RETAIL RESEARCH Stock Update 12 Oct 2017

Karur Vysya Bank Ltd

RETAIL RESEARCH P a g e | 1

Industry CMP Sequential Targets Time Horizon BFSI Rs. 131.5 Rs. 167.5 & Rs. 183.5 3-4 quarters

We had issued a Pick of the Week report on Sep 18, 2017 (when its CMP was Rs.157) with a recommendation to “Buy at CMP and add on declines to price band of Rs. 139-142” for sequential targets of Rs. 181 and Rs. 201 over the next 3-4 quarters.

Refer: https://www.hdfcsec.com/uat.hsl.research.pdf/KarurVysyaBankPickoftheWeek18091720170918091318.pdf. Corporate Action (Rights Issue) Company had approved a rights issue at its board meeting held on May 29, 2017 in the ratio of 1:6 @Rs.2+74 =Rs.76. Exdate for determining the eligible Equity Shareholders to apply for Rights Equity Shares in the issue was Oct 12, 2017. (Record date Oct 13, 2017). Now, the stock has almost dipped to the add on dips band (adjusted to Rs 127.5-130.5 band) and investors may look to add for revised target price of Rs 167.5 and Rs 183.5 assuming that the investors subscribe to the rights issue to their full entitlement. We are reproducing the Pick of the Week report below for your reference.

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Recommendation

Buy at CMP and add on declines

Add on dips to

Rs. 139-142

Sequential Targets

Rs. 181-201

Time Horizon

3-4 Quarters

Industry

BFSI

CMP

Rs. 157

FUNDAMENTAL ANALYST AtulKarwa atul.karwa@hdfcsec.com

HDFC Scrip Code KARVYSEQNR BSE Code 590003 NSE Code KARURVYSYA Bloomberg KVB IN CMP Sep 15 2017 157.00 Equity Capital (Rs Cr) 121.86 Face Value (Rs) 2 Eq- Share O/S(Cr) 60.93 Market Cap (Rs Cr) 9566.0 Book Val (FY17-Rs) 82.6 Avg.52 Wk Volume 12,82,000 52 Week High 156.5 52 Week Low 80.0

Shareholding Pattern % (June 30, 17) Promoters 2.1 Institutions 43.2 Non Institutions 54.7 Total 100.0

Karur Vysya Bank is a south based private-sector bank, headquartered in Karur in Tamil Nadu. Set up in 1916 by M. A. Venkatarama Chettiar and Athi Krishna Chettiar, it has recently completed 100 years of operations and is one of the oldest banks in India. The bank has a strong presence in its home state of Tamil Nadu and other southern states. However to expand its business it is scaling up its operations in other states. At the end of Q1FY18 the bank had 719 branches (53% in Tamil Nadu, 85% in South India) and 1750 ATMs. Total business of the bank has grown to ~Rs 97000 cr. Investment Rationale

Loan growth likely to pick up from FY18 onwards Shift in focus to Retail/SME segment CASA deposits receive a demonetization boost Forthcoming rights issue to alleviate capital concerns New MD (ex-Citi) to bring fresh insights and strategy for growth in NII and fee income

Concerns

High geographic concentration Competitive intensity in its retail foray Deterioration in asset quality Absence of promoter group

View and Valuation KVB has consistently maintained comfortable capital adequacy, backed by regular capital infusion through rights issues and moderate internal accruals. The proposed rights issue (1:6 @Rs 76) would ensure capital availability for growth in the coming years. With a major portion of troubled assets either restructured or recognized as NPA, slippages should decline the going forward. With a shift in focus to Retail/SME lending, loan growth is expected to pick up. Lower credit costs would ensure higher growth in PAT and improvement in return ratios. New MD Mr P R Seshadri appointed in Sept 2017 has come from Citi and could bring in fresh insights and strategies to boost NII and fee income. We feel investors could buy the stock at the CMP and add on declines to Rs. 139-142 band (1.75x FY19E ABV) for sequential targets of Rs. 181 (2.25x FY19E ABV) and Rs. 201 (2.5x FY19E ABV) in 3-4 quarters. At CMP of Rs. 157 it is trading at 1.95x FY19E ABV.

