India | Banking & Financial Services | Sector Update India...

JM Financial Institutional Securities Limited

Time to be selective

We re-initiate coverage on the banking sector with a cautious outlook and a

preference for private banks (PvB) over public sector banks (PSB). Strong

leadership, adequate capitalisation, large retail franchises and skilled

manpower provide a strong competitive advantage to PvBs over their peers.

Agility in the face of rapid changes in the landscape, as traditional moats are

besieged, is needed for survival. PvBs are much ahead of PSBs in this respect

too. With still some stressed asset accretion ahead, we prefer retail oriented

lenders for their granular portfolios and low credit concentration. Large

wholesale lenders would continue to experience high stressed asset

accretion, weaker core revenue growth and hence muted earnings growth

through FY18E with a recovery potentially FY19E onwards. HDFCB, IIB, YES

and ICICIBC are our preferred picks in the sector.

Multiple factors to stump credit growth, revival to take a while: We

forecast a CAGR of 11.4% for system credit growth over FY16-19E. This

compares with a CAGR of 19.8% over FY01-16 in banking system credit.

Disintermediation from the corporate bond market, few triggers for pick-up in

corporate credit and potentially higher risks to even retail credit growth would

keep overall credit growth muted. Retail penetration is likely to increase due

to persistent increase in growth, greater penetration of financial services and

wider variety of lenders in the fray. However, retail credit alone would not be

adequate to pick-up slack. Low interest rates, coupled with increase in

investments from corporate sector are required to boost overall credit

growth.

More stressed assets to come, tools in place: We have aggregated and

analysed data from c.1,000 listed companies with debt of more than `1bn,

excluding c.127 known cases of stressed assets. Our study reveals that stress

in segments such as infrastructure, construction, capital goods, metals and

mining and realty has increased with worse Debt/Equity and Debt/EBITDA

ratios now as compared to FY11-12. Of these companies, 533 have a

Debt/EBITDA>3 and have a cumulative debt of `14.7tn whereas 494

companies have a Debt/Equity>1 and also have a gross debt of `14.6tn. While

this is cumulative debt, and not only bank debt, a large part of this would

have come from banks as most of the smaller companies would have little

access to money markets.

Significant financial outperformance expected from PvBs: We expect

substantial deviation in operating performance and earnings progression

between PvBs and PSBs within our coverage universe. PvB are estimated to

deliver 16.7% CAGR in operating profits and 15.7% in net profit CAGR over

FY16-19E. PSBs would deliver 11% CAGR in operating profit in the same

period. RoA for PvBs would range from 1.4-1.6% on a blended basis whereas

the same for PSB’s would range from 0.2-0.5% over FY16-19E. Higher

margins, stronger revenue growth, operating leverage and declining loan loss

provisions would make the difference. HDFCB, IIB, KMB and YES would have

better earnings performance compared to ICICIBC and AXSB.

Superior earnings growth would attract premium valuations: In the

medium term, low loan growth, muted revenue performance and high loan

losses would keep financial performance of wholesale oriented lenders

sluggish. This would also keep overall performance of the banking basket

weak. Hence, we recommend remaining neutral-weight on financials. We

recommend BUY for HDFCB, IIB and YES. We rate ICICIBC, AXSB and SBI as BUY

since they are a balanced play with a strong retail and corporate franchises.

KMB and BoB would be a HOLD due to i) high valuations for KMB and ii)

sustained high stressed loan formation in the case of BoB. PNB is rated SELL.

PSB’s, as a group, are trading at P/BVs which are lower than 1 SD below their

10-year average. While this would make them attractive ‘value’ picks, we

believe they would remain trading plays at best.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Banks Rating TP (`) Upside (%)

IIB BUY 1572 30

HDFCB BUY 1501 21

YES BUY 1606 21

ICICIBC BUY 326 22

SBIN BUY 309 20

AXSB BUY 555 14

KMB HOLD 816 13

BOB HOLD 177 11

PNB SELL 113 -14

Source: JM Financial

India Banking Sector

18 January 2017

India | Banking & Financial Services | Sector Update

JM Financial Research is also available

on: Bloomberg - JMFR <GO>,

Thomson Publisher & Reuters,

S&P Capital IQ and FactSet.

Please see Appendix I at the end of this

report for Important Disclosures and

Disclaimers and Research Analyst

Certification.

Banking Update – Banking sector initiation note 18 January 2017


Table of Contents

Contents Page No.

Banking Update - Banking sector initiation note 1

Multiple factors stump credit growth, revival to take a while 4

More stressed assets to come, tools in place 12

Substantial outperformance expected from PvBs 20

Superior earnings growth would attract premium valuations 27

Companies Section

Axis Bank 31

Bank of Baroda 35

HDFC Bank 39

ICICI Bank 44

IndusInd Bank 50

Kotak Bank 54

Punjab National Bank 60

State Bank of India 65

Yes Bank 72



Exhibit 1. JMFL: Indian banks/financials valuation matrix

Company Price Mkt Cap P/E (x) P/B (x) RoE Reco Target

(`) Upside

($mn) FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E

Government Banks

BOB 159 5,409 17.4 11.0 7.4 1.0 0.9 0.8 5.7% 8.5% 11.6% HOLD 177 11%

PNB 131 4,101 17.1 9.8 8.5 0.7 0.7 0.6 4.5% 7.2% 7.7% SELL 113 -14%

SBI (Consolidated) 257 29,391 21.7 16.0 9.4 1.1 1.0 0.9 5.1% 6.4% 10.2% BUY 309 20%

SBI (Standalone) 257 29,391 18.9 14.4 10.4 1.3 1.2 1.1 7.1% 8.6% 10.9% BUY 309 20%

New Private Banks

AXSB 487 17,157 23.0 14.0 10.5 2.0 1.8 1.6 9.2% 13.7% 16.1% BUY 555 14%

HDFCB 1,241 46,654 21.3 18.1 15.1 3.7 3.2 2.8 18.8% 19.2% 19.8% BUY 1501 21%

ICICIBC (Consolidated) 267 22,921 14.9 12.0 9.8 1.6 1.4 1.3 11.0% 12.6% 14.0% BUY 326 22%

ICICIBC (Standalone) 267 22,921 16.8 17.9 14.4 1.7 1.6 1.4 11.0% 9.0% 10.4% BUY 326 22%

KMB (Consolidated) 725 19,640 30.4 25.9 22.6 3.5 3.1 2.8 12.3% 12.8% 13.0% HOLD 816 13%

KMB (Standalone) 725 19,640 44.1 36.7 29.7 5.0 4.4 3.9 11.9% 12.7% 13.9% HOLD 816 13%

YES 1,329 8,277 16.9 13.3 10.5 3.4 2.8 2.3 21.9% 23.2% 24.2% BUY 1606 21%

IIB 1,213 10,674 24.7 19.8 15.7 3.6 3.2 2.7 15.8% 17.1% 18.5% BUY 1572 30%

Source: JM Financial; Prices as of January 17, 2017

Exhibit 2. JMFL: Indian Banks/Financials valuation matrix

Company BVPS Adj. BVPS EPS EPS Growth(%)

FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E

Public Sector Banks

BOB 164 177 197 78 106 130 9 15 22 -139% 59% 49%

PNB 180 192 205 13 48 63 8 13 15 -138% 75% 15%

SBI (Consolidated) 244 258 281 118 145 181 12 16 27 -25% 36% 70%

SBI (Standalone) 201 216 235 144 162 190 14 18 25 6% 32% 38%

New Private Banks

AXSB 238 270 308 186 218 263 21 35 46 -39% 64% 33%

HDFCB 332 385 448 324 377 439 58 69 82 20% 18% 20%

ICICIBC (Consolidated) 169 185 204 136 158 188 18 22 27 -5% 24% 23%

ICICIBC (Standalone) 161 172 185 130 147 170 16 15 19 -5% -6% 25%

KMB (Consolidated) 205 232 263 205 232 263 24 28 32 26% 18% 15%

KMB (Standalone) 146 164 187 138 156 177 16 20 24 44% 20% 24%

YES 390 470 574 379 454 553 79 100 126 30% 27% 27%

IIB 332 384 449 78 106 130 49 61 77 28% 24% 26%




Multiple factors stump credit growth, revival to

take a while

We believe bank credit growth would recover only gradually in the medium term.

Increasing disintermediation of bank loans, risk aversion on part of PSBs (c.71%

of the banking system as of FY16), low likelihood of a pick-up in corporate credit

and increasing headwinds to retail credit growth would keep overall credit

growth at 11.4% CAGR over FY16-19E as compared to 19.8% CAGR over FY01-16.

We discuss in detail our hypothesis on credit growth in the following sections.

Disintermediation of bank credit, corporate bond issuances rising

Outstanding corporate bonds in India, `20.2tn as of FY16, have increased at 18%

CAGR over FY11-16 as compared to c.12% CAGR each for bank credit (`65.6tn)

and bank credit to large Industry (`22.4tn) as of FY16. At the same time, the

spread of AAA and AA rated 1-year corporate bonds over bank base rate moved

deep into the negative. AAA-rated one year corporate bonds are currently trading

c.2% below ICICIBC’s (used as proxy) base rate. Hence, large corporate have

opted for money market borrowings instead of bank borrowings. High interest

rate differential and wider investor participation in bond markets are sustaining

credit substitution. For example, money market borrowings have replaced bank

credit partly for large NBFCs (see Exhibit 4).

Exhibit 3. Sharp fall in bond rates led to disintermediation of corporate credit

Spread of ICICIBC base rate over corporate bonds rising

Growth in corporate bonds, bond issuances and bank credit

Source: Bloomberg, SEBI, JM Financial.

Exhibit 4. Marked change in mix of sources of borrowings in the system

Change in source of borrowing in the industry

Decline in bank borrowings as % of overall borrowings

Source: Bloomberg, SEBI, JM Financial; BC = Bank credit.

6

7

8

9

10

11

12

13

Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

India - AAA - 1 Yr. Corp Bond - AA - 1 Yr. ICICI Base Rate

14

25

0

23 22

16 18

23

14

19

15 17

20

15 13

6 3

-6 -10

-5

-

5

10

15

20

25

30

FY12 FY13 FY14 FY15 FY16 1HFY17

Corp Bond Issuance Outstanding Corp Bonds Bank credit to Industry

% YoY

36 35 37 37 40 43

51 53 52 51 49 47

13 12 12 12 11 10

0%

25%

50%

75%

100%

FY12 FY13 FY14 FY15 FY16 1HFY17

Corp Bonds BC to Large Industry BC to SME

29.3%

35.1%

57.6%

63.2%

74.5%

18.0% 15.9%

47.6%

54.8%

62.2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

HDFC LICHF Bajaj Finance Chola finance M & M Financial

FY12 FY16



Corporate credit – recovery to be very gradual

The manufacturing capacity utilisation index has been largely stable in the 9-11%

range over FY04-16. At the same time, gross fixed capital formation (GFCF) has

declined steadily – i.e. the pace of investments in the economy has moderated –

and Private Final Consumption Expenditure (PFCE) has increased moderately. As

private consumption increases, capacity utilization should rise since there is very

little new capacity addition. However, this is playing out very gradually. It could

be long before demand rebounds enough for capacity utilization to rise and drive

new investments. Weak corporate balance sheets would mean a gradual recovery

in GFCF is more likely. Thus, a recovery in investments may be U-shaped rather

than V-shaped.

Large growth in corporate credit largely stems from fresh capital expenditure for

capacity expansion. However, there have been few new project announcements

as compared to that during 3QFY06-3QFY09 period. Most projects under

implementation have been stagnant for the private sector too, across

manufacturing, power, telecom or metals. Even demand for maintenance capital

expenditure is weak. There has been some decline in the quantum of

abandoned/shelved projects and an increase in revived projects. However, this

change is too weak yet to drive overall industry credit growth.

Exhibit 5. Capacity utilisation needs to increase much more for private

sector investments pick up


Exhibit 6. YoY growth in under implementation investment projects – no recovery in sight (%)

Source: CMIE, JM Financial.

-40

-30

-20

-10

0

10

20

30

40

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

2010

-11

2011

-12

2012

-13

2013

-14

2014

-15

2015

-16

Capacity Utilisation Gr. In GFCF (%) Growth in PFCE (%)

V-shaped recovery afterImpact of global financial crisis

-40

-20

0

20

40

60

80

100

120

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

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-06

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Dec

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Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Government Private Sector

(% YoY)

-100

-50

0

50

100

150

200

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

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Dec

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Dec

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Dec

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Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Manufacturing Metals & metal products

Communication services Electricity

(% YoY)



Exhibit 7. Some improvement of late, but not enough to drive resurgence in capital expenditure

Narrowing of ‘jaws’ a positive sign, but not enough Pick-up in new investment projects, credit growth still muted

Source: CMIE, JM Financial.

A few segments have seen an improvement in their debt service coverage ratios,

viz., materials, auto, logistics, textiles, hotels, packaging and others. However,

these do not constitute the more credit intensive segments. We have aggregated

data for c.1,000 listed companies across industries. Together, the above

mentioned sectors constitute 18.4% of debt of the c.1,000 companies. However,

industries such as metals, capital goods, telecom, construction and

infrastructure wherein debt/equity is still worsening or interest coverage ratio

(ICOR) is still declining constitute 40.5% of the total debt of companies under

consideration. We have presented this data in detail in Exhibit 21-22. The highly

leveraged companies still have a bulk of debt of the sector and are still awaiting

restructuring or loan work-out before they can commence borrowing. Hence, any

new credit demand for capacity expansion is unlikely in these companies.

The table below also shows that overall credit growth is largely driven by

corporate credit. Only a pick-up in credit-intensive sectors such as infrastructure,

steel, construction, etc. have actually driven credit growth in the past. As the

credit growth outlook for these sectors remains weak, we do not foresee any

sharp improvement in corporate credit demand.

Exhibit 8. Sectoral credit growth – Industry and services have been the real growth drivers

CAGR Incremental credit growth (% mix)

Growth (%) FY00-10 FY10-13 FY13-16 FY00-10 FY10-13 FY13-16

Agri & allied activities 25.1% 12.3% 14.4% 14.0% 9.5% 17.5%

Industry 20.7% 19.4% 7.0% 41.7% 50.2% 29.8%

- Infrastructure 24.3% 9.8% 19.1% 14.0%

- Metals and Metal products 24.5% 9.8% 8.3% 6.1%

- Textiles 14.8% 3.9% 3.4% 1.3%

- Gems and Jewelry 24.4% 6.0% 1.6% 0.7%

- Construction 5.7% 12.6% 0.4% 1.3%

- Others 15.9% 3.9% 17.4% 6.4%

Personal Loans 26.8% 15.3% 15.8% 19.9% 17.1% 29.5%

Services 25.1% 16.6% 10.2% 24.4% 23.2% 23.2%

Total 23.3% 17.0% 10.4% 100.0% 100.0% 100.0%


Structural retail credit growth drivers intact, but risks increasing

Retail credit growth has been an outcome of both demand side and supply side

factors. First, there has been a sustained increase in wages over FY00-16. The

per capita GDP and per capital income have also shown sustained increase since

1975-76, but their pace of growth in the past 10-15 years has increased

substantially. Data on growth in industrial wages also reflect a similar trend

(Exhibit 10).

0

500

1,000

1,500

2,000

2,500

3,000

Se

p-06

Mar

-07

Se

p-07

Mar

-08

Se

p-08

Mar

-09

Se

p-09

Mar

-10

Se

p-10

Mar

-11

Se

p-11

Mar

-12

Se

p-12

Mar

-13

Se

p-13

Mar

-14

Se

p-14

Mar

-15

Se

p-15

Mar

-16

Se

p-16

Abandoned/Shelved/Stalled Projects (Rs bn) Revived Projects (Rs bn)

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

De

c-0

1

Jun-

02

De

c-0

2

Jun-

03

De

c-0

3

Jun-

04

De

c-0

4

Jun-

05

De

c-0

5

Jun-

06

De

c-0

6

Jun-

07

De

c-0

7

Jun-

08

De

c-0

8

Jun-

09

De

c-0

9

Jun-

10

De

c-1

0

Jun-

11

De

c-1

1

Jun-

12

De

c-1

2

Jun-

13

De

c-1

3

Jun-

14

De

c-1

4

Jun-

15

De

c-1

5

Jun-

16

New Investment Projects (LHS, Rs bn) Credit growth (RHS, %)



Over FY00-16, hikes awarded by pay commissions, increase in proportion of

services sector jobs, wage negotiations, inflation-linked increase and

improvement in corporate salaries have been several reasons for the rapid

increase in industrial wages. The pace of growth in industrial wages has jumped

up in the past 5-10 years to 15-16% CAGR as compared to c.10% CAGR over 20 or

30 years. This has increased the marginal propensity to consume and improved

borrowers’ credit-worthiness. Increased affordability of houses, vehicles,

consumer durables, etc. and change in consumption patterns have been driving

retail credit growth.

Second, financial institutions have strengthened their acquisition and

underwriting infrastructure, optimised processes and reduced turn-around-time.

The widening and deepening of credit bureau infrastructure has provided ready

data on customer behaviour with regards to consumption, spending, repayment,

incomes, etc. All these metrics, strengthened over time, provides lenders huge

scope to run predictive analytics and develop targeted approach to lending. This

has reduced acquisition cost and increased cross-selling of fund-based and fee-

based products to retail consumers.

Exhibit 9. Pace of growth of five-year average per capita GDP and five-year

average per capita income have increased in the past 15 years

Source: JM Financial; NNI = Net National Income

Exhibit 10. Industrial wages have risen much faster in the past decade

Source: CMIE, JM Financial

The growth in wages, however, is likely to face several headwinds. First, both the

IIP and IIP (manufacturing) have shown a sustained decline since the Global

Financial Crisis (GFC). Growth in corporate revenues has slowed down

considerably since then as well. However, as seen in the following charts, salaries

-1.0

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1955

-56

1959

-60

1963

-64

1967

-68

1971

-72

1975

-76

1979

-80

1983

-84

1987

-88

1991

-92

1995

-96

1999

-00

2003

-04

2007

-08

2011

-12

Per capita GDP Per capita NNI(%)

Pace of growth has increased considerably

16.215.3

10.4 10.7

5-year 10-year 20-year 30-year

CAGR in industrial wages upto FY14

Significant increase in growth in the near term

12.5 12.3

14.6

Operating income Operating expenses Salaries and wages

FY01-16 CAGR (%)



and wages continue to grow rapidly. Such dichotomy is unlikely to sustain for

long. Salaries have risen to c.13% of corporate operating expenses as of 1HFY17

as compared to 8.7% in 1HFY07. Partly, this has been possible due to operating

leverage through rationalization of other expenses. However, as growth in

corporate revenues remains weak, salary growth would also slow down. It is

difficult to predict when this will play out. However, either corporate incomes

have to rise or salary growth has to moderate. One of the two outcomes is

inevitable. We do not see any prescient triggers to corporate revenue growth.

Hence, we believe the key driver of retail credit consumption, an increase in

salaries, could come under pressure in the medium term.

