -14.0% 83,195 -6.1% 105,941 -4.0%Operat ing expenses 24,463 -5.3% 28,487 -6.7% 33,431 -6.8%Pre-provis ioning prof its 35,451 -19.1% 54,708 -5.8% 72,509 -2.7%Provis ions for NPAs 7,487 -14.1% 11,073 -3.3% 14,786 -3.3%Provis ions for std. assets 656 -56.0% 1,143 -47.1% 1,548 -47.0%Provis ions on inves tments 1,470 218.2% 3,675 783.8% 2,940 685.6%

Other provisions 527 643 813Total provis ions 10,140 -9.5% 16,534 12.6% 20,086 3.4%PBT 25,311 -22.5% 38,174 -12.0% 52,423 -4.8%Tax 6,834 -40.2% 12,216 -19.6% 18,348 -4.8%PAT 18,477 -12.9% 25,959 -8.0% 34,075 -4.8%

Balance sheetDeposits 1,669,220 0.0% 2,082,481 0.0% 2,570,211 0.0%Net advances 1,141,979 -3.0% 1,430,360 -2.7% 1,819,691 -2.5%Total assets 1,997,766 -0.1% 2,441,394 -0.1% 3,011,466 0.0%

Net interest margin 2.31% -0.48% 2.84% -0.10% 2.94% 0.01%Book value 170.39 -1.11% 215.93 -1.30% 277.54 -0.99%EPS 36.58 -12.91% 51.39 -7.96% 67.46 -4.83%ROA 1.02% -0.15% 1.17% -0.10% 1.25% -0.06%ROE 23.6% -3.33% 26.6% -1.95% 27.3% -1.07%

Tax rate 27.0% -8.00% 32.0% -3.00% 35.0% 0.00%Cost income 40.8% 3.75% 34.2% -0.23% 31.6% -0.93%Core cost income 46.0% 6.16% 37.0% 0.11% 33.9% -0.75%




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Valuation and risks

We have revised our loan growth assumptions for

FY10 to 18.3% from 21.9%. Also, margin

estimate trimmed by 48bp and 10bp in 2010 and

2011, respectively. Also, we have lowered

estimate for non interest income by 6.9% , 12.4%

and 13.4% to INR20.2bn , INR17.2bn and

INR22bn, respectively. Provision estimates have

been revised by -9.5% in 2010, +12.6% in 2011

and +3.4% in 2012.As a result, we are revisingour net profit forecast by +21% in 2010, +11.9%

in 2011 and +1.5% in 2012, respectively.

We value Union bank using a combination of

economic profit model (EPM), PE, and PB

methodologies. We assign a 75% weight to the PE

and 15% to P/B and 10% to DCF components.

The three-stage EPM uses explicit forecasts until

FY12e followed by 10 years of semi-explicit

forecasts, where we assume 8% loan CAGR and a

20% dividend payout. The final stage of 12 years

(fade period) assumes convergence of ROE and

COE. We assume a risk free rate of 8%, beta of 1,

and equity risk premium of 6%, translating into a

cost of equity of 14%. Our EPM value is INR308.



above and below the hurdle rate of 10.5% forIndia. Our target price of INR302 (INR335




current share price. We therefore reiterate our

Overweight (V) rating on Union Bank shares.


FY10e FY11e FY12e

Income statementInterest income 11% 32% 31%Interest expense 15% 24% 33%Net interest income 4% 51% 28%Other income – ex treasury 17% 27% 28%Treasury gain 110% -8% 19%Total other income 37% 15% 26%Operating income 13% 39% 27%Core operating income 7% 45% 28%Operating expense 10% 16% 17%Operating profit 15% 54% 33%Core operating profit 4% 69% 34%Loan loss provisions 37% 48% 34%Other provisions 39% 106% -3%Total provisions 37% 63% 21%Pre tax profit 8% 51% 37%Tax 11% 79% 50%Net profit 7% 40% 31%Core PBT -8% 72% 41%Balance sheetAdvances 18% 25% 27%Deposits 20% 25% 23%CASA mixGross NPLs 15% 8% 6%Net NPLs 90% 12% 0%Total assets 24% 22% 23%




New 306 276 308 302 24%Old 359 244 292 335




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Disclosure appendix

Analyst Certification

The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the

opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their

personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific

recommendation(s) or views contained in this research report: Sachin Sheth and Todd Dunivant

Important disclosuresStock ratings and basis for financial analysis

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which

depend largely on individual circumstances such as the investor’s existing holdings, risk tolerance and other considerations.

Given these differences, HSBC has two principal aims in its equity research: (1) to identify long-term investment opportunities

based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12-month horizon; and

(2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical

or event-driven techniques on a 0- to 3-month horizon and which may differ from our long-term investment rating. HSBC has

assigned ratings for its long-term investment opportunities as described below.

This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC

publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research.

Details of these short-term investment opportunities can be found under the Reports section of this website.