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Financial Summary Particulars (Rs Cr) Q1FY18 Q1FY17 YoY-% Q4FY17 QoQ-% FY16 FY17 FY18E FY19E NII 539 481 11.9 580 -7.1 1781 2074 2330 2635 PPP 449 346 29.8 507 -11.4 1303 1571 1760 1935 PAT 148 146 1.1 218 -32.0 568 606 801 942 EPS (Rs) 2.4 2.4 1.1 3.6 -32.0 9.3 9.9 13.1 15.5 P/E (x) 16.9 15.8 11.9 10.2 P/ABV (x) 2.2 2.4 2.2 2.0 RoAA (%) 1.0 1.0 1.2 1.3

Source: (Company, HDFC sec)

Company Profile: Karur Vysya Bank is a south based private-sector bank, headquartered in Karur in Tamil Nadu. Set up in 1916 by M. A. Venkatarama Chettiar and Athi Krishna Chettiar, it has recently completed 100 years of operations and is one of the oldest banks in India. The bank has a strong presence in its home state of Tamil Nadu and other southern states. However to expand its business it is scaling up its operations in other states. The Bank commenced their operations on July 1, 1916 in the aftermath of the First World War, with a view to revive agriculture, trade and industry in and around Karur. In Jan 1927, it opened the first branch at Dindigul. In the year 1952, the Bank became a scheduled bank. Since then it has grown with the merger of number of small regional banks like Selvavridhi Bank (1963), Salem Shri Kannika Parameswari Bank and Pathinengrama Arya Vysya Bank (1964) and Coimbatore Bhagyalakshmi Bank (1965). KVB is one of the earliest banks in the country to achieve full networking of its branches under Core Banking Solutions. The Bank has always been a frontrunner in adopting and leveraging on technology to offer products and services to its customers. At the end of Q1FY18 the bank had 719 branches (53% in Tamil Nadu, 85% in South India), 1750 ATMs and over 6.4 mn customers. The bank has added 44 branches in FY17 and 8 in Q1FY18 to take the total network to 719 branches. The performance of the bank has been consistently recognized by leading publications and other organizations. Best Small Bank Award given by Business World Magna Awards 2014 recognizing Banking excellence The Sunday Standard Best Bankers' Awards 2013 awarded the Best Banker Growth Mid-Sized award to KVB State Forum of Banker's Club, Kerala Excellence Awards 2014 selected KVB as the third Best bank among private sector

banks at national level Institute of Public Enterprises (IPE) – BFSI- awarded "Best Bank in Private Sector" in June 2013

KEY HIGHLIGHTS

Sluggish loan book growth of 6.6% CAGR over last 3 years, now showing signs of recovery

KVB is now looking to ramp up its Retail/SME book offering industry-specific customised products. Retail loan book has grown at CAGR of 26.6% in last 5 years and accounts for 15.5% of the total advances

CASA deposits which were

increasing gradually received a demonetization boost by ~440 bps to 27.7% leading to declining cost of funds

Asset quality better than most of

the corporate lenders. With a large portion of stressed assets already accounted for, NPA levels are expected to taper

Change in top management to bring

fresh insight and strategy to grow the top and bottom line

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Kompella Portfolio Investment Advice Magazine, Hyderabad recognized KVB as the "Top Bank in the Old Private Sector" and " Third Best Bank of the Quarter" among public sector, old private sector and new private sector banks for the quarter ended 30.06.2013

Best Bank award among small Banks by IDBRT for " Banking Technology (Electronic Payment Systems)" for the year 2012-13

In the NSDL Star Performer Awards 2013, KVB bagged "Top Performer in New Accounts opened (Bank Category)" Total business over the last 5 years FY12-FY17 has grown at a CAGR of 11.1% to ~Rs 95100 cr with advances growing at 11.4% to ~Rs 41400 cr and deposits growing at 10.8% to ~Rs 53700.

About 53% of the branches are in Tamil Nadu Business has grown at CAGR of 11.1% over FY12-17

(Source: Company, HDFC sec)

Key company milestones Year Milestone 1916 Commenced operations in and around Karur 1927 Opened first branch at Dindigul 1952 Became a Scheduled Bank

1963-65 Acquired and merged 4 smaller regional banks 2003 Entered into tie up with Bajaj Allianz for General Insurance and Birla Sunlife for Life Insurance products

2004-05 Completed 100% computerization and implemented CBS in all branches 2012-13 Crossed Rs 50000 cr business and 500 branch network

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Investment Rationale: Loan growth likely to pick up from FY18 onwards Over the last 3 years, KVB has witnessed a sluggish loan book growth of 6.6% CAGR as compared to 23.8% CAGR growth witnessed during FY11-FY14. The bank was sustaining a strong growth till FY14. However, tough measures taken by the regulator and sluggish economic growth in the subsequent years resulted in a moderate growth phase for the bank. Higher dependence on corporate loans further aggravated the situation as demand for incremental capex from corporates was muted. However, post demonetization over the last 2 quarters loan book growth has shown some signs of recovery growing by 7.7% yoy at the end of Q1FY18. The growth was largely driven by 11.7% growth in commercial segment which mainly comprises of working capital finance to SMEs. Management has guided for 12-15% growth in FY18, down from earlier expectations of 15-18% growth.