Exhibit 11. Strong trends in wage growth a key driver of retail credit growth

Source: Bloomberg, JM Financial

Exhibit 12. Wages have increased despite sharp deterioration in corporate financial performance

Source: CMIE, JM Financial

Exhibit 13. ASI data indicates a broad-based growth in workers’ wages

Type of organisation 2011 2014 % CAGR

1. Individual Proprietorship 49,268 70,240 12.5

2. Joint Family(HUF) 1,507 1,461 (1.0)

3. Partnership 91,774 1,31,127 12.6

4. Public limited company 3,53,207 3,77,188 2.2

5. Private limited company 2,91,066 6,20,833 28.7

6. Govt Dept. Enterprises 6,683 7,405 3.5

7. Public Corporation 40,978 28,756 (11.1)

8. Corporate Sector(4+5+6+7) 6,91,933 10,34,181 14.3

9. Khadi & Village Industry 147 320 29.7

10.Handloom Industry 14 85 83.2

11.Co-operative Society 20,135 25,048 7.5

12.Others (Incl NR) 1,677 2,501 14.3

TOTAL 8,56,455 12,64,964 13.9

Source: JM Financial; Annual survey of Industries

-20

-10

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10

20

30

Mar

-99

Mar

-00

Mar

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-14

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Mar

-16

Wage gr. (%) IIP (%) IIP - Manufacturing (%)

-20

-

20

40

60

Mar

-99

Mar

-00

Mar

-01

Mar

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Mar

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Mar

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Mar

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Mar

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Mar

-12

Mar

-13

Mar

-14

Mar

-15

Mar

-16

Corporate credit gr. (%) Retail credit gr. (%) Wage gr. (%)

-20

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-

10

20

30

40

50

60

Sep

-01

Sep

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Sep

-03

Sep

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Sep

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Sep

-10

Sep

-11

Sep

-12

Sep

-13

Sep

-14

Sep

-15

Sep

-16

Income gr. (%) Expenses gr. (%) Salaries gr. (%)

4.0

6.5

9.0

11.5

14.0

60.0

65.0

70.0

75.0

80.0

85.0

90.0

Sep

-01

Sep

-02

Sep

-03

Sep

-04

Sep

-05

Sep

-06

Sep

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Sep

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Sep

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Sep

-10

Sep

-11

Sep

-12

Sep

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Sep

-14

Sep

-15

Sep

-16

Expenses/Income (%) Salaries/Income (%) Salaries/Expenses (%)



Exhibit 14. Credit/GDP multiplier – nowhere near the ‘thumb-rule’ of 3.0x!

Source: JM Financial; GDP – Gross Domestic Product

Credit growth to remain muted in the medium term

Our arguments above lead us to take a moderate view of system credit growth in

the medium term. Growth in industry credit is likely to remain muted. Retail

credit growth would still outpace industry credit substantially, leading to an

increase in retail penetration. However, the impact of demonetisation and

whether our concerns with regards to retail credit drivers come true, would

decide the course of retail credit growth. We estimate CAGR in credit growth of

11.4% over FY17E-20E as compared to 19.8% CAGR over FY01-16. Only a pick-up

in corporate credit growth can take overall loan growth closer to historical

averages. As discussed earlier, we do not anticipate this by FY18E at least.

Exhibit 15. Credit growth unlikely to retrace to historical highs


Retail credit penetration may also rise as an outcome of demonetization. Banks,

especially PSBs, have benefitted from a large number of new accounts being

opened post demonetization. Under the Pradhan Mantri Jan Dhan Yojna (PMJDY)

itself, PSBs added c.9.5mn deposit accounts while PvBs added c.0.3mn deposit

accounts between November 09, 2016 and January 1, 2017. Moreover, balances

in accounts increased by `173bn for PSBs and `9.2bn for PvBs. The percentage of

Aadhar seeded accounts has also increased, bringing a higher proportion of

customers in the formal fold. All of this presents a significant growth opportunity

for both PSBs and PvBs as an outcome of demonetization. However, it will depend

on the client mining capability and ability of banks to create products suited to

the needs of a particular part of the population for successfully cross-selling

products to these accounts.

0.0

1.0

2.0

3.0

4.0

FY92 FY97 FY02 FY07 FY12 1H17

Credit/GDP multiplier (x) Average (x)

0%

5%

10%

15%

20%

25%

30%

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

Loan growth (%) Deposit growth (%)

average credit growth for FY01-16 - 19.8%

average for FY17-20E - 11.4%



Exhibit 16. Credit growth in retail segments - recent impact due to

demonetisation


Despite the tepid growth at the system level, we believe PvBs will grow much

faster and acquire market share from PSBs rapidly. While a loan market share

shift from PSBs to PvBs has been gradual so far – PvBs have moved up from

18.1% share in FY10 to 24.6% in FY16 – the incremental share of PvBs has

increased substantially.

Reasons why the PvBs would continue to gain a larger portion of incremental

loans:-

– Consolidation within the SBI Group would lead to exposure limits being

exhausted for several individual and group loans, driving credit to other

banks, mostly PvBs

– PSBs, forming c.71% of the system loans currently have low tier 1 ratio,

high GNPA ratios and are risk averse. PvBs are nibbling away at their

large corporate and SME loans

– In the MCLR regime, loan pricing of mid-sized banks such as YES, IIB,

KMB and regional banks such as CUB, FB have become much more

competitive than in the base rate regime. These can now bid for better

quality corporate customers. However, this has been affected due to the

sharp MCLR cuts by larger banks post demonetisation with the gap

widening again. We believe as the demonetisation situation normalises,

the gap between the various MCLR’s will once again narrow.

Exhibit 17. Shrinking gap between lending rates due to MCLR regime

Pre-cut (Nov'16) Post-cut (Jan '17)

Base rate MCLR Base rate MCLR

SBI 9.30% 8.90% 9.25% 8.00%

ICICI 9.30% 8.95% 9.25% 8.20%

AXSB 9.35% 9.05% 9.25% 8.25%

YES 10.25% 9.25% 10.25% 8.95%

IndusInd 10.60% 9.60% 10.55% 9.10%

City Union 10.50% 9.75% 10.50% 9.75%

Federal Bank 9.63% 9.45% 9.63% 8.95%


-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

FY12 FY13 FY14 FY15 FY16 1Q17 2Q17 Nov'16

Housing Credit Cards Vehicle Loans Others Retail loans



– Most nationalised banks, excl. SBI, do not have any meaningful

capabilities in retail credit. Typically, PSB branches are understaffed for

retail operations (see employee/branches) and there is not enough

expenditure on intiatives such as branding and publicity. Mere branch

distribution would not get them high quality retail assets or liabilities.

Comparatively, the ratio of advertising expense to overall expenses and

employee per branch ratios are much higher for PvBs than PSBs.

Exhibit 18. PSBs’ investments in retail franchise building are much lower

than PvBs’

Employee/Branch as of FY16 (x) Avg. advertising and publicity expenses

as % of total expense (FY14-16)

PNB 10.5 0.4%

BOB 9.8 0.9%

SBI 13.3 0.8%

HDFCB 19.4 1.3%

ICICI 16.7 1.6%

AXSB 17.3 1.0%

IIB 23.1 1.1%

YES 17.5 3.1%


Exhibit 19. PSBs have shown higher delinquencies in risky-retail products

Mar ’15 O/S LAP portfolio (` bn) 90+ DPD (%)

PvBs 468 1.1%

PSBs 202 4.7%

NBFC 594 2.7%

HFCs 470 1.9%

Others 131 3.6%

Source: CIBIL data as of Mar ‘15, Data is for individual non-housing loan mortgages, Indiabulls Housing Finance, JM

Financial



More stressed assets to come, tools in place

The stressed are still stressed

A sector-wise bottom up calculation of debt/equity, debt/EBITDA and interest

coverage ratio trends indicates that several credit intensive sectors are still

significantly stressed with high indebtedness and weaker ability to service debt.

We conducted the exercise of analysing key balance sheet and income statement

data across c.1,000 listed companies, those with debt above `1bn each as of

FY16. We have removed the known stressed cases (c.127) where the company

might have been classified as NPA, or undergone one or the other forms of debt

resolution, while retaining the few cases where companies have exited

restructuring successfully. Thus, the indebtedness scenario is devoid of impact

of already stressed assets and PSUs who would ideally not turn non-performing.

We have highlighted the state of indebtedness of the top-10 sectors with the

highest level of debt as compared to the total debt of these c.1,000 companies.

The top five sectors together account for 50.9% of the total debt whereas the

next five sectors account for 14.4% of the total debt.

Exhibit 20. Sector-wise distribution of debt among the c.1,000 companies


Companies which have not turned non-performing yet are still demonstrating

stressed levels of debt and low levels of debt serviceability. Sectors such as

construction, textiles, infrastructure, metals and mining and realty had

debt/EBITDA ratios in the range of 4.0 -8.8x as of FY16 and interest coverage

ratios in the range of 1.0 -3.3x. Most of these sectors have seen a consistent

deterioration in these multiples over FY11-16. Similarly, capital goods has

witnessed a sustained deterioration in debt/EBITDA and interest coverage ratio

which stand at at 2.9x and 3.1x respectively, as of FY16. Auto ancillaries and

pharmaceuticals on the other hand display better trends while the telecom sector

has also seen some stability in its multiples although debt/equity has been rising

slightly.

The following charts clearly highlight that there is high potential of slippages

from highly indebted companies which are mostly classified as ‘standard’ in the

banks’ loan books.

13.0%12.1%

10.7%9.3%

5.8%

4.2% 3.9%2.9%

1.8% 1.6%

0.0%

5.0%

10.0%

15.0%

Met

als

& M

inin

g

Infr

astr

uctu

re

Tel

ecom

Mat

eria

ls

Tex

tiles

Rea

lty

Pha

rmac

eutic

als

Con

stru

ctio

n

Cap

ital g

oods

Aut

o A

ncill

iarie

s



Exhibit 21. Credit intensive sectors still show deterioration in indebtedness, debt service capability

Source: RBI, JM Financial.

1.9 2.6 2.9 3.2 3.5 3.8 3.25.2 6.8 6.6 7.0 8.0 7.5 7.9

3.3

2.5 2.3

1.9 1.6 1.7

2.3

-

2.0

4.0

6.0

8.0

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

FY11 FY12 FY13 FY14 FY15 FY16 1HFY17

Infrastructure Developers & Operators

Debt/Equity (x) Debt/EBITDA (x) ICOR (x, RHS)

0.7 0.7 0.8 0.8 0.9 1.0 1.44.4 4.8 5.0 5.0 5.9 5.9 8.2

3.0

2.3 2.1 2.0 1.9 2.0 2.0

-

1.0

2.0

3.0

4.0

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0


Realty


1.1 1.2 1.4 1.5 1.8 2.0 1.92.7 3.6 7.4 4.8 9.3 8.8 5.4

5.5

4.1

2.3

3.5

1.5 1.6

2.2

-

2.0

4.0

6.0

8.0

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0


Metals & Mining


0.7 0.8 0.8 0.9 0.8 0.8 0.91.8 2.3 2.8 3.2 3.1 2.9 4.0

5.6

3.9 3.5

3.2 2.9 3.1 3.1

-

2.0

4.0

6.0

8.0

10.0

12.0

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5


Capital Goods


3.0 2.3 2.1 2.0 1.9 2.0 2.02.5 2.6 2.8 3.3 3.2 3.0 2.9

5.3 5.1

4.8

3.9 4.0 4.2

4.7

-

2.0

4.0

6.0

8.0

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5


Materials

ICOR (x, RHS) Debt/EBITDA (x) ICOR (x, RHS)

1.1 1.2 1.3 1.3 1.6 1.9 1.93.3 3.4 3.3 3.1 2.8 3.1 3.9

6.8

4.7 4.4 4.6

6.1

4.7 4.0

-

2.0

4.0

6.0

8.0

10.0

12.0

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5


Telecom


1.3 1.7 1.8 2.1 2.3 2.7 2.34.6 5.4 6.6 9.0 9.0 8.8 9.3

2.5

1.9

1.5

1.1 1.0 1.1 1.1

-

1.0

2.0

3.0

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0


Construction


1.4 1.4 1.5 1.6 1.6 1.7 1.43.0 3.5 3.6 4.0 4.1 4.0 4.0

4.8

3.4 3.5 3.1 3.0 3.3 3.2

-

2.0

4.0

6.0

8.0

10.0

12.0

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5


Textiles




Exhibit 22. Sectors with lower debt and higher cash flows are much better off


We also cut the pie based on the turnover of companies in the chart below. It

clearly indicates that the indebtedness and the ability to manage the debt is

much weaker in companies with low turnover, i.e., in turnover range of `0-5bn

than in large companies. The debt/EBITDA and debt/equity ratios of companies

with turnover of more than `15bn compares favorably with that of companies

with lower turnover. A company-wise look at the data reveals a number of

companies in the `0-10bn range of total debt that have very poor profitability

trends and will potentially slip into non-performing loans going forward.

A comparison based on Debt/EBITDA>3 and Debt/Equity>1 also shows a large

amount of debt is still stressed. Nearly 533 of our c.1,000 companies have

Debt/EBITDA >3 and have a cumulative debt of `14.7tn while 494 of the total

companies have Debt/Equity>1 and also comprise `14.6tn of the total debt

(constituting all forms of borrowing). This pertains to total debt and not only

bank debt. This leads us to conclude that a large amount of stressed debt has

still not been declared ‘stressed’ and these would slip in the next few quarters.

Exhibit 23. Indebtedness of the companies according to turnover, Debt/Ebitda and Debt/Equity (x)


While we have taken stock of the financial performance in 1HFY17 for the above

companies, we should mention that there has been a marked improvement in

some sectors, specially iron and steel in 1HFY17 owing to the sharp rally in

commodity prices. Debt/Equity and ICOR has improved for Metals (largely Iron

and Steel) and infrastructure, the two industries accounting for the largest

portion of stressed loans. While this raises the scope of some form of loan work-

out, their ratios are still in the stressed range and there has not been much

improvement in demand in both sectors. If such trends sustain, banks would be

able to recover a larger share of these loans.

1.0 1.3 1.2 1.0 0.8 0.8 0.82.1 2.7 2.3 2.0 1.7 1.6 2.2

5.8

4.4

4.9

5.7

6.5

8.1

6.5

2.0

4.0

6.0

8.0

10.0

-

0.5

1.0

1.5

2.0

2.5

3.0


Auto Ancillaries


0.5 0.5 0.5 0.5 0.5 0.6 0.81.0 1.8 1.6 1.6 1.6 2.0 2.5

16.6

7.3 8.5 8.2

10.2 9.8 9.6

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

-

0.5

1.0

1.5

2.0

2.5

3.0


Pharmaceuticals


4.4

1.61.1 1.1

10.9

8.1

8.2

9.6

0.4

1.1

2.5

4.4

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

-

2.0

4.0

6.0

8.0

10.0

12.0

<=2.5 >2.5 and <=5 >5 and <=15 >15

As per Turnover


0.5

2.0

0.5

2.3

1.5

6.5

1.6

5.7

8.8

2.0

8.1

2.3

0.0

4.0

8.0

12.0

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Debt/ebitda =<3 Debt/ebitda >3 D/E <=1 D/E >1

As per indebtness




Exhibit 24. Key stressed sectors have shown some improvement in indebtedness, debt service capability in 1HFY17


Exhibit 25. Credit intensive sectors show improvement in 1HFY17


A bank-wise comparison of wholesale oriented players indicates reasonably high

exposures for PNB, SBI, ICICIBC and AXSB to large debt-ridden sectors in general.

BoB and YES have relatively lower fund-based exposures. A comparison of non-

fund based exposures, however, indicates that PvBs and PNB have high

exposures, particularly to iron and steel and construction. Given risks, some of

these would devolve and convert into non-fund-based exposures in the medium

term.

Exhibit 26. Comparison of funded bank exposure to critical sectors as on 2Q17 (as % of their overall FB* exposure)

Source: JM Financial; *FB = Fund-based

3.8

3.2

2.03 1.89

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

FY16 1HFY17

Debt / Equity

Infrastructure Developers & Operators Metals & Mining

1.7

2.3

1.6

2.2

-

0.5

1.0

1.5

2.0

2.5

FY16 1HFY17

ICOR


7.57.9

8.8

5.4

-

2.0

4.0

6.0

8.0

10.0

FY16 1HFY17

Debt /Ebitda


4.1%

6.9%

4.1%

6.8%

9.2%

4.0%4.4%

12.1%

5.2%

3.9%

5.0%

3.9%

1.3%

2.4% 3.2%

5.8%

1.2%1.0%

5.6%

2.2%

4.8%

6.4%

9.5%

2.7%

0.4%0.9%

1.4%

2.5% 3.1% 2.7%

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

ICICI Yes Axis PNB SBI BOB

Power Other Infra Construction Iron & Steel (incl. metals & metals products) Textiles



Exhibit 27. Comparison of non-funded Exposure to critical sectors as on 2Q17 (as % of their overall NFB* exposure)

Source: JM Financial; *NFB = Non Fund-based

In the telecom sector, the twin impact of Reliance Jio’s offers and demonetisation

are likely to impact industry profitability in the near term. Our Telecom analysts

expect EBITDA to decline for incumbent operators in upcoming quarters, given

that RJio has extended its free offer till March 2017 and incumbents are

indulging in a price-war. A slide in EBITDA and an increase in Net-debt to Equity

would result in a drop in debt service capability for the sector at large. Moreover,

with the entry of a new player with deep pockets and surge in industry capacity,

we are likely to witness a shake-out of smaller or mid-sized players who would be

compelled to either sell out, or be driven to bankruptcy.

As of November 2016, bank debt to telecom industry stood at `849bn or 1.3%.

Among banks, while no one has large fund-based exposures to telecom, AXSB

and YES have high proportion of non-fund based exposures. This could become a

source of stress which is currently un-recognised. Exposures to telecom

companies other than Bharti, Vodafone, Idea and Reliance Jio may be risky.

Exhibit 28. Telecom exposures could pose higher risk going ahead


4.8%

8.1%

4.1%

12.3%

3.6% 4.0%

7.0%

14.9%

20.4%

3.3%

7.2%

9.5%

6.8%

12.0%

5.1%3.8%

1.0% 2.0%

7.1% 6.7%5.5%

11.4%

3.0%

9.5%

0.6% 0.6% 0.4%

2.0%0.7%

3.5%

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

18.0%

21.0%

24.0%

ICICI Yes Axis PNB SBI BOB

Power Other Infra Construction Iron & Steel (incl. metals & metals products) Textiles

1.7%

0.7% 0.8%1.2% 1.0%

10.6%

9.3%

0.0%

1.1%

2.0%

0%

2%

4%

6%

8%

10%

12%

Yes Axis PNB SBI BOB

Fund based exposure Non-fund based exposures



Tools in place, pace of resolution should increase

After much trial and error, the toolbox for stressed asset resolution seems to be

attaining a more unanimously acceptable shape and form. With a new bankruptcy

code, a revised Scheme for Structuring of Stressed Assets (S4A), the updated

Strategic Debt Restructuring (SDR) norms and the erstwhile 5-25 refinance and

restructuring schemes, banks’ seem amply tooled for stressed asset resolution.