HSBC believes an investor’s decision to buy or sell a stock should depend on individual circumstances such as the investor’s

existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating

systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research

report. In addition, because research reports contain more complete information concerning the analysts’ views, investors

should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not

be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities

Stock ratings

HSBC assigns ratings to its stocks in this sector on the following basis:

For each stock we set a required rate of return calculated from the risk free rate for that stock’s domestic, or as appropriate,

regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents

the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a

stock to be classified as Overweight, the implied return must exceed the required return by at least 5ppt over the next 12

months (or 10ppt for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to

underperform its required return by at least 5ppt over the next 12 months (or 10ppt for a stock classified as Volatile*). Stocks

between these bands are classified as Neutral.

Our ratings are re-calibrated against these bands at the time of any ‘material change’ (initiation of coverage, change of

volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management

review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without

necessarily triggering a rating change.

*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12

months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However,

stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past



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month’s average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating,however, volatility has to move 2.5ppt past the 40% benchmark in either direction for a stock’s status to change.

Prior to this, from 7 June 2005 HSBC applied a ratings structure which ranked the stocks according to their notional target

price vs current market price and then categorised (approximately) the top 40% as Overweight, the next 40% as Neutral and

the last 20% as Underweight. The performance horizon is two years. The notional target price was defined as the midpoint of

the analysts’ valuation for a stock.

From 15 November 2004 to 7 June 2005, HSBC carried no ratings and concentrated on long-term thematic reports which identified

themes and trends in industries, but did not make a conclusion as to the investment action that potential investors should take.

Prior to 15 November 2004, HSBC’s ratings system was based upon a two-stage recommendation structure: a combination of

the analysts’ view on the stock relative to its sector and the sector call relative to the market, together giving a view on the

stock relative to the market. The sector call was the responsibility of the strategy team, set in co-operation with the analysts.For other companies, HSBC showed a recommendation relative to the market. The performance horizon was 6-12 months. The

target price was the level the stock should have traded at if the market accepted the analysts’ view of the stock.

Rating distribution for long-term investment opportunities

As of 19 February 2010, the distribution of all ratings published is as follows:

Overweight (Buy) 46% (12% of these provided with Investment Banking Services)

Neutral (Hold) 38% (12% of these provided with Investment Banking Services)

Underweight (Sell) 16% (11% of these provided with Investment Banking Services)

Information regarding company share price performance and history of HSBC ratings and price targets in respect of its long-

term investment opportunities for the companies the subject of this report,is available from www.hsbcnet.com/research.



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HSBC & Analyst disclosuresDisclosure checklist

Company Ticker Recent price Price Date Disclosure

AXIS BANK LTD AXBK.BO 1098.50 19-Feb-2010 4, 7BANK OF BARODA BOB.NS 589.10 19-Feb-2010 6, 7CANARA BANK CNBK.BO 379.00 19-Feb-2010 6, 7HDFC HDFC.NS 2480.95 19-Feb-2010 6HDFC BANK HDBK.NS 1683.75 19-Feb-2010 4, 6, 7ICICI BANK ICBK.NS 840.05 19-Feb-2010 1, 2, 4, 5, 6, 7, 11PUNJAB NATIONAL BANK PNBK.BO 896.00 19-Feb-2010 6, 7STATE BANK OF INDIA SBI.NS 1942.40 19-Feb-2010 4, 6, 7UNION BANK OF INDIA UNBK.BO 242.75 19-Feb-2010 7

Source: HSBC

1 HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months.

2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next3 months.

3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company.

4 As of 31 January 2010 HSBC beneficially owned 1% or more of a class of common equity securities of this company.5 As of 31 December 2009, this company was a client of HSBC or had during the preceding 12 month period been a client

of and/or paid compensation to HSBC in respect of investment banking services.

6 As of 31 December 2009, this company was a client of HSBC or had during the preceding 12 month period been a clientof and/or paid compensation to HSBC in respect of non-investment banking-securities related services.

7 As of 31 December 2009, this company was a client of HSBC or had during the preceding 12 month period been a client

of and/or paid compensation to HSBC in respect of non-securities services.8 A covering analyst/s has received compensation from this company in the past 12 months.

9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, asdetailed below.

10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of thiscompany, as detailed below.

11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or insecurities in respect of this company

Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment

banking revenues.

For disclosures in respect of any company mentioned in this report, please see the most recently published report on that

company available at www.hsbcnet.com/research.

* HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures

1 This report is dated as at 19 February 2010.2 All market data included in this report are dated as at close 17 February 2010, unless otherwise indicated in the report.3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its

Research business. HSBC’s analysts and its other staff who are involved in the preparation and dissemination of Researchoperate and have a management reporting line independent of HSBC’s Investment Banking business. Information Barrierprocedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or

price sensitive information is handled in an appropriate manner.4 As of 31 January 2010, HSBC beneficially owned 2% or more of a class of common equity securities of the following

company(ies) : HDFC BANK

5 As of 31 January 2010, HSBC and/or its affiliates (including the funds, portfolios and investment clubs in securitiesmanaged by such entities) either, directly or indirectly, own or are involved in the acquisition, sale or intermediation of,1% or more of the total capital of the subject companies securities in the market for the following Company(ies) : STATEBANK OF INDIA , ICICI BANK , AXIS BANK LTD , HDFC BANK