Advances growth has slowed down over the last 3 years, but could rise from hereon

(Source: Company, HDFC sec)

Shift in focus to Retail/SME segment KVB was largely dependent on corporate advances for its loan growth. Post the economic slowdown and the increasing levels of NPAs the bank is now looking to ramp up its Retail/SME book. KVB will formulate customised package of products for the SME segment. The bank expects its experience in lending to a range of SMEs to come in handy for coming out with comprehensive niche solutions. The bank targets SMEs whose credit needs are up to Rs.25 cr. It has been offering industry-specific customised products like timber plus, pharma plus, transport plus, textile plus, rice plus, steel plus and commodity plus, among others, tailored to suit the specific requirements of each of these trades. KVB plans to broad-base its product portfolio by targeting various clusters across districts. Currently, SMEs account for about a third of its portfolio.

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Over the last 5 years Retail loan book has grown at CAGR of 26.6% to Rs 6592 cr at the end of Q1FY18. Retail loan book now accounts for 15.5% of the total advances up from 8.1% in FY12. While the share of commercial loans has remained steady at 34%, share of agriculture loan book has expanded from 15.7% to 18%.

Share of retail loans have grown from 8.1% to 15.5%

(Source: Company, HDFC sec)

CASA deposits receive a demonetization boost KVB’s deposits were growing at a healthy rate of 15.2% CAGR over FY11-FY16. It received a boost during demonetization resulting in low cost CASA deposits increasing by 27.5% yoy in FY17. Term deposits however grew marginally by 1.1% leading to an overall 7% growth in deposits. CASA ratio had been gradually increasing from 19.2% to 23.3% during FY12-FY16. The demonetization boosted the CASA ratio by ~440 bps to 27.7% at the end of FY17. These additional deposits have stayed in the system and not exited even after 6+ months post demonetisation (CASA 29.2% in Q1FY18). Strong growth in deposits led to 86 bps decline in cost of funds in FY17 to 6.5%.

Deposits got a boost backed by CASA

(Source: Company, HDFC sec)

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Asset quality likely to improve Though the asset quality has deteriorated over the past 5 quarters, its GNPA ratios at 4.3% is relatively better than most of the corporate lenders. Increase in NPA is primarily attributable to aggressive consortium lending to steel/Infra/Textile sector during FY10-12 which are now slipping into NPAs. Average slippage ratio for KVB was less than 1% over FY06-16 reflecting the stringent credit appraisal and monitoring standards and niche in SME financing. GNPA/NNPA have increased over the last 5 quarters from 1.3%/0.6% in FY16 to 4.3%/2.9% at the end of Q1FY18 while the provision coverage ratio has slipped from 82.5% to 57% during the same period. The management had identified Rs 600-650 cr of watchlist accounts of which Rs 200 cr slipped into NPA in Q1FY18. Further the RBI dispensation pushed back the classification of NPA resulting in sharp deterioration in asset quality during Q1FY18. KVB has opened three recovery branches in Jun-Jul 2017, which will fully focus on recovering Rs 800-900 cr of stressed loans across segments. Another branch will be added in Q2FY18. With a large portion of stressed assets already accounted for, NPA levels are expected to taper along with pick up in lending activity.

Asset quality expected to improve

(Source: Company, HDFC sec)

Rights issue to alleviate capital concerns KVB is planning to raise around Rs 760 crore through a rights issue, in order to fund its future growth. The Board of Directors in May-17 decided to issue equity shares via rights issue to its eligible shareholders in the ratio of one equity share for every six held. The funds would be used to fuel growth, which is expected to rise this fiscal on the back of overall economic growth. The issue price has been fixed at Rs 76 per equity share, including a premium of Rs 74 per equity share. The record date has not been announced yet. Capital Adequacy ratio of the bank stood at 11.7% at the end of Q1FY18 with Tier I capital of 11%. The proposed rights issue would strengthen the balance sheet (and capital adequacy levels) in light of the higher NPA levels.