What is needed is consensus among lenders. Perhaps the system now recognizes

that value destruction can be ascribed more to inaction alone.

Hence, there has been an increased pace of stressed asset resolution in the last

12-18 months. Bankers seem to be prevailing over promoters now, and have

been able to recover some dues through asset monetisation, sale of loans to

ARCs and restructuring. We believe more NPAs will crystallise in FY17-18E. Of the

total system impaired loans of 14.4% as of 1HFY17, GNPAs comprise 9.1%,

restructured loans comprise 3.2% and the currently declared ‘watchlist’ by the

banking system is `1.35tn or c2.1% of bank credit.

We believe much of the watchlisted or restructured loans will dissipate into non-

performing loans or pass through a S4A or SDR as demand conditions have failed

to pick-up and bankers become more aggressive in loan classification. PvBs have

a smaller share of the stressed assets as compared to PSBs. Within the former,

the retail lenders have a miniscule share as compared to the wholesale lenders,

mainly AXSB and ICICIBC.

Exhibit 29. Total stressed assets – outstanding and accretion for banks under our coverage

Source: Company, JM Financial.

Exhibit 30. Market share of stressed assets for banks under our coverage


0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

FY12

FY13

FY14

FY15

FY16

FY17

E

FY18

E

FY19

E

FY20

E

Oustanding impaired (As a % of loan book) (%)

Wholesale Private Retail Private

Other PSB (Ex-SBI) SBI & Group

0%

2%

4%

6%

8%

10%

12%FY

12

FY13

FY14

FY15

FY16

FY17

E

FY18

E

FY19

E

FY20

E

Impaired asset accretion (%)

Wholesale Private Retail Private

Other PSB (Ex-SBI) SBI & Group

12% 11% 12% 13%20% 20% 18% 17% 16%

42% 37% 39% 35%36% 36% 36% 34% 33%

46% 52% 48% 52%44% 44% 46% 49% 51%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

Stressed Asset market share (%)Private banks SBI & Group Other PSB (Ex-SBI)

42% 43% 45% 45%57%

73%80% 86%

93%

58% 57% 55% 55%43%

27%20% 14%

7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Stressed Asset Mix (%) GNPAs Restructured + Watchlist



It is interesting to note that slippages outside of the watch-list and restructured

loans are still high for large wholesale lenders such as SBI, AXSB and ICICIBC.

Annualised slippages, outside of watchlisted and restructured accounts, as a

percentage of wholesale loans are 2.8% for ICICBC, 2.4% for AXSB and 1.7% for

SBI, as of 1HFY17. This is despite an Asset Quality Review and a tremendous

spike in impaired asset accretion in FY16. Such high slippage ratios for wholesale

loans, outside of the restructured loans and watch-list, indicate that the

underlying portfolio quality of the remaining loans is still stressed. This

corroborates our hypothesis in the earlier section, ‘the stressed are still

stressed’. We are probably not at the peak of stressed loans identification though

we may be close to it.

Exhibit 31. Ex-watchlist/restructured slippages still remain high


We build in higher loan loss provisions (LLP) for our universe of stocks for

FY17E/18E respectively since the PCR for our universe of stocks has declined

from 59% in FY07 to 43% as of FY16. LLPs will only start declining from FY19E

onwards as PCR would have recovered by then. The LLP will likely remain c.1.2-

2.8% for AXSB, c.1.7-3.6% for ICICIBC and c.1.7-2.4% for SBI through FY17-20E

and at 60-65bps for retail PvBs and YES bank. This would result in coverage

ratios increasing for wholesale lenders and being maintained for retail lenders.

Other PSBs would be unable to increase coverage ratios meaningfully for lack of

adequate operating profits.

Exhibit 32. LLP to remain high and aid recovery in PCR for wholesale PvBs


1.8%

0.8%

1.1%

1.6%1.4%

1.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

2.0%

ICICI AXIS SBI

Annualised Slippage as a % of Loan book

1Q17 2Q173.1%

1.3%

1.6%

2.8%

2.4%

1.7%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

ICICI AXIS SBI

Annualised Slippage as a % of Non retail/agri Loan book

1Q17 2Q17

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E

LLP (%)

Wholesale Private Retail Private SBI & Group Other PSB

30%

40%

50%

60%

70%

80%

90%

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E

Provision coverage ratio (%)

Wholesale Private Retail Private Other PSB SBI & Group



Exhibit 33. Stressed asset resolution tools provided by RBI and examples of their successful usage

Scheme Methodology Asset classification Successful examples of resolution**

Conversion of

distressed debt

into equity at fair

prices (Strategic

Debt

restructuring)

If the borrower is unable to achieve the viability

milestones or adhere to ‘critical conditions’ as

per the restructuring package, SDR can be

approved and invoked by the majority of JLF

members (minimum of 75% by value and 60% by

number), converting debt into equity in a way

that all lenders under the JLF collectively hold

51% of borrower’s share capital.

The conversion price will be as per ‘fair value’

pricing formula by RBI subject to ‘floor of face

value’. JLF and lenders should divest their

holdings in the equity within 18 months by

finding a new promoter who must acquire a

minimum 26% stake in the entity.

Existing standard assets to

continue with same

classification for 18months

or until new promoter comes

in. In case of failure to

successfully resolve the

asset, it will be classified as

NPA after the 18months

period.

1) Eight consortium lenders had invoked SDR in

Gammon Infrastructure in Nov-15 and took over

53.54% controlling stake in the company by

converting debt to equity. In Aug ‘16, nine

projects of Gammon Infra were acquired by

Brookfield Asset Management in `67bn deal

wherein lenders received c`17bn of the total

outstanding `110bn debt of the Gammon group

2) Another SDR case of Electrosteel Ltd with

nearly `100bn in debt is in process of being

resolved as per media reports.

‘Scheme for

Sustainable

Structuring of

Stressed Assets’

(S4A)

The S4A envisages the determination of the

sustainable debt level for a stressed borrower,

and bifurcation of the outstanding debt into

sustainable debt (Part A) and equity/quasi-equity

instruments (Part B) which are expected to

provide upside to the lenders when the borrower

turns around. Lenders will have to provide higher

of the following in their books, a) 25% of total

debt Or b) 50% of Part B debt. There shall not be

any extension of the repayment schedule or

reduction in the interest rate for servicing of Part

A.

Part A (Sustainable debt) of

NPA assets to be converted

to 'Standard' on

implementation of S4A by all

lenders and higher

provisioning as given in the

guidelines.

Lenders invoked S4A in a construction company

- HCC’s Ltd. where its total funded debt of

`51bn will be divided into two parts:

Part A) Sustainable Debt – `27bn (52.5%)

Part B) Unsustainable Debt – `24bn (47.5%)

- a) Lenders will subscribe to 24.4% fresh equity

which will bring the promoter holding to 27.4%

from 36% currently. Share price to be

determined by SEBI guidelines and accordingly,

debt will be reduced to the extent of conversion

amount. (At `40/share, `10bn of debt to be

converted to equity)

-b) Balance portion of Part B will be converted to

Optionally Convertible Debentures for 10yrs at

0.01% (11.5% YTM)

5/25 structuring

- Flexible

structuring of

'new' and

'existing' long

term project

loans to

Infrastructure

and core

Industries

These guidelines allow banks to fix a longer

amortization period, say 25 years for ‘new’ and

‘existing’ standard term loans to projects in all

sectors, where joint exposure of lenders exceed

` 2.5bn, with periodic refinancing, say every 5

years.

Additionally, structuring of existing standard

restructured loans under these guidelines will

not be considered as repeated restructuring and

the asset will continue to be classified as

standard assets in banks’ books.

Standard asset

Multiple cases of 5/25 have been done by

almost all corporate lending banks and they

continue to carry these loans in their books as

standard.

As per media reports JSPL’s `25bn loan and Part

of (`90bn) of Essar steel’s loans have been

refinanced under this scheme where these steel

projects can be given extended loan repayment

schedules in line with the project tenure.

'Insolvency and

Bankruptcy Code,

2015

Under Current bankruptcy rules, the decision to

liquidate an ailing company can take years,

thereby, enabling managers to divest assets

from the company. Key Highlights of the new

code are: a) Consolidates into a single law a host

of legislations that deal with the subject. b)

Proposes fast-tracking resolution of insolvency

cases and improve recoveries of amount lent to

companies within a timeline of 180 days,

extendable by another 90 days; c) Allows

operational creditors like employees to also call

for insolvency resolution; d) Proposes Insolvency

Regulator to exercise regulatory oversight over

insolvency professionals, insolvency professional

agencies and informational utilities;

Useful for assets classified or

identified as Non-performing

wrt quick recoveries

ICICI Bank Ltd has filed an application on 26th

Dec’16 in the National Company Law Tribunal

(NCLT) against Innoventive Industries Ltd with a

total debt of `10bn to initiate a corporate

insolvency process under the new bankruptcy

law.

Other tools given by RBI for tackling bad debt

Creation of CRILC: Banks are required to report to CRILC information on- borrowers with exposure exceeding ` 50mn, borrowers classified as non-

cooperative borrowers, borrower accounts classified as SMA-2, JLF formed for SMA-2 accounts CAP adopted for same, failure to form a JLF on time or to follow

devised CAP.

Creation of new ‘SMA’ category for classification of accounts: To recognize incipient stress in accounts, RBI created a new ‘Special Mention Account’ (SMA)

category of accounts which would include three sub categories: SMA-NF (Non-financial signals of stress), SMA-1 (Principal or interest overdue between 31-60

days) and SMA-2 (Principal or interest overdue between 61-90 days)

Formation of Joint Lenders’ Forum (JLF): RBI directed mandatory formation of JLF for SMA-2 accounts where joint exposure of lenders (under consortium or

multiple banking arrangement lending) exceeds `1 bn to resolve stress in the account before it turns into NPA.

Source: RBI, JM Financial; ** As per BSE filings or media reports in the public domain



Substantial outperformance expected from PvBs

Improved competitive positioning with regards to capital, reach, brand and

manpower has placed PvBs in a dominating position in the Indian banking

landscape. In the past decade, PvBs and SBI have gained market share gradually

in both balance sheet and P&L metrics from both foreign banks and PSBs (ex-SBI).

PvBs and SBI are poised to gain market share much more rapidly now as

compared to others in the system. These banks have advantages of i) strong

capital position, ii) ability to drive balance sheet growth through customer

acquisition, iii) ability to drive revenue growth through wider product offering

and cross-selling and iv) better debt resolution capability. Other PSBs have been

significantly weakened due to high stressed assets, low capitalisation, extreme

risk aversion and lack of any credible plan for a turnaround.

Within our coverage universe, we expect PvBs to deliver a CAGR of 16.7% in

operating profits and 15.7% in net profits over FY16-19E. PSBs, on the other

hand, would deliver a CAGR of 11% in operating profit in the same period. RoA

for PvBs would range from 1.4-1.5% on a blended basis whereas the same for

PSB’s would range from 0.2-0.5% over FY16-19E.

Cornering balance sheet at the expense of PSBs (ex-SBI)

The balance sheet market share shift has been gradual for most of the last

decade. For example, PvBs gained a 3.9% share of loans over FY06-16. Of this,

1.8% was from foreign banks, 1.1% from the SBI Group and the remaining from

other PSBs. Similarly, they gained 1.5% market share in deposits, partly from the

SBI group and partly from foreign banks in the same period. We believe the

market share shifts in both loans and deposits is going to be much more radical

in the next five years as compared to the last decade.

Lack of adequate staff is a major source of competitive disadvantage for PSBs.

Their employee per branch is c.8.7 as of FY16 versus c.11.4 for SBI group and

c.16 for PvBs. Private bank not only attract better staff but also generate better

efficiencies and productivity. This shows up in manpower intensive operations

such as retail credit growth, savings and retail term deposit accretion,

distribution of fee products and collections.

Within corporate loans, client acquisition is a function of width of service

offerings spanning fund-based, fee-based, transaction based and off-balance

sheet products. Private bank provide most of these under one roof. With PSB’s

becoming risk averse, the former have been cherry picking clients with ease. It

will be tough for PSBs to regain their share of clients’ wallets, once they lose the

them.

Retail penetration of PSBs, barring SBI, is extremely weak. Most PvBs have moved

from branch-led loan growth to centralized loan processing. PSBs have only

selectively done so. Branch managers at PSBs, who would often source SME and

MSME loans have still not adjusted to the CASA and fee orientation that private

bank branches have. Retail loans also require strong follow-up and collection

infrastructure, which is absent for PSBs.



Exhibit 34. Loan market share shift for the entire banking sector to be much faster hereon

Source: RBI, JM Financial

PvBs’ liability acquisition has accelerated post deregulation of savings deposit

rates. Banks such as KMB, YES and IIB which were hitherto much smaller in size

have gained scale and reach, have rolled out innovative deposit products and

developed a targeted deposit gathering strategy. For instance, IIB has identified

several ‘home markets’ – essentially micro-markets where it aims to have the

highest branch density and deposit market share. With the recent acquisition of

ING, KMB has acquired strong footprint in South India where it was absent

earlier. YES has increased its branch network substantially and has benefitted

from savings bank deregulation. It has managed to build its CASA ratio to 30.3%

as of 1HFY17. These, along with the large banks such as ICICIBC, HDFCB and

AXSB are not just acquiring deposits but are ensuring they improve the quality of

their liability franchise. Such focused deposit gathering strategy seems has not

been displayed by PSBs.

Exhibit 35. Deposit market share shift for the entire banking sector

Source: RBI, JM Financial

Revenue growth to be healthier for smaller sized banks

We estimate a CAGR of 16.5% in core revenues (NII + core fee income) for PvBs

over FY16-19E as compared to a CAGR of 10.6% for PSBs under our coverage.

Healthier loan growth, high loan to deposit ratios, better loan mix, better CASA

mix and lower interest reversals due to lower slippages would lead to stronger

margins and NII growth for PvBs. Within PvBs, however, NII growth for retail

oriented players like HDFCB, IIB, KMB and for YES would be superior to that of

AXSB and ICICIBC. The latter’s’ larger portfolio size, larger proportion of low-

yielding and slow-growing corporate portfolio and higher slippage related loss of

income would impact margins and NII over FY16-19E.

0%

10%

20%

30%

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60%

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Loans Market Share (%)

SBI & Group Other SOEs Private Banks

-20%

-10%

0%

10%

20%

30%

40%

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60%

70%

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FY

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Incremental Loans Market Share (%)


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98

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Deposit Market Share (%)


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16

Incremental Deposit Market Share (%)




Exhibit 36. NII and fee revenue market share split for banks in our coverage universe

Source:Company, JM Financial.

NII growth for SBI and BoB would be moderate. For SBI, consolidation of associate

banks and continuing high slippages, even outside the watchlist, would

moderate its NII growth. BoB’s balance sheet is currently contracting as the

management tries to run-down low yielding advances and focus on improving

productivity. However, persistently high slippages would keep interest reversals

high and hence, NII growth would remain muted.

Exhibit 37. Key margin drivers for banks under our coverage

FY16-19E

Loans

CAGR

Avg. Retail+ Agri loan

mix Avg Casa NII CAGR Avg. LDR Avg. NIM

Axis Bank 17.2% 40.6% 46.0% 15.5% 93.4% 3.4%

ICICI Bank 14.4% 51.0% 44.9% 10.0% 98.9% 3.1%

Yes Bank 24.0% 33.0% 31.9% 25.4% 84.4% 3.4%

HDFC Bank 19.2% 48.7% 43.1% 18.9% 83.4% 4.4%

IndusInd Bank 25.7% 43.7% 36.5% 26.0% 90.9% 3.9%

Kotak Bank 17.0% 69.5% 38.6% 15.9% 84.0% 4.2%

SBI 11.4% 34.2% 42.2% 9.4% 81.7% 2.6%

BOB 6.5% 23.3% 24.1% 5.0% 66.6% 2.0%

PNB 8.6% 30.3% 37.4% 6.1% 72.5% 2.4%


Smaller PvBs such as YES and IIB have robust fee income contributions to overall

revenue growth. Fees from debt capital market, syndication, transaction banking,

foreign exchange income and structured products form a large chunk of fees. Of

late, these banks have also tuned-up their focus on third party distribution which

has picked up meaningfully. Retail fees have been in the range of 20-25% of

overall fees for YES over FY14-1HFY17. Similarly for IIB, retail fees have increased

from an average of c.44% of overall non-interest income in FY14 to c.49% as of

FY16.

Fee growth for larger banks such as ICICIBC and AXSB will remain muted, as

compared to the medium sized banks, due to the high proportion of corporate

banking fees which are sluggish at the moment. While these banks have

sophisticated products too, their fee growth has ebbed. For these, non-interest

income has been propped up by exchange gains and gains from sale of strategic

stakes in the recent past. We build in a modest recovery in fee income for both

these banks.

HDFCB and KMB are relatively risk averse and steer clear of certain fee-based

products where they believe the inherent risks are higher. These would continue

to witness growth in fees in-line with balance sheet but the contribution of such

fees to operating revenues would remain low in comparison to other banks.

16.4%

37.1%

83.6%

62.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

FY

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07

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09

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12

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13

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14

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15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E

NII Market share (%)

Private banks SBI & Group Other PSB SOE Banks

32.8%

47.0%

67.2% 53.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

FY

05

FY

06

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FY

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FY

17E

FY

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FY

19E

FY

20E

Core fee market share (%)




Exhibit 38. Fee income contribution to remain high for PvBs

Core fee income growth Core fee income/total income Core fee/assets

FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E

Axis Bank 13.3% 6.0% 13.0% 16.3% 31.9% 31.9% 29.3% 29.0% 1.7% 1.5% 1.5% 1.5%

ICICI Bank 8.5% 3.3% 12.4% 12.9% 34.7% 34.7% 33.7% 33.6% 1.7% 1.6% 1.6% 1.6%

Yes Bank 28.7% 33.8% 25.0% 24.0% 33.7% 33.7% 34.5% 34.6% 1.6% 1.8% 1.8% 1.8%

HDFC Bank 19.1% 16.5% 19.5% 20.0% 26.1% 26.1% 25.9% 26.1% 1.5% 1.5% 1.5% 1.5%

IndusInd Bank 29.7% 20.1% 22.9% 24.1% 40.3% 40.3% 37.8% 37.8% 2.5% 2.4% 2.3% 2.4%

Kotak Bank 44.8%#

10.2% 30.9% 25.5% 24.0% 24.0% 25.2% 26.5% 1.5% 1.2% 1.4% 1.5%

SBI 22.1% 0.2% 22.0% 17.5% 27.2% 27.2% 28.7% 29.8% 1.1% 1.0% 1.1% 1.1%

BOB 12.5% 10.3% 17.3% 14.9% 21.5% 21.5% 25.8% 27.1% 0.6% 0.6% 0.8% 0.8%

PNB 27.9% 21.2% 9.8% 9.9% 26.1% 26.1% 29.5% 29.5% 0.9% 1.0% 1.0% 1.0%

Source: Company, JM Financial. #- KMB acquired eING Vysya bank in FY16 and hence growth figure is not comparable.