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Disclaimer

* Legal entities as at 31 January 2010

‘UAE’ HSBC Bank Middle East Limited, Dubai; ‘HK’ The Hongkong and Shanghai Banking

Corporation Limited, Hong Kong; ‘TW’ HSBC Securities (Taiwan) Corporation Limited; ‘CA’ HSBC

Securities (Canada) Inc, Toronto; HSBC Bank, Paris branch; HSBC France; ‘DE’ HSBC Trinkaus &

Burkhardt AG, Dusseldorf; 000 HSBC Bank (RR), Moscow; ‘IN’ HSBC Securities and Capital Markets

(India) Private Limited, Mumbai; ‘JP’ HSBC Securities (Japan) Limited, Tokyo; ‘EG’ HSBC Securities

Egypt S.A.E., Cairo; ‘CN’ HSBC Investment Bank Asia Limited, Beijing Representative Office; The

Hongkong and Shanghai Banking Corporation Limited, Singapore branch; The Hongkong and

Shanghai Banking Corporation Limited, Seoul Securities Branch; The Hongkong and Shanghai BankingCorporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; ‘GR’

HSBC Pantelakis Securities S.A., Athens; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv,

‘US’ HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler A.S., Istanbul; HSBC

México, S.A., Institución de Banca Múltiple, Grupo Financiero HSBC, HSBC Bank Brasil S.A. – Banco

Múltiplo, HSBC Bank Australia Limited, HSBC Bank Argentina S.A., HSBC Saudi Arabia Limited.

Issuer of report

HSBC Securities and Capital Markets

(India) Private Limited

Registered Office

52/60 Mahatma Gandhi Road

Fort, Mumbai 400 001, India

Telephone: +91 22 2267 4921

Fax: +91 22 2263 1983

Website: www.research.hsbc.com

This document has been issued by HSBC Securities and Capital Markets (India) Private Limited (“HSBC”) for the information of its customers only. HSBC

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written permission of HSBC Securities and Capital Markets (India) Private Limited. MICA (P) 177/08/2009



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Carlo DigrandiGlobal Industry Head, FIG +44 20 7991 6843 [email protected]

Banks

EuropeRobin DownAnalyst, Global Sector Head, Banks +44 20 7991 6926 [email protected]

Matthew Czepliewicz+44 20 7991 6709 [email protected]

Peter Toeman+44 20 7991 6791 [email protected]

Dimitris Haralabopoulos+30 210 696 5214 [email protected]

Marcel Mballa-Ekobena+44 20 7991 6809 [email protected]

Johannes Thormann+49 211 910 3017 [email protected]

Aybek Islamov+44 20 7992 3624 [email protected]

Carlo Mareels+44 20 7991 6722 [email protected]

Rob Murphy+44 20 7991 6748 [email protected]

CEEMEALevent Bayar


Latin AmericaVictor Galliano+1 212 525 5253 [email protected]

Mariel SantiagoFinancials


AsiaTodd DunivantAnalyst, Head of Banks, Asia-Pacific +852 2996 6599 [email protected]

York Pun+852 2822 4396 [email protected]

Kathy Park +82 2 3706 8755 [email protected]

Sachin Sheth+91 22 2268 1224 [email protected]

Katherine Lei+852 2996 6926 [email protected]

Sarah Hung+886 2 8725 6026 [email protected]

Specialist Sales

Nigel Grinyer+44 20 7991 5386 [email protected]

Matthew Charlton+44 20 7991 5392 [email protected]

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Martin Williams

Insurance

EuropeKailesh MistryAnalyst, Head of European Insurance


Dhruv Gahlaut+44 207 991 6728 [email protected]

Thomas Fossard+33 1 56 52 43 40 [email protected]

AsiaJames GarnerAnalyst, Head of Asian Insurance

+852 6394 7866 [email protected]

John Russell+852 2822 4321 [email protected]

Seewon Oh+852 2822 3053 [email protected]

Real Estate

EuropeJohn Fraser-AndrewsHead of Real Estate Equity Research, Europe +44 20 7991 6732 [email protected]

Nic Lyle+44 20 7992 1823 [email protected]

Thomas Martin+49 211 910 3276 [email protected]

Stéphanie Dossmann+33 1 56 52 43 01 [email protected]

AsiaAshutosh Narkar+91 22 2268 1474 [email protected]

Louisa Fok +852 2996 6629 [email protected]

Michelle Kwok +852 2996 6918 [email protected]

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Credit Research

Banks and Insurance

AsiaDilip ShahaniAnalyst, Head of Global Research, Asia-Pacific +852 2822 4520 [email protected]

Devendran MahendranSovereigns and Financial Institutions +852 2822 4521 [email protected]

North AmericaVan HesserGlobal Head of Credit Research, US Banks +1 212 525 3114 [email protected]

Monica A ParekhAssociate +1 212 525 4117 [email protected]

R. Scott FrostInsurance


Global Financial Institution Group

Research Team

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indian banks - psu banks[1]

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