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Lower interest reversals and higher CASA deposits to ensure NIM stability As KVB has been reorganizing its lending book with focus on Retail and SME segments we have seen an expansion in NIMs over the past few years. Backed by a surge in low cost CASA deposits post demonetization cost of funds declined by over 100 bps in H2FY17 resulting in an overall decline of 86 bps in FY17. Although some portion of these deposits is likely to get converted to term deposits, overall CASA ratio is likely to remain stronger than earlier. Lower interest reversals on back of expected improvement in asset quality should help in maintaining NIMs going forward.

NIM likely to stabilize between 3.5-3.7%

(Source: Company, HDFC sec)

Return ratios to improve on back of waning credit costs Credit costs spiked up to 1.7% in FY17 on account of 19% increase in write offs. However, with a major portion of the troubled assets being restructured or recognised as NPAs, we expect credit costs to come down going forward. It should also result in higher growth at PAT level and improvement in return ratios.

Return ratios to improve

(Source: Company, HDFC sec)

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Change in top management to bring fresh insight and strategy to grow the top and bottom line Post the extension of 3 months given to earlier MD Mr.K Venkataraman, KVB vide the Reserve Bank of India's approval has appointed Shri P R Seshadri as MD & CEO of the Bank for a period of 3 years from Sept 2017. Mr Seshadri is an alumnus of IIM Bangalore and has a commercial and retail banking experience of more than 25 years. He had been involved with Citibank India in various capacities. He moved to Singapore in 2005 as MD and Regional Head of Lending business, Asia Pacific. More recently, he was CEO of BFC Bank Ltd., a global payment bank established in London. Q1FY18 Result Review KVB reported a PAT of Rs 148 cr (+1.1% yoy) despite of 11.9% yoy growth in net interest income primarily on account of higher provisioning for bad loans. Asset quality deteriorated further as some of the large corporate accounts slipped into NPAs. GNPA/NNPA increased 69/32 bps sequentially to 4.3%/2.9%. Provision coverage ratio stood at 57% as compared to 78.5% a year earlier. Non-interest income grew by 45.6% yoy to Rs 236 cr due to treasury gains. Core fee income was up 30% yoy.

Loan growth at 7.7% yoy was driven by 12% yoy growth in SME loans. CASA growth was strong at ~30% yoy with CASA ratio expanding to ~29% (~150 bps qoq). NIMs slipped 28 bps to 3.7% as higher slippages put pressure on loan yields. Management expects disbursements to pick up in the rest of the year and has guided for 12-15% growth in advances and moderation in NIM levels. KVB opened three loan recovery branches in Tamil Nadu (TN) and Andhra Pradesh (AP) which will focus on the recovery of ~Rs 800 cr of NPAs. Particulars Q1FY18 Q1FY17 YoY (%) Q4FY17 QoQ (%) Interest Income 1384 1385 -0.1 1433 -3.4 Interest Expenses 846 904 -6.5 853 -0.9 Net Interest Income 539 481 11.9 580 -7.1 Non interest income 236 162 45.6 232 1.9 Total Income 775 643 20.4 812 -4.6 Operating Expenses 325 297 9.5 305 6.7 Pre Provisioning Profit 449 346 29.8 507 -11.4 Prov & Cont 233 130 79.4 218 7.3 Profit Before Tax 216 216 -0.1 290 -25.4 Tax 68 70 -2.5 72 -5.6 PAT 148 146 1.1 218 -32.0 EPS 2.4 2.4 1.1 3.6 -32.0 GNPA 4.3 1.8 248 bps 3.6 69 bps NNPA 2.9 0.8 206 bps 2.5 32 bps

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Concerns: High geographic concentration KVB derives more than half of its business from ~53% of its branches located in the state of Tamil Nadu. Any change in the socio-political scenario or a natural calamity could impact its borrowers and worsen the asset quality. Competitive intensity in its retail foray Due to higher stress in corporate loans, most banks are looking at retail and MSME segments for growth. KVB is likely to face greater competitive intensity as it looks to expand its retail footprint even as this might impact its fee income. Deterioration in asset quality NPA of the bank have increased significantly in the past 2 years. Any further deterioration in asset quality could result in higher provisioning requirements leading to lower profitability. Absence of promoter group The bank does not have a clearly identified promoter group or a large shareholder, which results in lower financial flexibility and a relatively low likelihood of bail out support in case of any unforeseen distress. Incoming MD may indulge in Kitchen sinking resulting in subdued numbers in Q2/Q3 FY18. It has been generally observed that new MD in any organization would like to clean up the books in the first period of their joining so that they can work upon improving the fully displayed situation. If the new MD indulges in this it may result in higher NPAs being recognized and lower income in Q2 or Q3FY18. View and Valuation KVB has consistently maintained comfortable capital adequacy, backed by regular capital infusion through rights issues and moderate internal accruals. The proposed rights issue (1:6 @Rs 76) would ensure capital availability for growth in the coming years. With a major portion of troubled assets either restructured or recognized as NPA, slippages should decline the going forward. With a shift in focus to Retail/SME lending, loan growth is expected to pick up. Lower credit costs would ensure higher growth in PAT and improvement in return ratios. New MD Mr P R Seshadri appointed in Sept 2017 has come from Citi and could bring in fresh insights and strategies to boost NII and fee income. We feel investors could buy the stock at the CMP and add on declines to Rs. 139-142 band (1.75x FY19E ABV) for sequential targets of Rs. 181 (2.25x FY19E ABV) and Rs. 201 (2.5x FY19E ABV) in 3-4 quarters. At CMP of Rs. 157 it is trading at 1.95x FY19E ABV.