Operating expenses to be dominated by retail, technology spends

Cost ratios show significant deviation between PvBs and PSBs. While the

cost/income ratio is the lowest for PvBs, cost/asset ratio is the highest. The

former is the lowest because of PvBs’ strong and diversified revenue sources

whereby growth in operating revenues have outpaced growth in operating

expenses. Operating leverage is also at play for PvBs as they have built systems

to handle much larger client base. PSBs on the other hand, have poor fee income

profiles and see occasional jumps in non-interest income through gain on sale of

investments. Structurally weaker revenue profile and stickier costs due to

pension burden and increasing investment requirement in technology would

keep cost/income ratio for PSBs structurally high.

The cost/asset ratio for PvBs is much higher due to the higher proportion of

retail assets and retail liabilities which require much more investment in

manpower, branches, branding and technology. PSBs, on the other hand, have a

much lower mix of retail assets as well as weaker retail liability profile

considering both CASA and retail term deposits (SBI and PNB would be

exceptions).

Exhibit 39. Cost ratio comparison for bank-groups under our coverage universe


Cost ratios in our coverage universe would also betray the same trends. PvBs

would continue to have elevated cost/asset ratios largely due to continuing

investments in their retail franchises. PSBs, with curtailed ability to spend on

increasing their employees per branch or per capita technology spends would

continue to have a low cost/assets ratio but high cost/income ratio (refer exhibit

18).

35%

40%

45%

50%

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FY

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Cost to income ratio (%)


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Cost to avg. assets ratio (%)




Exhibit 40. Cost ratios trend for PvBs and PSBs

Cost to income Cost to assets

FY16 FY17E FY18E FY19E FY16 FY17E FY18E FY19E

Axis Bank 38.5% 39.8% 40.7% 40.7% 2.0% 2.1% 2.1% 2.1%

ICICI Bank 38.2% 40.8% 41.4% 41.2% 1.9% 1.9% 1.9% 1.9%

Yes Bank 40.9% 41.3% 41.2% 41.1% 2.0% 2.1% 2.2% 2.2%

HDFC Bank 44.3% 43.9% 43.5% 43.2% 2.6% 2.6% 2.5% 2.5%

IndusInd Bank 47.0% 47.0% 47.4% 47.0% 2.9% 3.0% 2.9% 3.0%

Kotak Bank 57.5% 52.0% 51.6% 51.0% 3.7% 2.8% 2.8% 2.8%

SBI 49.1% 51.4% 51.5% 51.0% 1.9% 1.9% 1.9% 1.9%

BOB 50.3% 45.7% 45.9% 46.0% 1.3% 1.3% 1.3% 1.4%

PNB 44.9% 46.4% 47.2% 46.4% 1.6% 1.7% 1.7% 1.6%


Meaningful asset quality improvement only by FY19E

As discussed in an earlier section, we believe a large amount of stressed loans

still remain unresolved in the system. Corporate asset quality is unlikely to

improve immediately and there will be a period of stressed asset resolution

which will increase the provision requirement of banks. Accordingly, we believe

slippage ratios and loan loss provisions would remain high in both FY17E and

FY18E. While their relative levels might improve, the absolute levels would still be

high in comparison with history.

LLPs should trend lower by FY19E and several industries which are facing high

debt/equity ratios and low interest coverage ratios would probably become

unleveraged enough to commence capital expenditure. ICICIBC, AXSB, SBI, BoB

and PNB would face higher slippage ratios in FY17E/18E.

Exhibit 41. Impaired loans and slippage ratio outlook for banks under our coverage universe

Slippage ratio Total impaired loans


Axis Bank 2.6% 6.9% 4.0% 2.3% 10.7% 11.1% 8.2% 6.0%

ICICI Bank 4.4% 8.0% 4.3% 2.3% 16.0% 11.4% 9.1% 5.9%

Yes Bank 1.2% 1.3% 1.1% 1.0% 1.4% 1.3% 1.3% 1.1%

HDFC Bank 1.6% 1.6% 1.5% 1.5% 1.0% 1.1% 1.1% 1.1%

IndusInd Bank 1.2% 1.4% 1.4% 1.4% 1.5% 1.4% 1.1% 1.1%

Kotak Bank 4.4% 1.8% 1.5% 1.5% 2.5% 2.5% 2.3% 2.1%

SBI 5.0% 3.4% 2.8% 2.5% 14.2% 13.2% 10.4% 8.1%

BOB 6.6% 4.5% 3.3% 3.0% 17.0% 15.7% 12.6% 10.4%

PNB 11.6% 9.0% 6.5% 6.5% 20.7% 17.8% 14.2% 12.3%

Source: Company, JM Financial

Exhibit 42. LLP and PCR trends for banks under our coverage universe

Specific LLP to average loans PCR


Axis Bank 1.23% 2.85% 1.60% 1.00% 58.6% 49.8% 57.4% 65.7%

ICICI Bank 1.56% 3.65% 2.00% 1.70% 50.6% 40.7% 40.8% 53.0%

Yes Bank 0.57% 0.52% 0.60% 0.60% 62.0% 56.9% 57.7% 63.9%

HDFC Bank 0.51% 0.60% 0.61% 0.60% 69.9% 68.3% 72.8% 73.2%

IndusInd Bank 0.64% 0.62% 0.62% 0.61% 58.6% 60.0% 62.0% 64.6%

Kotak Bank 0.76% 0.58% 0.61% 0.56% 55.5% 53.2% 54.7% 55.8%

SBI 1.95% 1.85% 1.50% 1.20% 43.2% 46.1% 48.4% 52.2%

BOB 3.45% 1.85% 1.50% 1.10% 52.1% 55.8% 61.6% 63.7%

PNB 4.66% 2.60% 2.10% 2.00% 36.5% 37.9% 41.9% 44.1%




Return ratios, earnings trajectory to show clear deviation

We estimate YES along with retail PvBs, i.e., HDFCB, KMB and IIB, to generate

significantly superior return ratios over FY16-19E. RoA for these banks are likely

to range from 1.6-1.9% over this time period, led by superior growth and market

share gains, capitalising on revenue generation opportunities and operating

leverage from better productivity. Given their relatively better positioned loan

quality, and higher provision coverage, we estimate loan loss provisions would

continue to remain low. We have not factored in dilution in our estimates.

Without dilution, we believe these stocks can generate a 19%-29% EPS CAGR over

FY16-19E owing to favourable positioning, strong execution and sustained

improvement in their business mix.

Earnings growth for AXSB and ICICIBC are likely to remain relatively muted.

Despite this, we believe net profit CAGR for AXSB would be 10% and for ICICIBC,

15% (pre-extraordinaries) over FY16-19E. Changes in asset classification of highly

levered accounts will likely continue in FY18E, leading to much higher loan loss

provisions and income reversals. While their retail loan portfolios would grow at

a healthy clip, we believe their corporate books will continue to grow moderately,

keeping overall balance sheet and revenue growth sluggish.

Exhibit 43. Return ratios comparison for banks under our coverage


Exhibit 44. Return ratios trend for JMF’s coverage universe

RoA RoE


Axis Bank 1.7% 0.9% 1.2% 1.5% 16.8% 9.2% 13.7% 16.9%

ICICI Bank 1.4% 1.2% 1.0% 1.1% 11.6% 10.3% 9.0% 10.4%

Yes Bank 1.7% 1.8% 1.8% 1.8% 19.9% 21.6% 22.2% 22.6%

HDFC Bank 1.9% 1.9% 1.9% 1.9% 18.3% 18.8% 19.2% 19.8%

IndusInd Bank 1.8% 1.9% 1.8% 1.9% 16.6% 15.9% 16.9% 18.2%

Kotak Bank 1.4% 1.5% 1.5% 1.6% 11.0% 11.9% 12.7% 13.9%

SBI 0.5% 0.5% 0.5% 0.7% 7.3% 7.1% 8.6% 10.9%

BOB -0.8% 0.3% 0.4% 0.6% -14.4% 5.7% 7.9% 10.5%

PNB -0.6% 0.3% 0.4% 0.4% -10.9% 4.5% 7.2% 7.6%


High capital requirement of PSBs to dilute returns

The tier 1 CAR for PvBs in the JM universe is 13.12%, significantly higher than the

tier 1 ratio of 9.87% for SBI (Consolidated) and 9.17% for other PSBs. The

difference would be even stark if we were to compare CET 1 ratios of these bank-

groups. PvBs can take much more risk and commit far more capital to growth as

compared to PSBs.

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

FY

05

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06

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08

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ROA (%)


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FY

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FY

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ROE (%)




Apart from growth, the lack of capital also impedes a bank’s ability to make

adequate provisions for impairment, take haircuts on loans being sold, take

quick decisions on stressed asset resolution, etc. Again, PvBs are better

positioned to tackle these situations. We are likely to see more rapid stressed

asset resolution with PvBs as they have much more capital cushion.

PSBs require successive rounds of dilution simply to meet minimum capital

adequacy norms as per Basel III. As per our calculations, SBI (consolidated)

requires another `631bn of capital over FY17-20E to account for coverage

shortfall and minimum Tier 1 needs as per Basel III. Similarly, PNB requires

additional capital of `321bn and BoB requires `68bn over FY17-20E. This is just

to meet minimum capital norms. Banks would need much more capital for

growth and even to take haircuts on large stressed assets which are yet to

accrue.

This would result in continuous capital infusion requirements. SBI could

monetize its stake in strategic investments or in its insurance subsidiaries. SBI

also trades at c.0.9x FY19E BVPS which would make any capital raising only

marginally dilutive as compared to other banks. However, for banks such as PNB,

BoB and others which are trading significantly below their book values, any

capital raising exercise would dilute returns to the minority shareholder.

Exhibit 45. Cumulative capital requirement for PSBs under coverage

Tier 1 ratio

FY17E FY18E FY19E FY20E

SBI (Consolidated)

Tier 1 CAR 10.40% 10.01% 9.83% 9.75%

Impact on Tier 1 due to coverage shortfall 3.42% 2.79% 2.25% 1.83%

Tier 1 Adj. for Coverage Shortfall 6.98% 7.22% 7.58% 7.92%

Min. Tier 1 + CCB + D-SIB* (Bucket 4) 8.65% 9.48% 10.30% 10.30%

Cumulative Capital Requirement (` mn) 328,805 485,513 646,647 631,327

Punjab National Bank

Tier 1 CAR 8.44% 8.22% 8.04% 8.00%



Min. Tier 1 + CCB 8.25% 8.88% 9.50% 9.50%

Capital Requirement (` mn) 255,299 260,908 303,789 321,053

Bank of Baroda

Tier 1 CAR 10.69% 10.63% 10.43% 10.15%



Min. Tier 1 + CCB 8.25% 8.88% 9.50% 9.50%

Capital Requirement (` mn) 48,026 44,591 63,333 67,938

Source: Company, JM Financial., Note: *SBI is considered as a Domestic-Systemically Important Bank (D-SIB) bucket 4 and

accordingly, the additional common equity tier 1 requirement is considered.

Exhibit 46. CET1 of major PSB as on 2Q17 (%)


10.28 10.09

8.76 8.75 8.50 8.25 8.06

0

2

4

6

8

10

12

SBI BOB PNB OBC BOI CNBK UBI

CET1 (%)



Superior earnings growth would attract premium

valuations

We recommend maintaining neutral weight on financials, with HDFCB, IIB, YES

and ICICIBC as our preferred picks. Our rating on these stocks would be BUY. We

would remain equal-weight on SBI and AXSB which we also rate BUY and

underweight on KMB and BOB and rate them as HOLD. PNB is the only SELL rated

stock in our basket. As seen in the matrix below, stocks are already clumped

together depending on whether they are PvBs or PSBs and depending on their

RoE. We note that the retail oriented lenders are valued higher and the wholesale

oriented lenders are already at a discount.

Exhibit 47. ROE and PB of banks in coverage universe (x)


PSBs are trading even lower than 1SD below their 10-year averages. However, this

does not make them ‘value picks’ since their earnings outlook remains weak and

their capitalization is currently inadequate to allow for large-scale resolution of

stressed loans. Several potential triggers for PSBs, which have been in public

discussion for a while, are i) remodeling of compensation package and HR

practices, ii) creation of a ‘bad bank’ and transfer of problem loans to the same,

iii) consolidation among PSBs, iv) infusing more private sector talent (already

underway), etc.

A combination of these steps, whenever undertaken, would still take long to

fructify. For example, only a part of the changes proposed by the P.J. Nayak

Committee report (October 2014) have been implemented. Only two notable

PSBs managed to appoint Chairmen from private sector banks by

September/October 2015 and the Bank Boards Bureau (BBB) was constituted in

February 2016, nearly one and a half years after the recommendation. Even

today, several suggestions regarding compensation and HR practices are

awaiting implementation. At best, such announcements/implementations would

be followed by a short rally in PSBs, making them trading plays at best.

AXSBICICIBC

YESHDFCB

IIB

KMB

SBIBOBPNB

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0 5 10 15 20 25

Pri

ce /B

oo

k (x

) F

Y18

E

ROE (%)



Exhibit 48. Valuation: PvBs Vs SOE Banks


Exhibit 49. Valuation premium: PvBs over PSBs and Retail-oriented private lenders over Wholesale oriented


Stocks with better earnings trajectory would receive premium valuations

We estimate stronger earnings trajectory for HDFCB, IIB and KMB. Superior loan

growth would be the key driver of such earnings growth over FY16-19E. These

banks are likely to generate strong core revenue growth, have minimal asset

quality issues and maintain strong RoA and RoE in the medium term. We

estimate net profit CAGR for HDFCB, KMB and IIB at 20%, 19% and 26% over FY16-

19E respectively. They would continue to receive premium valuations as

compared to other banks.

So why do we recommend BUY on HDFCB and IIB and HOLD on KMB? At 3.9x

FY19E BVPS (standalone) and RoE of 11-14% through FY16-19E, we believe

valuations for KMB are expensive. KMB typically receives a valuation premium for

the high quality leadership team, execution skills and pristine asset quality.

However, their preference for quality often leads to inconsistent approach to loan

growth whereby the bank either brakes or accelerates growth depending on the

perceived risk in the system. This prevents the bank from leveraging its capital,

leading to sustained low RoE. We believe returns from KMB would be muted still.

As such, the discounts of HDFCB and IIB to KMB should narrow going ahead.

We would differentiate between YES, which we rate as BUY, and AXSB or ICICIBC

(both rated BUY) though. YES had a much smaller balance sheet when the

infrastructure credit boom was underway and had opted out of consortium

participation. Thus, it has standalone exposures and charges on collateral and in

multiple cases, it has been able to recover its dues separately from other banks

due to ring-fenced contracts. In the long term, YES is also a play on reducing

concentration risks as the retail business mix gradually increases and improves

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Pvt. Banks Fwd. P/B (x) SD+1 SD-1 Average

0.5

1.0

1.5

2.0

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

SOE Banks Fwd. P/B (x) SD+1 SD-1 Average

-

50

100

150

200

250

300

350

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Pvt Bks / PSBs SD+1 SD-1 Average

-

20

40

60

80

100

120

140

160

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Retail Pvt / Wholesale Pvt SD+1 SD-1 Average



valuation multiples. YES would continue to deliver strongest earnings growth

among the wholesale oriented lenders in the medium term. Timely capital raising

remains a concern. It currently trades at 2.3x FY19E BV (without factoring in

dilution).

Exhibit 50. Valuations: P/B trends in Retail and Wholesale PvBs


Exhibit 51. Valuation premium: Premium/Discount of KMB over IIB and HDFC Bank.


Be selective about ‘value’ picks

Our analysis of c.1,000 companies also reveals a significant portion of smaller

companies but with very high debt/equity and interest coverage ratio levels. A

number of these companies are also loss-making currently. Banks’ own slippage

ratio, outside of loans that slip from the watchlist or restructured loans, is quite

high still.

Large banks under our coverage where valuations have corrected reasonably due

to high stressed asset accumulation are PNB, SBI, BoB, AXSB and ICICIBC among

others. These banks would continue to report high slippage ratios in the near

term. We would like to differentiate between ‘stressed asset accrual coming off

highs’ and ‘slippages remaining high still’. While slippage ratios may come off

from highs of 4QFY16-1QFY17, they would still be significantly higher than long

term averages. For example, we estimate the slippage ratio for ICICIBC to likely

peak at 7.95% of opening loans in FY17E and then drop to 4.5% in FY18E.

However, at 4.5% of opening loans, the slippage ratio would still be higher than

the previous peak of 4.1% in FY05!

On the flip side, should corporate asset quality start improving sooner than

expected, some of these banks would re-rate rapidly. Between ICICIBC and AXSB,

we would prefer the former given a chunk of stressed asset accumulation has

already taken place and the group has several non-banking assets to monetize to

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Retail Pvt. Banks Fwd. P/B (x) SD+1 SD-1 Average

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Dec

-06

Dec

-07

Dec

-08

Dec

-09

Dec

-10

Dec

-11

Dec

-12

Dec

-13

Dec

-14

Dec

-15

Dec

-16

Wholesale Pvt. Banks Fwd. P/B (x) SD+1 SD-1 Average

-

20

40

60

80

100

120


KMB / IIB SD+1 SD-1 Average

-20

-10

-

10

20

30

40

50

60

70


KMB / HDFC SD+1 SD-1 Average



raise capital. Furthermore, performance of subsidiaries is best-in-class and these

are already contributing more to group profits. Hence, we initiate coverage with a

BUY on ICICIBC.

AXSB, on the other hand, is likely to see much more stressed asset accretion in

FY17E/18E which would normalize from FY19E onwards. This would lead to

pressure on earnings in the near term. RoA would be aided, however, by a strong

retail franchise and profitability from the same. As such, we rate AXSB as BUY but

with moderate upside. Valuation premium received by AXSB over ICICIBC will

likely dwindle in the medium term too.

Like ICICIBC or AXSB, SBI also offers a balanced play on retail growth and

profitability on the one hand and a potential resurgence in corporate sector on

the other. While its capital requirements are high, it has the option to monetize

non-core assets to raise the capital, without significantly diluting the minority

shareholder. We recommend BUY on SBI.

While BOB is taking significant efforts for a turnaround, we believe valuations

have already priced in a significant improvement whereas actual earnings

performance is still lack-lustre. There are several execution risks as well. Hence,

we rate BoB as HOLD.

PNB has too many fronts on which to improve, capital, revenue growth,

profitability, stressed asset accrual, etc. At best, there might be short trading

rallies but we would prefer SBI or BOB for their superior inherent strengths and

earnings power. We recommend SELL on PNB.

Exhibit 52. Valuation premium: Axis over ICICI and SBI over BoB


Exhibit 53. Valuation premium: Premium of ICICI over SBI – likely to expand

with more stressed asset resolution


-30

-20

-10

-

10

20

30

40

50

60

70

80


Axis/ICICI SD+1 SD-1 Average

-30

-20

-10

-

10

20

30

40

50

60

70


SBI/BOB SD+1 SD-1 Average

-20

-

20

40

60

80

100

120

140


ICICI/SBI SD+1 SD-1 Average


Testing times ahead, high long term return potential

We initiate coverage on AXSB with a BUY rating and a target price of `555/share

(1.8x FY19E BV). However, we believe near term upside is limited. AXSB’s

stressed loans, ex-GNPAs of 4.53%, were 6.33% as of 1HFY17 (watchlist adjusted

for overlaps). Much of these loans are likely to slip into GNPAs, keeping

slippage ratios and loan loss provisions elevated in FY17E/18E. Although the

level of stressed assets is estimated to show gradual improvement, the absolute

levels would only normalize by FY19E/20E. Such asset quality would impact

margins and fee income too. AXSB would, however, benefit from its retail

franchise which would counter-balance the corporate franchise with its higher

growth, better margins and better asset quality. In the near term though,

stressed loan formation would be an overhang on the stock’s performance.

High stressed loan formation in FY17E/18E, improvement by FY19E: We

estimate stressed loans would peak at 14.6% in FY17E, as compared to 10.7%

currently with further slippages expected from the restructured loans and

watchlist. Progressively, while total impaired loans would subside, the mix of

GNPAs in impaired loans would rise substantially. This would lead to higher loan

loss provisions, which we estimate would be c.285bps in FY17E, 160bps in

FY18E and 120bps in FY19E. This compares with an average of 79bps over

FY06-16. AXSB’s slippages outside the watchlist are 1.4% of opening loans,

indicating high degree of residual stress.

Gradual improvement in operating performance: Operating performance of

the retail portfolio is likely to buoy the overall earnings growth. Strong retail

loan growth, superior margins and fee income growth and lower stressed retail

loans would prop-up PPoP RoA over FY16-19E. The offsetting factor would be the

pressure on corporate loan growth, low corporate margins given interest

reversals and higher share of refinance and moderating corporate fee income.

PPoP RoA will likely trough at 3% over FY16-19E while RoA would trough at

c.0.9% in FY17E and recover to c.1.4% by FY19E. RoA is unlikely to retrace to 1.6-

1.7% levels in the medium term in our view.

Lower normalised return ratios warrant lower multiples: AXSB’s RoA and RoE

averaged 1.65% and 18.5% respectively over FY10-16. Due to the factors

highlighted above, we estimate the average RoA and RoE over FY16-19E to be

1.2% and 13% respectively. Such significant reduction in return ratios would

warrant a compression in valuation multiples. Partially, such a compression has

been factored into the stock price with the stock at 1.6x FY19E BV. However, we

would ascribe a fair value multiple of 1.8x (`555/share) for the medium term

considering profitability metrics have been revised down to a new normal. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 1165.1 / US$ 17.1

Shares in issue (mn) 2,382.8

Diluted share (mn) 2,382.8

3-mon avg daily val (mn) ` 4299.1/US$ 63.3

52-week range ` 638.3/366.7

Sensex/Nifty 27,236/8,398

`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 3.0 -6.1 30.2

Relative* 0.2 -5.1 18.8

* To the BSE Sensex

Shareholding Pattern (%)

Dec-16 Mar-16

Promoters 28.9 29.7

FII 51.9 40.9

DII 10.5 15.7

Public / others 8.7 13.6

-20%

0%

20%

40%

60%

80%

100%

0

100

200

300

400

500

600

700

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

AXIS Bank

AXIS Bank Relative to Sensex (RHS)

Axis Bank | AXSB IN

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage Price: `486

BUY

12M Target: `555

Exhibit 1. Axis Bank: Financial Summary (Standalone) (` bn)

Y/E March FY15 FY16E FY17E FY18E FY19E

Net Profit 73.6 82.2 50.5 83.0 110.5

Net Profit (YoY) (%) 18.3% 11.8% -38.6% 64.2% 33.2%

Assets (YoY) (%) 20.5% 13.8% 17.5% 16.7% 17.8%

ROA (%) 1.7% 1.7% 0.9% 1.2% 1.4%

ROE (%) 17.8% 16.8% 9.2% 13.7% 16.1%

EPS (`) 31.0 34.5 21.2 34.8 46.4

EPS (YoY) (%) 17.3% 11.2% -38.6% 64.2% 33.2%

P/E (x) 15.7 14.1 22.9 14.0 10.5

BV (`) 188.5 223.1 238.4 269.5 308.3

BV (YoY) (%) 15.8% 18.4% 6.9% 13.1% 14.4%

P/BV (x) 2.6 2.2 2.0 1.8 1.6

Source: Company data, JM Financial. Note: Valuations as of 17/01/2017








Certification.

Axis Bank 18 January 2017


Exhibit 2. : DuPont Analysis (%)

Y/E March FY15 FY16 FY17E FY18E FY19E Remarks / Observations

NII / Assets (%) 3.4% 3.4% 3.2% 3.2% 3.3% High interest reversals, lower yields on corporate portfolio and competitive

pressure on retail margins would result in muted NIMs

Core other income / Assets (%) 1.7% 1.7% 1.5% 1.5% 1.5%

Corporate fees could still slow down meaningfully and so could translation gains

Other income / Assets (%) 2.0% 1.9% 2.0% 1.9% 1.8%

Total Income / Assets (%) 5.3% 5.3% 5.2% 5.1% 5.1%

Employee Cost to Assets (%) 0.7% 0.7% 0.7% 0.7% 0.7% Competitive pressures would keep investments in technology and operations high.

AXSB has state-of-the-art back-end systems which would require continuous

investments and upgradation

Other Cost to Assets (%) 1.4% 1.4% 1.4% 1.4% 1.4%

Cost to Assets (%) 2.2% 2.0% 2.1% 2.1% 2.1%

PPP / Assets (%) 3.2% 3.3% 3.2% 3.0% 3.0%

Provisions / Assets (%) 0.6% 0.8% 1.8% 1.2% 0.9% Asset quality pressures would remain elevated, keeping loan losses high

PBT / Assets (%) 2.6% 2.5% 1.3% 1.9% 2.1%

Core ROA (%) 1.7% 1.7% 0.9% 1.2% 1.4% Substantially lower RoA as compared to its long term averages would weigh on

stock performance ROA (%) 1.7% 1.7% 0.9% 1.2% 1.4%


Exhibit 3. Axis Bank: One-year forward P/BV (x) and one-year forward PE (x)

Source: Bloomberg, JM Financial.

Key risk to our call:-

Sharp reduction in stressed asset formation: A recovery in corporate asset

quality, whether driven by low interest rates, faster loan work-outs or

increasing commodity prices would result in lower-than-estimated stressed

asset formation. This would have the dual impact of better revenue

recognition, higher corporate fee income and lower loan loss provisions.

AXSB’s earnings performance would be greatly improved in the event of

such an upturn.

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17

Axis Fwd. P/BV (x) SD+1 SD-1 Average

4

9

14

19

24

29


Axis Fwd. P/E (x) SD+1 SD-1 Average



Key data and outlook

Exhibit 4. Axis Bank: Composition of top 10 sectors in the watch-list

Fund based Exposures 4Q16 1Q17 2Q17

Sector Amount

(`bn)

%

mix

Amount

(`bn)

%

mix

Amount

(`bn)

%

mix

Iron and Steel 54.3 24% 52.8 26% 16.5 12%

Power 52.0 23% 54.8 27% 56.5 41%

Textiles 15.8 7% 14.2 7% na na

Services 13.6 6% na na na na

Oil and Gas 13.6 6% 12.2 6% 17.9 13%

Mining 11.3 5% 6.1 3% na na

Infra & Construction 11.3 5% 12.2 6% 11.0 8%

CRE 9.1 4% 8.1 4% 2.8 2%

Cement 9.1 4% 6.1 3% 6.9 5%

Shipping 6.8 3% 6.1 3% 4.1 3%

Industrials na na 6.1 3% na na

Other 29.4 13% 30.4 15% 22.1 16%

Total fun based exposure 226.3 100% 203.0 100% 137.9 100%

Non- Fund Based Exposures 26.3 25.6 19.0

Total Exposure (FB+NFB) 252.5 228.6 156.9

Reduction in Funded Watchlist

39%

Reduction in Total Watchlist 38%


Exhibit 5. Axis Bank: Stressed asset trends should would decline adequately only by FY19E


Exhibit 6. Axis Bank: Outstanding impaired asset break up

Outstanding as on Sep’16 (` bn) 2Q17

GNPA 163.8

Restructured 67.0

5/25 scheme 50.1

Strategic Debt Restructuring 10.6

Security receipts 14.0

Watchlist (Ex-5/25, SDR and restructured) 82.0

Total Impaired asset 387.5

As a % of Loans 10.7%


1.1% 1.2% 1.4% 1.4%1.8%

6.2%

5.3%

4.4%

3.3%

0.3% 0.4% 0.4% 0.5%0.7%

3.2%2.7%

2.0%

1.2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%


Gross NPLs (%) Net NPLs (%) Coverage (RHS) (%)

2.8% 3.3%

4.8%5.3%

10.7%

14.6%

11.7%

9.2%

6.7%

0.0%

4.0%

8.0%

12.0%

16.0%


Gross NPLs (%) Restructured standard(%) Other Impaired



Financial Tables (Standalone)

Profit & Loss (` bn)

Y/E March FY15 FY16 FY17E FY18E FY19E

Net Interest Income 142.2 168.3 185.5 216.9 259.1

Profit on Investments 9.9 10.2 25.0 25.0 25.0

Exchange Income 9.8 12.8 11.0 13.0 15.2

Fee & Other Income 63.9 70.8 77.5 87.0 101.1

Non-Interest Income 83.7 93.7 113.5 125.0 141.3

Total Income 225.9 262.0 299.1 341.9 400.3

Operating Expenses 92.0 101.0 118.9 139.2 162.9

Pre-provisioning Profits 133.9 161.0 180.1 202.6 237.4

Loan Loss Provisions 20.8 41.9 110.0 72.6 65.9

Provisions on Investments -0.5 0.8 -1.0 0.0 0.0

Other Provisions 3.0 -5.6 -5.0 5.0 5.0

Total Provisions 23.3 37.1 104.0 77.6 70.9

PBT 110.6 123.9 76.2 125.0 166.6

Tax 37 42 26 42 56

PAT (Pre-Extra ordinaries) 73.6 82.2 50.5 83.0 110.5

Extraordinaries (Net of Tax) 0.0 0.0 0.0 0.0 0.0

Reported Profits 73.6 82.2 50.5 83.0 110.5

Dividend 13 0 14 9 18

Retained Profits 60.5 82.2 36.5 74.1 92.4


Balance Sheet (` bn)


Equity Capital 4.7 4.8 4.8 4.8 4.8

Reserves & Surplus 442.0 526.9 563.4 637.5 729.9

Deposits 3,224.4 3,579.7 4,224.0 4,942.1 5,856.4

Borrowings 797.6 992.3 1,191.3 1,389.2 1,620.1

Other Liabilities 150.6 151.1 188.9 226.6 267.4

Total Liabilities 4,619.3 5,254.7 6,172.4 7,200.3 8,478.6

Investments 1,323.4 1,220.1 1,442.2 1,667.1 1,947.2

Net Advances 2,810.8 3,387.7 3,929.8 4,597.8 5,451.0

Cash & Equivalents 361.0 499.8 632.2 692.2 801.7

Fixed Assets 25.1 35.2 39.5 44.0 49.2

Other Assets 98.9 111.8 128.6 199.2 229.4

Total Assets 4,619.3 5,254.7 6,172.4 7,200.3 8,478.6


Key ratios (%)


Growth (YoY) (%)

Deposits 14.8% 11.0% 18.0% 17.0% 18.5%

Advances 22.2% 20.5% 16.0% 17.0% 18.6%

Total Assets 20.5% 13.8% 17.5% 16.7% 17.8%

NII 19.0% 18.3% 10.2% 16.9% 19.5%

Non-Interest Income 13.0% 12.0% 21.1% 10.1% 13.0%

Operating Expenses 16.5% 9.7% 17.7% 17.1% 17.0%

Operating Profits 16.8% 20.3% 11.9% 12.5% 17.2%

Core Operating Profits 11.3% 21.7% 2.8% 14.5% 19.6%

Provisions 10.5% 59.3% 180.3% -25.4% -8.7%

Reported PAT 18.3% 11.8% -38.6% 64.2% 33.2%

Yields / Margins (%)

Interest Spread (%) 2.84% 2.92% 2.79% 2.85% 2.95%

NIM (%) 3.46% 3.51% 3.34% 3.35% 3.42%

Profitability (%)

Non-IR to Income (%) 37.0% 35.8% 38.0% 36.6% 35.3%

Cost to Income (%) 40.7% 38.5% 39.8% 40.7% 40.7%

ROA (%) 1.74% 1.67% 0.88% 1.24% 1.41%

ROE (%) 17.8% 16.8% 9.2% 13.7% 16.1%

Assets Quality (%)

Slippages (%) 1.25% 2.63% 6.90% 4.00% 3.00%

Gross NPAs (%) 1.45% 1.78% 6.17% 5.34% 4.43%

Net NPAs (%) 0.47% 0.74% 3.20% 2.65% 1.97%

Provision Coverage (%) 68.0% 58.6% 49.8% 51.7% 56.6%

Specific LLP (%) 0.70% 1.23% 2.85% 1.60% 1.20%

Net NPAs / Networth (%) 2.95% 4.74% 22.10% 18.98% 14.65%

Capital Adequacy (%)

Tier I (%) 12.07% 12.51% 11.40% 11.11% 10.85%

CAR (%) 15.09% 15.29% 14.39% 13.94% 13.48%


DuPont Analysis (%)


NII / Assets (%) 3.37% 3.41% 3.25% 3.24% 3.30%



Cost to Assets (%) 2.18% 2.05% 2.08% 2.08% 2.08%

PPP / Assets (%) 3.17% 3.26% 3.15% 3.03% 3.03%

Provisions / Assets (%) 0.55% 0.75% 1.82% 1.16% 0.90%

PBT / Assets (%) 2.62% 2.51% 1.33% 1.87% 2.12%

Tax Rate (%) 33.5% 33.6% 33.6% 33.6% 33.6%

ROA (%) 1.74% 1.67% 0.88% 1.24% 1.41%

RoRWAs (%) 2.34% 2.20% 1.15% 1.61% 1.83%

Leverage (x) 10.2 10.1 10.4 11.0 11.4

ROE (%) 17.8% 16.8% 9.2% 13.7% 16.1%


Valuations


Shares in issue (mn) 2,370.5 2,382.8 2,382.8 2,382.8 2,382.8

EPS (`) 31.0 34.5 21.2 34.8 46.4

EPS (YoY) (%) 17.3% 11.2% -38.6% 64.2% 33.2%

P/E (x) 15.7 14.1 22.9 14.0 10.5

BV (`) 188 223 238 270 308

BV (YoY) (%) 15.8% 18.4% 6.9% 13.1% 14.4%

P/BV (x) 2.58 2.18 2.04 1.80 1.58

DPS (`.) 5.5 5.9 3.7 7.6 10.5

Div. yield (%) 1.1% 1.2% 0.8% 1.6% 2.2%



It’s a long climb still

BoB is currently in the process of repairing its balance sheet, re-organising its

businesses and improving its core revenue generation capability to bolster

profitability. Stock catalysts have been the appointment of a CEO from the

private sector, subsequent aggressive NPA recognition and increased focus on

core operations. Various exercises across products, operations, technology,

systems, et al are underway, manned by external consultants and internal core

teams. We estimate these will improve RoA from 32bps in FY17E to c.66bps by

FY19E. Risks to such an outcome could be from i) sustained high slippage

ratios, ii) execution risks delaying the pace of improvement, iii) an increase in

compensation package of employees or iv) the decision to merge a weaker

bank(s) with BoB. These could significantly alter the current estimates of

recovery and capital requirement. The bank is trading at 0.8x FY19E BV or 1.25x

FY19E ABV which factors in significant improvement already. Hence, we initiate

coverage with HOLD and a target price of `177/share (0.9x FY19E BV).

Lower concentration risk versus peers, better capitalisation: As compared to

peers, BoB has inherited relatively lower loan concentration in highly leveraged

sectors. It has also reduced exposures to these sectors over the past two years.

BoB also has a higher mix of retail credit – average c.19% of total domestic credit

over FY08-16 – which further reduces the concentration risk. Its CET 1 ratio of

10.09% as of 2QFY17 is second only to that of SBI and Indian Bank. This is

without dilution in FY17E, unlike SBI. We believe BoB would have a much better

risk appetite and higher growth and solvency capital versus peers.

Operating parameters would improve over FY16-19E: Focus on high margin

business and CASA, fewer interest reversals due to waning slippages and higher

contribution of fees through cross-selling would improve BoB’s operating

revenue growth to 9% Cagr over FY16-19E. Despite cost rationalization

measures, incremental expenditure on technology and manpower will remain

high due to competitive pressures. We factor in moderation in slippage ratios

from 6.6% in FY16 to 3.25% in FY18E. This, along with better resolution, would

bring down the GNPA ratio from 11.4% as of 2QFY17 to c.8.7% by FY19E.

Valuations already primed for strong earnings recovery: BoB is currently

trading at 0.8x FY19E BV (1.25x ABV). This is at a premium to most peers and at

par with SBI. We estimate RoA to improve from 0.32% from FY17E to c.0.7% by

FY19E and RoE to improve to 11.6% by then as well. The current trading

multiples are adequately pricing in a strong recovery in our opinion. We do not

expect BoB to receive a significant premium over SBI. Along with various risks

highlighted above, we believe the stock has limited upside hereon. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 366.5 / US$ 5.4




52-week range ` 179.6/109.4


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute -0.4 5.4 26.1

Relative* -3.2 6.4 14.7

* To the BSE Sensex


Dec-16 Mar-16

Promoters 59.2 59.2

FII 12.1 11.5

DII 21.2 22.3


-30%

-20%

-10%

0%

10%

20%

30%

40%

0

50

100

150

200

250


Bank of Baroda

Bank of Baroda Relative to Sensex (RHS)

Bank of Baroda | BOB IN

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage

Price: `159

HOLD

12M Target: `177

Exhibit 1. BOB: Financial Summary (Standalone) (` bn)


Net Profit 34.0 -54.0 21.1 33.6 50.0

Net Profit (YoY) (%) -25.2% NM NM 58.7% 49.0%

Assets (YoY) (%) 8.4% -6.5% 0.9% 6.4% 9.9%

ROA (%) 0.5% -0.8% 0.3% 0.5% 0.7%

ROE (%) 9.2% -14.4% 5.7% 8.5% 11.6%

EPS (`) 15.3 -23.4 9.2 14.5 21.6

EPS (YoY) (%) -27.3% NM NM 58.7% 49.0%

P/E (x) 10.5 -6.9 17.5 11.0 7.4

BV (`) 175.2 156.1 164.4 177.4 196.9

BV (YoY) (%) 8.0% -10.9% 5.3% 8.0% 11.0%

P/BV (x) 0.9 1.0 1.0 0.9 0.8









Certification.