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Financial Statements

Income Statement Ratio Analysis Particulars FY15 FY16 FY17 FY18E FY19E Particulars FY15 FY16 FY17E FY18E FY19E

Interest Income 5396 5443 5622 5911 6464 Return Ratios Interest Expenses 3930 3662 3549 3581 3829 Calc. Yield on advances 12.0% 11.5% 11.0% 10.9% 10.7% Net Interest Income 1466 1781 2074 2330 2635 Calc. Cost of borrowings 8.3% 7.3% 6.5% 6.2% 6.0% Non-interest income 590 707 782 844 901 NIM 2.9% 3.4% 3.7% 3.7% 3.8% Operating Income 2055 2488 2856 3174 3536 RoAE 12.3% 12.9% 12.6% 15.0% 15.7% Operating Expenses 1103 1185 1285 1414 1601 RoAA 0.9% 1.0% 1.0% 1.2% 1.3% PPP 952 1303 1571 1760 1935 Asset Quality Ratios Prov & Cont 481 391 687 584 560 GNPA 1.9% 1.3% 3.6% 4.2% 4.1% Profit Before Tax 471 912 883 1176 1375 NNPA 0.8% 0.6% 2.5% 2.9% 2.8% Tax 7 344 277 375 433 Growth Ratios PAT 464 568 606 801 942 Advances 6.2% 8.2% 4.7% 11.5% 13.5% Borrowings 2.1% 12.1% 7.2% 7.7% 11.8% Balance Sheet NII 14.2% 21.5% 16.4% 12.4% 13.1% Particulars FY15 FY16 FY17 FY18E FY19E PPP 13.6% 36.9% 20.6% 12.0% 9.9% Share Capital 122 122 122 122 122 PAT 8.1% 22.3% 6.8% 32.1% 17.6% Reserves & Surplus 4124 4451 4914 5509 6231 Valuation Ratios Shareholder funds 4246 4573 5036 5631 6353 EPS 7.6 9.3 9.9 13.1 15.5 Deposits 44690 50079 53700 57851 64656 P/E 20.6 16.9 15.8 11.9 10.2 Borrowings 2901 2894 1696 2281 2847 Adj. BVPS 65.2 71.5 65.7 70.7 80.5 Other Liab & Prov. 1372 1517 1488 1596 1708 P/ABV 2.4 2.2 2.4 2.2 2.0 SOURCES OF FUNDS 53209 59064 61919 67359 75564 Dividend per share 2.6 2.8 2.6 2.8 3.0 Cash & Bank Balance 2749 2892 4345 3818 3782 Dividend Yield (%) 1.7 1.8 1.7 1.8 1.9 Investment 12375 14443 14857 15964 17861 Other Ratios Advances 36109 39084 40908 45612 51770 Cost-Income 53.7 47.6 45.0 44.5 45.3 Fixed Assets 411 420 419 435 470 Credit-Deposit 80.8 78.0 76.2 78.8 80.1 Other Assets 1564 2225 1390 1529 1682 TOTAL ASSETS 53209 59064 61919 67359 75564

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

One year Forward PABV One year price movement

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PICK OF THE WEEK Sep 18, 2017

KARUR VYSYA BANK

Fundamental Research Analyst: Atul Karwa (atul.karwa@hdfcsec.com) HDFC securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone: (022) 3075 3400 Fax: (022) 2496 5066 Website: www.hdfcsec.com Email: hdfcsecretailresearch@hdfcsec.com. Compliance Officer: Binkle R. Oza Email: complianceofficer@hdfcsec.com Phone: (022) 3045 3600 __________________________________________________________________________________________________________________________________________________________________________________________ Disclosure: I, (AtulKarwa, MMS), authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. 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