Bank of Baroda 18 January 2017




NII / Assets (%) 1.9% 1.8% 2.0% 2.0% 2.1% Margin expansion due to fewer interest reversals, higher margin lending and reducing

cost of funds

Core other income / Assets (%) 0.5% 0.6% 0.6% 0.7% 0.8% More focus on third party distribution, transaction banking, higher share of wallet of

corporate/SME customers and recoveries should drive fees Other income / Assets (%) 0.6% 0.7% 0.9% 1.0% 1.0%


Employee Cost to Assets (%) 0.6% 0.7% 0.7% 0.7% 0.7%

Little scope of improvement since a lot of initiatives in operations and technology are

cost intensive. Other Cost to Assets (%) 0.5% 0.6% 0.6% 0.6% 0.7%

Cost to Assets (%) 1.1% 1.3% 1.3% 1.3% 1.4%

PPP / Assets (%) 1.4% 1.3% 1.6% 1.6% 1.7%

Provisions / Assets (%) 0.7% 2.2% 1.1% 0.9% 0.7% Moderation in loan losses due to declining slippages, increased recoveries and turn in

NPA cycle

PBT / Assets (%) 0.8% -1.0% 0.5% 0.7% 1.0%

Core ROA (%) 0.5% -0.8% 0.3% 0.5% 0.7% Expect substantial RoA improvement, but it would be off a low base. Absolute levels

would still remain low ROA (%) 0.5% -0.8% 0.3% 0.5% 0.7%


Exhibit 3. BOB: One-year forward P/BV (x)


Key risks to our call:-

Continued stressed asset formation: While we are building in moderation

in stressed asset formation, the pace of resolutions remains uncertain. A

delay in the pace of resolution or sustained stressed asset formation might

keep loan loss provisions higher for longer.

Execution risks: It might take much longer than anticipated to implement

new operational procedures, develop new tools and change the

organizational approach from more traditional methods to newer ones. Most

of the senior and mid-management cadre would have been with the bank for

long and might find it time-taking to adjust to new ways of banking.

Threat of a merger of a weaker bank: BoB is among the better banks in the

system with stronger capitalization and asset quality metrics than many

smaller PSBs. If the Bank Board Bureau or the government decides to

consolidate PSBs, BoB could be in contention to absorb a smaller bank. This

would significantly worsen capital ratios, operating metrics and throw the

recovery process off-track until integration challenges are addressed.

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00


BOB Fwd. P/BV (x) SD+1 SD-1 Average




Exhibit 4. BOB: Watch list accounts - FY17 and flow rate scenario (as per company) (` bn)

Sector High confidence accounts Watch list accounts Total

Restructured loans 73.0 64.3 137.3

SMA-2 57.6 73.9 131.5

Sub-total 130.6 138.2 268.8

Estimated slippages 150.0

Estimated recovery and upgradations 100.0

Net flow to NPLs 50.0

High side scenario 100.0

Likely case scenario 50.0

Best case scenario 30.0


Exhibit 5. BOB: Contribution of stressed sector to total funded and non-funded exposure (%)

FY15 FY16 2Q17

Name of the sector Fund based Non-Fund based Fund based Fund based Fund based Non-fund based

Iron & Steel 4.2% 5.0% 4.2% 4.6% 4.0% 5.8%

Power 5.0% 3.7% 4.8% 3.0% 4.0% 4.0%

Other Infra 4.0% 7.0% 4.1% 6.5% 3.9% 9.5%

Gems & Jewellery 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%

Construction 0.4% 7.7% 2.2% 2.0% 2.6% 2.4%

Textiles 4.4% 4.8% 4.1% 3.6% 3.9% 3.5%

Total for 7 sectors 18.1% 28.3% 19.5% 19.8% 18.4% 25.2%


Exhibit 6. BOB: Stressed asset resolutions to improve


Exhibit 7. BOB: Outstanding impaired asset break up (1H17) (%)

Outstanding as on 30th

Sept 2016 (` bn) 2Q17

GNPA 429.4

Restructured 138.6

5/25 scheme 25.8







0%

10%

20%

30%

40%

50%

60%

70%

80%

0%

2%

4%

6%

8%

10%

12%

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E


6.2%

8.4% 8.5%9.6%

17.0% 16.5%

13.1%

11.1%

9.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%


Gross NPLs (%) Restructured Standard(%) Other Impaired Loans








Exchange Income 10.1 12.5 11.9 13.3 15.3

Fee & Other Income 23.9 25.7 30.3 36.1 41.5


Total Income 175.9 177.4 192.5 207.5 230.7




Provisions on Investments -1.5 3.4 1.0 1.0 1.0

Other Provisions 3.1 14.2 0.5 0.8 0.5


PBT 54.2 -67.0 31.6 50.1 74.6

Tax 20.2 -13.0 10.4 16.5 24.6

PAT (Pre-Extra ordinaries) 34.0 -54.0 21.1 33.6 50.0


Reported Profits 34.0 -54.0 21.1 33.6 50.0

Dividend 8.5 0.0 2.1 3.4 5.0

Retained Profits 25.5 -54.0 19.0 30.2 45.0




Equity Capital 4.4 4.6 4.6 4.6 4.6


Deposits 6,175.6 5,740.4 5,797.8 6,203.6 6,824.0

Borrowings 352.6 334.7 314.6 307.8 336.7



Investments 1,223.2 1,204.5 1,315.1 1,338.3 1,451.5

Net Advances 4,280.7 3,837.7 3,760.9 4,137.0 4,633.5

Cash & Equivalents 1,483.5 1,399.0 1,372.5 1,428.4 1,549.8

Fixed Assets 18.9 21.3 21.5 22.1 23.5

Other Assets 133.8 210.0 263.5 241.7 215.9

Total Assets 7,140.0 6,672.5 6,733.5 7,167.7 7,874.2


Key ratios (%)


Growth (YoY) (%)

Deposits 8.6% -7.0% 1.0% 7.0% 10.0%

Advances 7.8% -10.3% -2.0% 10.0% 12.0%

Total Assets 8.4% -6.5% 0.9% 6.4% 9.9%

NII 10.2% -3.4% 4.6% 5.1% 10.6%

Non-Interest Income -1.4% 13.6% 18.3% 14.0% 12.4%

Operating Expenses 8.5% 16.3% -1.3% 6.2% 9.7%

Operating Profits 6.0% -11.1% 18.4% 9.2% 12.4%

Core Operating Profits 3.5% -14.3% 14.5% 9.8% 13.7%

Provisions 18.5% 245.2% -53.0% -12.3% -16.2%

Reported PAT -25.2% -258.8% -139.2% 58.7% 49.0%


Interest Spread (%) 1.67% 1.59% 1.81% 1.85% 1.86%

NIM (%) 1.96% 1.90% 2.07% 2.10% 2.13%

Profitability (%)

Non-IR to Income (%) 25.0% 28.2% 30.7% 32.5% 32.9%

Cost to Income (%) 43.6% 50.3% 45.7% 45.1% 44.4%

ROA (%) 0.50% -0.78% 0.32% 0.48% 0.66%

ROE (%) 9.2% -14.4% 5.7% 8.5% 11.6%

Assets Quality (%)

Slippages (%) 2.18% 6.63% 4.50% 3.25% 3.00%

Gross NPAs (%) 3.73% 10.01% 11.21% 9.78% 8.66%

Net NPAs (%) 1.89% 5.06% 5.28% 3.99% 3.33%


Specific LLP (%) 0.92% 3.45% 1.85% 1.50% 1.10%



Tier I (%) 9.87% 10.79% 11.06% 11.02% 10.86%

CAR (%) 12.60% 13.17% 13.37% 13.42% 13.28%


DuPont Analysis (%)


NII / Assets (%) 1.92% 1.84% 1.99% 2.01% 2.06%



Cost to Assets (%) 1.12% 1.29% 1.31% 1.35% 1.36%

PPP / Assets (%) 1.44% 1.28% 1.56% 1.64% 1.70%


PBT / Assets (%) 0.79% -0.97% 0.47% 0.72% 0.99%

Tax Rate (%) 37.3% 19.4% 33.0% 33.0% 33.0%

ROA (%) 0.50% -0.78% 0.32% 0.48% 0.66%

RoRWAs (%) 0.91% -1.40% 0.54% 0.83% 1.12%

Leverage (x) 18.6 18.4 18.1 17.6 17.4

ROE (%) 9.2% -14.4% 5.7% 8.5% 11.6%


Valuations



EPS (`) 15.3 -23.4 9.2 14.5 21.6

EPS (YoY) (%) -27.3% NM NM 58.7% 49.0%

P/E (x) 10.5 -6.9 17.5 11.0 7.4

BV (`) 175 156 164 177 197

BV (YoY) (%) 8.0% -10.9% 5.3% 8.0% 11.0%

P/BV (x) 0.9 1.0 1.0 0.9 0.8

DPS (`.) 3.8 0.0 0.9 1.5 2.2

Div. yield (%) 2.4% 0.0% 0.6% 0.9% 1.3%



Would maintain its leadership position

HDFCB enjoys a leadership position in the Indian banking system due to a top

notch management team which has built an institution based on clearly-laid-out

processes and an ability to straddle both retail and wholesale segments. A

robust retail liability franchise, ability to rapidly adapt to a shifting landscape

and moderate risk appetite are critical competitive advantages. Despite its size,

HDFCB will continue to gain market share in loans and deposits given its multi-

channel approach and large addressable market. Adequate capital, best-in-class

manpower, superior profitability and earnings trajectory would keep the

hegemony unchallenged in the medium term. We value HDFCB at 3.35x FY19E

BVPS or `1501/share. It is a preferred pick.

Loan growth to sustain a CAGR of 20%, current mix would be maintained:

Even with a 20% CAGR in loan growth, HDFCB would gain c.190bps in market

share over FY16-20E. HDFCB would be able to grow faster than the system due

to expanding reach, customer acquisition from PSU banks, smaller private banks

and NBFCs and increasing cross-selling to existing customers. The bank is likely

to sustain its c.50:50 mix between retail and non-retail loans. However,

unsecured lending within retail loans could increase further. Retail liability

franchise will continue to be cornerstone of its liabilities. With lower interest

rates, the threat to SA from differential rate offering of competitors will reduce.

Strong performance, superior profitability through FY19E: Margins would

sustain between 4.3-4.4% over FY16-19E. The drop in funding costs and higher

mix of retail loans would offset the margin pressures from dropping yields. Core

fee contribution to total income would remain at c.20% while cost ratios would

decline only marginally since savings through efficiency gains would be

reinvested into analytics, technology, alternate channels development and more.

HDFCB carries 25bps floating provisions and has a 70% provision coverage ratio

with best-in-class asset quality. We estimate 19% CAGR in EPS through FY16-19E.

Compounding to sustain, so would valuation premium: HDFCB chooses to

bypass certain forms of lending and fee income which other banks are not shy

of taking. This underscores the discipline and adherence to processes within the

bank. That which the bank is giving up by way of growth or additional fee

income, it is making up for in terms of quality. Such philosophy is likely to

continue at the bank, such that the current balance of loan growth, CASA mix,

asset-liability matching, profitability and earnings trajectory are maintained. RoA

and RoE would continue at c.1.9% and 19-20% respectively through FY16-19E.

HDFCB is currently trading at 2.8x FY19E BV but below its 10-year average PB.

We believe this is an attractive opportunity to buy the stock. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 3161.9 / US$ 46.5




52-week range ` 1318.5/928.0


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 4.8 0.1 18.8

Relative* 1.9 1.1 7.5

* To the BSE Sensex


Dec-16 Mar-16

Promoters 21.4 21.5

FII 32.2 32.2

DII 11.2 11.2


-10%

0%

10%

20%

30%

40%

50%

60%

0

200

400

600

800

1000

1200

1400


HDFC Bank

HDFC Bank Relative to Sensex (RHS)

HDFC Bank | HDFCB IN

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage

Price: `1,238

BUY

12M Target: `1,501

Exhibit 1. HDFC Bank: Financial Summary (Standalone) (` bn)


Net Profit 102.2 123.0 147.1 173.7 208.1

Net Profit (YoY) (%) 20.5% 20.4% 19.7% 18.1% 19.8%

Assets (YoY) (%) 20.1% 20.0% 19.0% 19.3% 19.9%

ROA (%) 1.9% 1.9% 1.9% 1.9% 1.9%

ROE (%) 19.4% 18.3% 18.8% 19.2% 19.8%

EPS (`) 40.8 48.6 58.2 68.7 82.3

EPS (YoY) (%) 15.3% 19.3% 19.7% 18.1% 19.8%

P/E (x) 30.4 25.5 21.3 18.0 15.0

BV (`) 247.4 287.5 331.9 384.5 448.1

BV (YoY) (%) 36.5% 16.2% 15.5% 15.9% 16.5%

P/BV (x) 5.0 4.3 3.7 3.2 2.8









Certification.

HDFC Bank 18 January 2017


Exhibit 2. HDFC Bank: DuPont Analysis (%)


NII / Assets (%) 4.1% 4.2% 4.2% 4.2% 4.2% Margins could moderate slightly despite higher retail loans and declining cost of

funds offsetting the pressure of falling yields


Contribution of core fee income would remain low as compared to other banks, but

would largely sustain at current levels Other income / Assets (%) 1.7% 1.7% 1.6% 1.6% 1.6%



All cost savings through efficiency would be channeled into analytics, technology,

omni-channel approach, etc. Other Cost to Assets (%) 1.7% 1.7% 1.7% 1.7% 1.7%

Cost to Assets (%) 2.6% 2.6% 2.6% 2.5% 2.5%

PPP / Assets (%) 3.2% 3.3% 3.3% 3.3% 3.3%

Provisions / Assets (%) 0.4% 0.4% 0.4% 0.4% 0.4% Expect loan losses to be moderate

PBT / Assets (%) 2.8% 2.9% 2.9% 2.8% 2.8%

Core ROA (%) 1.9% 1.9% 1.9% 1.9% 1.9%

Best-in-class profitability

ROA (%) 1.9% 1.9% 1.9% 1.9% 1.9%


Exhibit 3. HDFCB Bank: One-year forward P/BV (x) and one-year forward PE (x)



Moderation in the momentum of retail credit growth: HDFCB’s high

dependence on retail assets for revenues and maintenance of low credit

costs on this portfolio is the key to overall profitability. A slowdown in retail

credit due to either macro-economic factors or continued slowdown in

corporate revenues might well impact growth, margins and loan loss

provisions for the Bank. HDFCB, however, has an extremely diversified retail

asset portfolio with a customer base spanning the HNI to mass market. Such

a risk has low probability of materialization and would have to be

widespread as well.

Loss of SA balances due to deregulation of savings bank rates: HDFCBs

savings accounts as a proportion of overall deposits have declined from

48.6% as of 3QFY12 to 40.4% as of 1HFY17. The decline can be ascribed to

the introduction of sweep deposits whereby SA balances are transferred to

term deposits and deregulation of savings bank interest rates whereby some

balances would have migrated to private banks offering differential rate

deposits. Further loss of SA balances or proportion would be detrimental to

the low funding costs at the bank. However, with a decline in interest rates,

we believe the interest rate differential between both term deposits and

differential rate savings product would diminish. We do not see this as an

imminent risk.

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5


HDFCB Fwd. P/BV (x) SD+1 SD-1 Average

8

12

16

20

24

28

32

36


HDFCB Fwd. P/E (x) SD+1 SD-1 Average




Exhibit 4. HDFC Bank: Loan book split

Loans (` bn) Loan Mix (%)

Customer Assets - As per internal classification FY14 FY15 FY16 2Q17 FY14 FY15 FY16 2Q17

Commercial Vehicle & Construction Equipment 230 249 309 336 7.5% 6.8% 6.6% 6.7%

Car Loans 388 468 573 644 12.7% 12.7% 12.2% 12.9%

2 wheeler loans 41 51 64 71 1.4% 1.4% 1.4% 1.4%

Sub-total - Auto Loans (Personal + Commercial) 660 768 946 1,051 21.6% 20.9% 20.2% 21.1%

Home Loans 193 241 319 336 6.3% 6.6% 6.8% 6.7%

Business Banking (includes LAP) 425 499 611 658 13.9% 13.6% 13.1% 13.2%

Loan against Securities 11 14 19 21 0.4% 0.4% 0.4% 0.4%

Gold Loans 41 41 46 51 1.3% 1.1% 1.0% 1.0%

Total Secured Retail loans (A) 1,330 1,562 1,940 2,116 43.6% 42.4% 41.5% 42.5%

Personal loans 206 260 377 450 6.7% 7.1% 8.1% 9.0%

Credit Cards 123 162 205 213 4.0% 4.4% 4.4% 4.3%

Other Retail 90 110 146 163 3.0% 3.0% 3.1% 3.3%

Total Unsecured Retail loans (B) 419 532 729 826 13.7% 14.5% 15.6% 16.6%

Domestic retail Total (A+B) 1,748 2,094 2,669 2,943 57.3% 56.9% 57.1% 59.1%

Kisan Gold Card (Agri loans) 105 163 229 249 3.5% 4.4% 4.9% 5.0%

Domestic wholesale 954 1,133 1,455 1,455 31.3% 30.8% 31.1% 29.2%

Overseas 244 291 323 334 8.0% 7.9% 6.9% 6.7%

Total Customer Assets 3,052 3,680 4,677 4,980 100.0% 100.0% 100.0% 100.0%


Exhibit 5. HDFC Bank: Asset quality to remain stable


Exhibit 6. HDFC Bank: Cost ratios to improve


1.0%1.0% 1.0%

0.9% 0.9%

1.1% 1.1% 1.1% 1.1%

0.2% 0.2%0.3% 0.2% 0.3%

0.4%0.3% 0.3%

0.4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%



1.1%1.0% 1.0% 1.0% 1.0%

1.2% 1.1% 1.1% 1.1%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%


Gross NPLs (%) Total Restructured Other Impaired loans

5%

15%

25%

35%

45%

55%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E

Cost / Assets (LHS) C-I Ratio (RHS)



Exhibit 7. HDFC Bank: Comparison of Funded Exposure to critical sectors (as % of bank’s overall funded exposure)


2.2%

1.7%

2.8%

4.4%

2.5%2.7%

2.1%

5.3%

3.0%

1.9%

2.2%2.3%

5.6%

3.3%

2.1%2.3% 2.3%

5.6%

3.6%

1.9%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Power Real Estate Services Road Transportation Iron and Steel

FY14 FY15 FY16 2Q17








Exchange Income 10.3 12.3 14.5 17.4 20.9

Fee & Other Income 73.9 87.9 102.2 122.1 146.5


Total Income 313.9 383.4 454.8 539.0 642.1




Provisions on Investments 0.0 0.2 -2.0 0.0 0.0



PBT 153.3 186.4 222.9 263.2 315.4

Tax 51.1 63.4 75.8 89.5 107.2




Dividend 24.3 29.0 34.8 40.7 47.3





Equity Capital 5.0 5.1 5.1 5.1 5.1

Reserves & Surplus 615.1 721.7 834.1 967.1 1,127.9

Deposits 4,508.0 5,464.2 6,557.1 7,868.5 9,520.9

Borrowings 452.1 530.2 597.9 705.1 797.8



Investments 1,664.6 1,638.9 1,999.5 2,376.7 2,842.5

Net Advances 3,655.0 4,645.9 5,435.7 6,533.8 7,873.2


Fixed Assets 31.2 33.4 37.3 41.4 46.0

Other Assets 190.9 243.8 324.3 370.2 408.1

Total Assets 5,905.0 7,088.5 8,434.8 10,065.9 12,065.3


Key ratios (%)


Growth (YoY) (%)

Deposits 22.7% 21.2% 20.0% 20.0% 21.0%

Advances 20.6% 27.1% 17.0% 20.2% 20.5%

Total Assets 20.1% 20.0% 19.0% 19.3% 19.9%

NII 21.2% 23.2% 18.9% 18.6% 19.2%





Provisions 30.7% 31.4% 17.6% 29.8% 19.0%

Reported PAT 20.5% 20.4% 19.7% 18.1% 19.8%


Interest Spread (%) 3.62% 3.68% 3.76% 3.79% 3.78%

NIM (%) 4.34% 4.42% 4.41% 4.39% 4.36%

Profitability (%)

Non-IR to Income (%) 28.7% 28.0% 27.9% 27.8% 27.8%

Cost to Income (%) 44.6% 44.3% 43.9% 43.5% 43.2%

ROA (%) 1.89% 1.89% 1.90% 1.88% 1.88%

ROE (%) 19.4% 18.3% 18.8% 19.2% 19.8%

Assets Quality (%)

Slippages (%) 1.59% 1.57% 1.55% 1.50% 1.50%

Gross NPAs (%) 0.93% 0.94% 1.11% 1.10% 1.13%

Net NPAs (%) 0.25% 0.28% 0.35% 0.30% 0.31%


Specific LLP (%) 0.52% 0.51% 0.60% 0.61% 0.60%



Tier I (%) 13.66% 13.22% 12.85% 12.44% 12.15%

CAR (%) 16.79% 15.53% 15.25% 15.04% 14.80%


DuPont Analysis (%)


NII / Assets (%) 4.14% 4.25% 4.23% 4.21% 4.19%



Cost to Assets (%) 2.59% 2.61% 2.57% 2.53% 2.51%

PPP / Assets (%) 3.22% 3.29% 3.29% 3.29% 3.30%


PBT / Assets (%) 2.83% 2.87% 2.87% 2.85% 2.85%

Tax Rate (%) 33.4% 34.0% 34.0% 34.0% 34.0%

ROA (%) 1.89% 1.89% 1.90% 1.88% 1.88%

RoRWAs (%) 2.66% 2.58% 2.53% 2.49% 2.49%

Leverage (x) 10.3 9.6 9.9 10.2 10.5

ROE (%) 19.4% 18.3% 18.8% 19.2% 19.8%


Valuations



EPS (`) 40.8 48.6 58.2 68.7 82.3

EPS (YoY) (%) 15.3% 19.3% 19.7% 18.1% 19.8%

PE (x) 30.4 25.5 21.3 18.0 15.0

BV (`) 247 287 332 385 448

BV (YoY) (%) 36.5% 16.2% 15.5% 15.9% 16.5%

P/BV (x) 5.0 4.3 3.7 3.2 2.8

DPS (`.) 9.7 11.5 13.7 16.1 18.7

Div. yield (%) 0.8% 1.0% 1.2% 1.4% 1.6%



A balanced play

ICICIBC, along with SBI, provides an opportunity to benefit from growth in a

profitable retail franchise while having an exposure to a potential corporate

recovery. Additionally, the subsidiaries are huge value drivers and offer stake

monetization opportunities. The contribution of group companies to ICICBC is

likely to increase and would offset the impact of slower earnings growth in the

bank. ICICIBC has high stressed assets among private peers, and high

concentration to stressed sectors too. On the other hand, its core business has

considerable contribution from retail franchise which supports margins, drives

fees and has lower GNPA ratio. A robust liability franchise, cutting-edge

technology based services and operations, ability to attract the best manpower

in the industry and its scale are durable competitive advantages. The RoA

should improve from c.1.2% in FY17E to c.1.4% by FY19E on the basis of margin

improvement and reduction in loan losses. We initiate coverage with BUY rating

and value ICICIBC at 1.6x FY19E Consolidated BVPS or `326/share.

Asset quality concerns remain high: ICICIBC’s impaired loan ratio of 15.7% as

of 1H17 has highest concentration in iron and steel, mining, cement, power and

rigs. As of 2QFY17, its cumulative exposure to these sectors was down to 11.9%

as compared to 13.3% in FY16, primarily due to slippages. Certain large

corporate loan work-outs which have already been announced will also help in

reduction of such exposure further. Nevertheless, out of the impaired loan ratio

of 15.7%, only 6.8% are classified as NPA. Based on our analysis of highly

leveraged sectors, much of the watchlist would slip into NPAs. Hence, we factor

in high slippage and loan losses in FY17E/18E and moderation thereafter.

Operating profitability to improve in the medium term: Although loan growth

may remain moderate, there will be a rapid shift in the mix towards retail loans.

Declining slippages would also lead to better income recognition over FY16-19E.

However, pressure on corporate yields and interest reversals would limit NIM

expansion over FY16-19E. Some improvement in core fee income and stable cost

ratios would aid expansion in PPoP RoA. Loan loss provisions are likely to

decline from 365bps in FY17E to 170bps in FY19E.

Valuation could rerate marginally, but overhang of NPA would remain:

ICICIBC is currently trading at 1.3x FY19E Consolidated BV and is now trading at

-1 SD below its 10-year average. The de-rating has been an outcome of

heightened stressed asset accrual over 2H16-1H17. With improvement in core

banking earnings and higher contribution of subsidiaries, valuations could re-

rate to 1.6x FY19E Consol BV. However, the overhang of NPA prevent a

substantial rerating unless a sustained corporate recovery cycle sets in.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: : (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 1562.3 / US$ 23.0




52-week range ` 298.4/180.8


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 5.0 3.7 19.6

Relative* 2.2 4.8 8.2

* To the BSE Sensex


Sep-16 Mar-16

Promoters 0.0 0.0

FII 63.2 38.9

DII 27.6 26.1


-30%

-20%

-10%

0%

10%

20%

30%

0

50

100

150

200

250

300

350

400

450


ICICI Bank

ICICI Bank Relative to Sensex (RHS)

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage Price: ` 268

BUY

12M Target: ` 326

ICICI Bank | ICICIBC IN

Exhibit 1. ICICI Bank: Financial Summary (Consolidated) (` bn)


Net Profit 122 102 99 124 153

Net Profit (YoY) (%) 10.8% -15.6% -4.7% 24.2% 22.7%

Assets (YoY) (%) 10.5% 10.9% 11.1% 11.6% 14.2%

ROA (%) 1.6% 1.3% 1.1% 1.2% 1.3%

ROE (%) 16.1% 12.4% 11.0% 12.6% 14.0%

EPS (`.) 22.3 18.8 17.9 22.2 27.3

EPS (YoY) (%) 10.4% -15.8% -4.7% 24.2% 22.7%

P/E (x) 12.0 14.3 15.0 12.1 9.8

BV (`.) 146.1 157.0 169.4 184.8 203.9

BV (YoY) (%) 10.4% 7.5% 7.9% 9.1% 10.3%

P/BV (x) 1.8 1.7 1.6 1.5 1.3





S&P Capital IQ and Factset.




Certification.

ICICI Bank 18 January 2017

JM Financial Institutional Securities Limited Page 46

Exhibit 2. : DuPont Analysis (Standalone) (%)


NII / Assets (%) 3.1% 3.1% 2.8% 2.9% 2.9%

Margins would remain under pressure in the

medium term due to interest reversals and

pressure on corporate yields




Employee Cost to Assets (%) 0.8% 0.7% 0.8% 0.8% 0.8% ICICIBC has invested into development of

cutting edge technology based solutions

across the business. Any savings from


Cost to Assets (%) 1.9% 1.9% 1.9% 1.9% 1.9%

PPP / Assets (%) 3.2% 3.0% 2.8% 2.7% 2.7%


PBT / Assets (%) 2.6% 1.3% 0.7% 1.4% 1.6%

Core ROA (%) 1.8% 1.0% 0.5% 1.0% 1.1%

ROA (%) 1.8% 1.4% 1.2% 1.0% 1.1%


Exhibit 3. : . ICICI Bank: One-year forward P/BV (x) and one-year forward PE (x)



A corporate recovery or a reduction in stressed asset formation for certain

highly leveraged sectors: A recovery in corporate asset quality, whether

driven by low interest rates, faster loan work-outs or increasing commodity

prices would result in lower-than-estimated stressed asset formation. This

would have the dual impact of better revenue recognition, higher corporate

fee income and lower loan loss provisions. ICICI Bank’s earnings

performance would be greatly improved in the event of such an upturn.


Exhibit 4. : . ICICI Bank (Standalone) – Trend in exposure to key stressed sectors

% of total exposure by stressed sectors Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Jun-16 Sep-16

Power 7.3% 6.4% 5.9% 5.5% 5.4% 5.4% 5.0%

Iron and Steel 5.2% 5.1% 5.0% 4.8% 4.5% 4.0% 3.8%

Mining 2.0% 1.7% 1.7% 1.5% 1.6% 1.6% 1.6%

Cement 1.2% 1.4% 1.4% 1.5% 1.2% 1.2% 1.1%

Rigs 0.5% 0.5% 0.8% 0.5% 0.6% 0.5% 0.4%

Total 16.2% 15.1% 14.8% 13.8% 13.3% 12.7% 11.9%

Of which:-

- Sub-investment grade exposures (`bn) 441 387 325

- Sub-investment grade as a % of total exposure 4.8% 4.2% 3.4%


0.5

1.0

1.5

2.0

2.5

3.0

3.5


ICICI Fwd. P/BV (x) SD+1 SD-1 Average

0

5

10

15

20

25

30

35

40

45

50


ICICI Fwd. P/E (x) SD+1 SD-1 Average



Exhibit 5. ICICI Bank (Standalone): Sub-investment grade exposures in five key sectors

Mar-16 Jun-16 Sep-16

Movement in sub-investment grade

exposure

Sub-investment

grade (` bn)

As a % of

respective

sectoral

exposure

Sub-investment

grade (` bn)

As a % of

respective

sectoral

exposure

Sub-investment

grade (` bn)

As a % of

respective

sectoral

exposure

Power 119.6 23.5% 114.3 22.8% 90.0 18.9%

Iron and Steel 90.1 21.2% 49.0 13.2% 47.1 13.0%

Mining 77.8 51.5% 77.3 52.1% 75.8 49.8%

Cement 66.4 58.7% 56.7 51.0% 56.2 53.7%

Rigs 25.1 44.4% 25.6 55.3% 0.4 1.2%

Promoter entities 61.6 64.4 55.3

Total 440.7 35.1% 387.2 32.9% 324.9 28.7%

Restructured book outstanding 85.7 72.4 63.3

Non-fund based exposure to existing NPLs 20.0 33.0 32.9

Total stressed exposure (` bn) 546.4 492.7 421.1


Exhibit 6. ICICI Bank (Standalone): Stressed asset resolutions to improve in the medium term


Exhibit 7. ICICI Bank (Standalone): Outstanding impaired asset break up (1H17)


Sept 2016 (` bn) 2Q17

GNPA 321.8

Restructured 63.3

5/25 scheme 27.0



Sub-investment grade exposure (Ex-5/25, SDR and restructured) 268.8




0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E


4.8% 4.6%5.3%

6.0%

16.0%

11.4%

9.1%

5.9%4.8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%





Financial Tables: ICICI (Standalone)





Exchange Income 20.4 22.7 20.5 23.0 25.4

Fee & Other Income 85.9 92.6 98.5 110.8 125.7


Total Income 312.2 331.7 354.9 396.6 449.3




Provisions on Investments 3.0 1.7 3.0 0.0 0.0

Other Provisions 1.9 48.0 -30.0 0.0 0.0


PBT 158.2 88.2 49.6 120.4 152.4

Tax 46.4 17.9 13.9 33.7 44.2




Dividend (Incld. Tax) 31.7 31.9 27.2 19.8 34.0





Equity Capital 11.6 11.6 11.6 11.6 11.6

Reserves 792.6 857.5 922.8 989.7 1,063.9

Deposits 3,615.6 4,214.3 4,930.7 5,768.9 6,749.6

Borrowings 1,724.2 1,748.1 1,792.4 1,868.7 2,083.0

Other Liab. 317.3 347.3 368.1 423.3 508.0

Total Liab. 6,461.3 7,178.8 8,025.6 9,062.2 10,416.1

Investments 1,865.8 1,604.1 1,813.4 2,021.7 2,314.7

Net Advances 3,875.2 4,352.6 4,861.9 5,615.5 6,514.0

Cash & Equiv. 423.0 879.3 954.0 1,048.3 1,192.6

Fixed Assets 47.3 47.6 51.6 56.5 62.8

Other Assets 250.0 295.1 344.7 320.3 332.0

Total Assets 6,461.3 7,178.8 8,025.6 9,062.2 10,416.1


Key ratios (%)


Growth (YoY) (%)

Deposits 8.9% 16.6% 17.0% 17.0% 17.0%

Advances 14.4% 12.3% 11.7% 15.5% 16.0%

Total Assets 8.7% 11.1% 11.8% 12.9% 14.9%

NII 15.6% 11.5% 1.7% 14.8% 13.9%

Non-Interest Income 16.8% -1.9% 16.4% 7.0% 12.2%



Core Operating Profits 14.8% 10.4% -5.2% 14.2% 14.1%

Provisions 48.5% 199.2% 37.6% -30.3% -0.3%

Reported PAT 13.9% -13.0% -4.8% -6.4% 24.8%


Interest Spread (%) 2.5% 2.5% 2.3% 2.4% 2.4%

NIM (%) 3.2% 3.3% 3.0% 3.0% 3.0%

Profitability (%)

Non-IR to Income (%) 39.0% 36.0% 39.2% 37.5% 37.2%

Cost to Income (%) 36.8% 38.2% 40.8% 41.4% 41.2%

ROA (%) 1.8% 1.4% 1.2% 1.0% 1.1%

ROE (%) 14.5% 11.6% 10.3% 9.0% 10.4%

Assets Quality (%)

Gross NPAs (%) 3.8% 5.8% 8.9% 6.5% 4.1%

Net NPAs (%) 1.6% 3.0% 5.5% 3.9% 2.0%


Specific LLP (%) 0.8% 1.6% 3.7% 2.0% 1.7%



Tier I (%) 12.8% 13.1% 12.7% 12.2% 11.5%

CAR (%) 17.0% 16.6% 16.1% 15.4% 14.7%


DuPont Analysis (%)


NII / Assets (%) 3.07% 3.11% 2.84% 2.90% 2.90%



Cost to Assets (%) 1.85% 1.86% 1.90% 1.92% 1.90%

PPP / Assets (%) 3.18% 3.00% 2.77% 2.72% 2.71%


PBT / Assets (%) 2.55% 1.29% 0.65% 1.41% 1.56%

Tax Rate (%) 29.4% 20.3% 28.0% 28.0% 29.0%

ROA (%) 1.80% 1.43% 1.22% 1.01% 1.11%

RoRWAs (%) 2.14% 1.69% 1.44% 1.20% 1.31%

Leverage (%) 8.1 8.2 8.4 8.8 9.4

ROE (%) 14.5% 11.6% 10.3% 9.0% 10.4%


Valuations



EPS (`.) 19.3 16.7 15.9 14.9 18.6

EPS (YoY) (%) 13.5% -13.2% -4.8% -6.4% 24.8%

PE (x) 13.9 16.1 16.9 18.0 14.4

BV (`.) 139 149 161 172 185

BV (YoY) (%) 9.4% 7.7% 7.5% 7.2% 7.4%

P/BV (x) 1.9 1.8 1.7 1.6 1.5

DPS (Rs.) 5.5 5.5 4.7 3.4 5.9

Div. yield (%) 2.0% 2.0% 1.7% 1.3% 2.2%




Financial Tables (Consolidated)

Profit & Loss (` mn)




Insurance Premium 220.8 263.8 316.6 364.1 415.1

Exchange Income 22.1 23.8 25.9 28.5 31.4

Fee & Other Income 85 91 96 105 116


Total Income 579 674 742 821 928


Pre-provisioning Profits 229 266 283 313 355


Provisions on Investments 4.1 3.0 3.0 4.0 5.4

Other Provisions 1 40 2 2 2

Total Provisions 45 123 217 133 135

PBT 183 143 66 180 220

Tax 54.0 33.8 18.4 50.3 61.7

PAT (Pre-Extra ordinaries) 129 109 47 129 159

Extra ordinaries(Net of Tax) 0.0 0.0 56.8 0.0 0.0

Share of minority interest 7.0 7.5 5.2 5.3 5.4

Share in Associates 0.0 0.0 0.0 0.0 0.0

Reported Profits 122 102 99 124 153

Dividend 33.9 34.6 32.0 39.5 48.0

Retained Profits 89 67 67 85 105


Balance Sheet (` mn)


Equity Capital 11.6 11.6 11.6 11.6 11.6

Reserves & Surplus 835.4 901.2 973.4 1,063.2 1,173.9

Deposits 3,859.6 4,510.8 5,277.6 6,174.8 7,224.5

Borrowings (Incld.

Sub Debt) 2,112.5 2,203.8 2,248.5 2,338.8 2,596.9

Minority Interest 25.1 33.6 35.9 38.3 40.6

Policyholder's

Funds 936.2 970.5 1,067.6 1,110.3 1,243.5



Investments 3,027.6 2,860.4 3,222.5 3,541.7 4,043.3

Net Advances 4,384.9 4,937.3 5,529.8 6,414.5 7,440.9


Fixed Assets 58.7 59.0 35.3 40.4 47.5

Other Assets 313.2 652.3 596.6 504.5 486.0

Total Assets 8,260.8 9,159.4 10,174.1 11,352.5 12,968.1


Key ratios (%)


Growth (YoY) (%)

Deposits 7.4% 16.9% 17.0% 17.0% 17.0%

Advances 13.2% 12.6% 12.0% 16.0% 16.0%

Total Assets 10.5% 10.9% 11.1% 11.6% 14.2%

NII 14.6% 11.7% 0.3% 10.2% 14.2%





Provisions 56.4% 171.3% 76.3% -38.5% 1.0%

Reported PAT 10.8% -15.6% -4.7% 24.2% 22.7%


Interest Spread (%) 1.7% 1.9% 1.7% 1.7% 1.7%

NIM (%) 3.0% 3.1% 2.8% 2.7% 2.7%

Profitability (%)

Non-IR to Income (%) 60.9% 62.5% 65.8% 65.9% 65.6%

Cost to Income (%) 60.5% 60.5% 61.9% 61.9% 61.7%

ROA (%) 1.6% 1.3% 1.1% 1.2% 1.3%

ROE (%) 16.1% 12.4% 11.0% 12.6% 14.0%

Assets Quality (%)

Slippages (%) 2.1% 3.9% 7.9% 4.2% 2.4%

Gross NPAs (%) 3.4% 5.2% 8.8% 6.4% 4.2%

Net NPAs (%) 1.4% 2.6% 5.2% 3.7% 1.9%


Specific LLP (%) 0.9% 1.7% 3.7% 2.0% 1.7%



Tier I (%) 12.9% 13.1% 11.1% 10.9% 10.6%

CAR (%) 17.2% 16.6% 13.9% 13.5% 13.0%


DuPont Analysis (%)


NII / Assets (%) 2.88% 2.90% 2.63% 2.60% 2.63%



Cost to Assets (%) 4.45% 4.68% 4.75% 4.72% 4.71%

PPP / Assets (%) 2.91% 3.06% 2.92% 2.91% 2.92%


PBT / Assets (%) 2.33% 1.64% 0.68% 1.67% 1.81%

Tax Rate (%) 29.4% 23.6% 28.0% 28.0% 28.0%

ROA (%) 1.64% 1.25% 1.08% 1.20% 1.30%

RoRWAs (%) 2.26% 1.72% 1.36% 1.42% 1.54%

Leverage (%) 9.8 9.9 10.2 10.5 10.8

ROE (%) 16.1% 12.4% 11.0% 12.6% 14.0%


Valuations



EPS (`.) 22.3 18.8 17.9 22.2 27.3

EPS (YoY) (%) 10.4% -15.8% -4.7% 24.2% 22.7%

PE (x) 12.0 14.3 15.0 12.1 9.8

BV (`.) 146 157 169 185 204

BV (YoY) (%) 10.4% 7.5% 7.9% 9.1% 10.3%

P/BV (x) 1.8 1.7 1.6 1.5 1.3

DPS (`.) 5.8 6.0 5.5 6.8 8.3

Div. yield (%) 2.2% 2.2% 2.0% 2.5% 3.1%



Doing the right things, perfectly

IIB is perfectly positioned to exploit the vacuum in the banking sector. Its high

capitalisation, smaller size and improving liability profile allows it to deliver

higher-than-system credit growth while maintaining profitability. In the past, the

bank has demonstrated how skilled executioners can enhance the effectiveness

of well-planned strategies. The management team, along with expanding

footprint, effective use of alternate channels and products and ability to provide

solutions using best-in-class technology and manpower provides strong

competitive edge versus peers. We estimate a CAGR of 26% in net profit, c.1.9%

RoA and c.18.5% RoE through FY16-19E for IIB. Consistent earnings and

profitability and lower stressed loans would warrant premium multiples. We

initiate coverage on IIB with a target price of `1572/share (3.5x FY19E BVPS).

Strong credit growth, superior operating revenues to support profitability:

We estimate a CAGR of 27% in loans over FY16-19E with retail loan mix rising in

the overall portfolio. Liability franchise would continue improving, and a

reduction in savings rates in future would further add to margins. NIMs are likely

to remain robust on account of improving retail mix, higher CASA (with

progressively lower SA rates) and high loans to deposit ratio (LDR). IIB has a

diversified fee income profile with fees spanning specialized activities like

structured finance, transaction banking, syndication and foreign exchange apart

from regular banking related fees. Together, with fund-based income, the bank

is likely to generate a CAGR of 27% in operating revenues over FY16-19E.

Asset quality to remain healthy, concentration risks manageable: Asset

quality risk for IIB largely emanates from its non-fund based exposures and its

exposures to certain segments as per Basel III like gems and jewelry (4%), lease

rental discounting (3.8%), real estate developers (3%) and telecom (2.6%). The

rest of the loan book is granular, long term trends of risk-weighted assets/total

assets are largely stable at 82-83% and exposure to top 20 clients has also been

steady. The key risk mitigating factor is the large and diversified retail portfolio

with low NPAs. Strong under-writing and constant monitoring would likely keep

NPAs in check and loan loss provisions low for IIB in the medium term.

Robust earnings outlook, premium valuations would sustain: IIB is trading at

2.7x FY19E BVPS, at a premium to most peers except HDFCB and KMB. Strong

capitalisation, sustained improvement in retail liability franchise, increasing mix

of retail loans, strong core fee accretion and stable asset quality would all driver

core RoA of 1.8-1.9% through FY16-19E and EPS CAGR of 26%. We value IIB at

3.5x FY19E BVPS or `1572 per share. Premium earnings trajectory would earn

the bank premium valuation in our view. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 725.7 / US$ 10.7

Shares in issue (mn) 595.0

Diluted share (mn) 595.0


52-week range ` 1256.1/799.0


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 12.1 0.4 31.7

Relative* 9.3 1.5 20.4

* To the BSE Sensex


Sep-16 Mar-16

Promoters 14.9 14.9

FII 54.7 43.3

DII 11.6 11.4


-20%

0%

20%

40%

60%

80%

100%

120%

140%

0

200

400

600

800

1000

1200

1400


IndusInd Bank

IndusInd Bank Relative to Sensex (RHS)

IndusInd Bank | IIB IN

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage Price: `1,213

BUY

12M Target: `1,572

Exhibit 1. IIB: Financial Summary (Standalone) (` bn)


Net Profit 17.9 22.9 29.2 36.4 45.9

Net Profit (YoY) (%) 27.4% 27.5% 27.8% 24.5% 26.1%

Assets (YoY) (%) 28.6% 25.4% 26.6% 23.9% 24.9%

ROA (%) 1.8% 1.8% 1.9% 1.8% 1.9%

ROE (%) 19.0% 16.6% 15.8% 17.1% 18.5%

EPS (`) 33.9 38.4 49.1 61.1 77.1

EPS (YoY) (%) 26.5% 13.4% 27.8% 24.5% 26.1%

P/E (x) 36.1 31.8 24.9 20.0 15.9

BV (`) 193.4 290.8 332.3 383.9 449.1

BV (YoY) (%) 17.7% 50.4% 14.3% 15.5% 17.0%

P/BV (x) 6.3 4.2 3.7 3.2 2.7









Certification.

IndusInd Bank 18 January 2017




NII / Assets (%) 3.5% 3.6% 3.8% 3.9% 4.0% Higher margins due to Improving CASA, lower SA costs and higher mix of retail loans

in the medium term

Core other income / Assets (%) 2.5% 2.5% 2.4% 2.4% 2.4% With higher penetration in large corporate accounts, fee contribution could trend

down slightly. Overall fee growth would be robust Other income / Assets (%) 2.6% 2.6% 2.6% 2.6% 2.6%



Sustained investments in technology, processes, security and manpower Other Cost to Assets (%) 1.9% 1.9% 2.1% 2.2% 2.2%

Cost to Assets (%) 2.9% 2.9% 3.0% 3.1% 3.1%

PPP / Assets (%) 3.1% 3.3% 3.4% 3.3% 3.4%

Provisions / Assets (%) 0.4% 0.5% 0.6% 0.5% 0.5% Present levels of loan losses to continue

PBT / Assets (%) 2.7% 2.8% 2.8% 2.8% 2.8%

Core ROA (%) 1.8% 1.8% 1.8% 1.8% 1.9%

Best-in-class RoA profile with strong core profitability

ROA (%) 1.8% 1.8% 1.8% 1.8% 1.9%


Exhibit 3. IIB: One-year forward P/BV (x) and one-year forward P/E (x)



Management change: Mr. Romesh Sobti is due to superannuate in January

2018, which is a year from now. As the date approaches, there would be

concerns on succession and potential reshuffle of the top management. We

believe a succession plan would be in place and if the same is

communicated to investors, the stock impact would be muted. We do not

anticipate a significant change in the working of the bank since there is

substantial depth in the top management team

Increase in NPAs in retail and SME: Competitive intensity in the retail space

has intensified with a huge number and variety of lenders with dilution in

best practices in the system. While the customer profile and underwriting

standards of IIB are significantly superior to the systems’ in general, a

contagion effect, if at all, would still be a risk. In SME and mid-corporate too,

substantial increase in leverage and dwindling order books could pose risks

to exposures.

Devolvement of off-balance sheet exposures: As seen in Exhibit 5, the off-

balance sheet exposures have increased substantially for the bank. It gets

the bank healthy fee based income; however, given the general down-turn in

corporate asset quality, there would be a risk of devolvement of these

exposures in the medium term which could increase concentration risk in

the bank.

0.4

0.9

1.4

1.9

2.4

2.9

3.4

3.9


IIB Fwd. P/BV (x) SD+1 SD-1 Average

0

5

10

15

20

25

30

35

40

45

50


IIB Fwd. P/E (x) SD+1 SD-1 Average




Exhibit 4.IIB: Trend in gross and net NPL for key products

Gross NPL - key products (%) FY10 FY11 FY12 FY13 FY14 FY15 FY16

CVs 1.50% 1.17% 1.00% 1.01% 1.38% 1.27% 1.00%

UVs 1.10% 1.08% 1.31% 0.88% 0.87% 1.08% 1.21%

Construction equipment 1.60% 1.37% 1.22% 1.17% 1.30% 1.44% 1.26%

Three wheeler 0.40% 0.62% 0.95% 0.84% 0.92% 0.92% 0.98%

Two wheeler 5.20% 3.77% 3.32% 2.95% 2.50% 2.53% 3.02%

Cars 3.70% 1.58% 0.99% 0.73% 0.52% 0.56% 0.50%

LAP/HL/PL 0.33% 0.65%

Cards 1.24% 1.45%

Total – CFD 1.83% 1.58% 1.36% 1.15% 1.25% 1.15% 1.08%

Total – CCB 0.82% 0.56% 0.61% 0.90% 1.02% 0.58% 0.74%

Total – Bank 1.23% 1.01% 0.98% 1.03% 1.12% 0.81% 0.87%


Exhibit 5.IIB: Trends in Risk weighted assets

Growth

RWAs Composition (` bn) FY14 FY15 FY16 FY15 (%) FY16 (%)

Credit risk, CVA and UFCE 586 767 994 30.9% 29.5%

Market risk 25 44 55 73.1% 25.4%

Operational risk 61 79 115 28.1% 46.0%

Total RWAs 673 889 1,163 32.2% 30.8%

Loans 551 688 884 24.8% 28.5%

Exposure

- Fund based exposure 796 975 1,232 22.4% 26.4%

- Non-fund based exposure 320 470 557 47.0% 18.6%

Total exposure 1,116 1,445 1,789 29.5% 23.9%

RWA/ total loans 122% 129% 131% 7.2% 2.3%


Exhibit 6. IIB: Comparison of Funded Exposure to critical sectors (as % of bank’s overall funded exposure)


2.4%

0.5%

1.7%

1.4%

4.3%

4.7%

0.9%1.1%

1.7%

3.8%

4.5%

0.9%

1.6%

4.3%4.1%

3.0%

0.8%

1.2%

4.0%3.8%

0%

1%

2%

3%

4%

5%

Real Estate Construction Infrastructure Gems and Jewellery Lease Rental Discounting

FY14 FY15 FY16 3Q17








Exchange Income 7.2 8.4 9.7 11.6 13.9

Fee & Other Income 17.1 23.1 28.4 35.6 44.5


Total Income 59.7 78.1 101.6 127.8 160.5







PBT 27.1 34.7 44.6 55.1 70.0

Tax 9.2 11.8 15.4 18.7 24.2




Dividend 2.6 3.5 4.5 5.6 7.1





Equity Capital 5.3 5.9 5.9 5.9 5.9


Deposits 741.3 930.0 1,264.8 1,593.7 2,023.9

Borrowings 206.2 221.6 227.8 277.4 335.9



Investments 248.6 312.1 391.1 486.1 598.9

Net Advances 687.9 884.2 1,114.1 1,426.0 1,825.3


Fixed Assets 7.7 8.7 10.5 12.4 14.7

Other Assets 62.0 70.6 100.2 90.2 78.0

Total Assets 1,114.0 1,396.8 1,768.3 2,191.5 2,737.3


Key ratios (%)


Growth (YoY) (%)

Deposits 22.5% 25.4% 36.0% 26.0% 27.0%

Advances 24.8% 28.5% 26.0% 28.0% 28.0%

Total Assets 28.6% 25.4% 26.6% 23.9% 24.9%

NII 18.3% 32.1% 34.7% 25.9% 27.4%





Provisions -16.8% 72.8% 29.9% 18.4% 24.7%

Reported PAT 27.4% 27.5% 27.8% 24.5% 26.1%


Interest Spread (%) 2.94% 3.08% 3.40% 3.48% 3.51%

NIM (%) 3.64% 3.82% 4.09% 4.09% 4.12%

Profitability (%)

Non-IR to Income (%) 42.7% 42.2% 40.1% 40.1% 39.2%

Cost to Income (%) 48.1% 47.0% 47.5% 48.8% 48.3%

ROA (%) 1.81% 1.82% 1.85% 1.84% 1.86%

ROE (%) 19.0% 16.6% 15.8% 17.1% 18.5%

Assets Quality (%)

Slippages (%) 1.62% 1.24% 1.30% 1.35% 1.35%

Gross NPAs (%) 0.81% 0.87% 0.95% 0.97% 0.95%

Net NPAs (%) 0.31% 0.36% 0.34% 0.36% 0.33%


Specific LLP (%) 0.55% 0.64% 0.66% 0.62% 0.62%



Tier I (%) 11.22% 14.92% 13.29% 12.42% 11.65%

CAR (%) 12.09% 15.50% 13.88% 13.16% 12.46%


DuPont Analysis (%)


NII / Assets (%) 3.45% 3.60% 3.85% 3.87% 3.96%



Cost to Assets (%) 2.90% 2.93% 3.05% 3.15% 3.15%

PPP / Assets (%) 3.13% 3.30% 3.37% 3.31% 3.36%


PBT / Assets (%) 2.74% 2.76% 2.82% 2.78% 2.84%

Tax Rate (%) 33.8% 34.1% 34.5% 34.0% 34.5%

ROA (%) 1.81% 1.82% 1.85% 1.84% 1.86%

RoRWAs (%) 2.30% 2.23% 2.22% 2.21% 2.24%

Leverage (x) 10.5 9.1 8.5 9.3 9.9

ROE (%) 19.0% 16.6% 15.8% 17.1% 18.5%


Valuations


Shares in issue (mn) 529.5 595.0 595.0 595.0 595.0

EPS (`) 33.9 38.4 49.1 61.1 77.1

EPS (YoY) (%) 26.5% 13.4% 27.8% 24.5% 26.1%

P/E (x) 36.1 31.8 24.9 20.0 15.9

BV (`) 193 291 332 384 449

BV (YoY) (%) 17.7% 50.4% 14.3% 15.5% 17.0%

P/BV (x) 6.32 4.20 3.68 3.18 2.72

DPS (`.) 4.7 4.7 7.6 9.5 11.9

Div. yield (%) 0.4% 0.4% 0.6% 0.8% 1.0%



High on quality, also on valuation

KMB has created a high quality banking franchise, strengthened by the recent

acquisition of erstwhile-INGVY (eINGVY), which is based on a balanced approach

between retail and wholesale loans. Like HDFCB, KMB has stayed away from

term lending, kept concentration risks low and focused on building a high

quality retail franchise. This is funded by an increasingly retail liability driven

balance sheet. However, its high tier-1 ratio (16.5% including profits as of

2QFY17) and low growth would keep the RoE at 12-14% over FY16-19E. KMB has

limited capacity for risk, which reflects in its moderate credit growth and low

fee income contribution. While its RoA would remain robust, RoE would remain

under-levered in the medium term. Hence, at current valuation of 2.8x FY19E

consolidated BV (3.9x standalone), the risk-reward is still unattractive. We

recommend HOLD on KMB with a target price of `816/share (3.1x FY19E

consolidated BV).

Growth and low leverage are key concerns: KMB’s credit growth has been

moderate thus far owing to lower risk appetite and teething issues post

integration - for wholesale segment earlier and recently for business banking.

Demonetisation would have impacted the improving momentum in business

banking. Currently, we estimate a loan CAGR of 17% over FY16-19E. Even at a

loan CAGR of 20%, RoE would go up to 15.5-16% by FY20E. To lever its capital,

the bank would have to grow in excess of 20% for a sustained period.

Meanwhile, if systemic risks increase, growth objectives could be revised lower.

Very high franchise quality, across subsidiaries too: KMB has built a high

quality franchise across its lending, insurance, asset management and broking

subsidiaries. The lending franchise has very high core profitability, well-

established underwriting processes, improving retail liability franchise and

prudent risk management systems. Asset quality risks are low owing to a

granular balance sheet, process-oriented lending and conservative loan

classification. Subsidiary performance is set to improve, especially with

increasing cross-selling through eINGVY branches

Risk reward in balance, growth could be a catalyst: With KMB trading at

expensive valuations, despite the low RoE and low loan growth in the medium

term, the risk-reward is currently unfavorable. Key profitability drivers such as

margins, core fee income, cost ratios and loan losses are likely to maintain

healthy trends. RoA is likely to increase to c1.7% by FY19E and RoE is likely to

increase to c.13% by FY19E. We do not estimate sustained high loan growth in

the near term, which may keep earnings CAGR below 20% over FY16-19E. Hence,

we recommend HOLD. Higher than estimated growth and sharp improvement in

subsidiary performance would be a risk to our call. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: : (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 1335.3 / US$ 19.6




52-week range ` 836.0/585.8


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 1.0 -5.6 7.5

Relative* -1.9 -4.6 -3.9

* To the BSE Sensex


Sep-16 Mar-16

Promoters 33.7 33.7

FII 43.0 35.9

DII 5.7 4.7


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

0

100

200

300

400

500

600

700

800

900


Kotak Mahindra Bank

Kotak Mahindra Bank Relative to Sensex (RHS)

18 January 2017


HOLD

12M Target: `816

Kotak Bank | KMB IN

Exhibit 1. KMB: Financial Summary (Consolidated) (` bn)


Net Profit 30.5 34.6 43.7 51.4 59.0

Net Profit (YoY) (%) 23.5% 13.6% 26.4% 17.7% 14.6%

Assets (YoY) (%) 21.5% 62.1% 14.1% 16.6% 19.6%

ROA (%) 2.2% 1.8% 1.7% 1.7% 1.7%

ROE (%) 14.8% 12.5% 12.3% 12.8% 13.0%

EPS (`.) 19.7 18.9 23.8 28.0 32.1

EPS (YoY) (%) 23.2% -4.4% 26.4% 17.7% 14.6%

PE (x) 36.9 38.6 30.5 26.0 22.6

BV (`.) 143.4 181.9 205.0 232.1 263.2

BV (YoY) (%) 15.8% 26.8% 12.7% 13.2% 13.4%

P/BV (x) 5.1 4.0 3.6 3.1 2.8









Certification.

Kotak Mahindra Bank 18 January 2017


Exhibit 2. : DuPont Analysis (Consolidated) (%)

Y/E March FY15 FY16* FY17E FY18E FY19E Remarks / Observations

NII / Assets (%) 4.7% 4.8% 4.2% 4.1% 4.0% Drivers are largely balanced, and hence we do not

estimate sharp expansion in margins.

Core other income / Assets (%) 4.2% 3.9% 3.6% 3.7% 3.7% Third party distribution would provide substantial jump

in fees Other income / Assets (%) 6.0% 3.9% 4.6% 4.8% 4.8%


Employee Cost to Assets (%) 1.8% 2.0% 1.6% 1.3% 1.3% KMB is making significant investments in technology and

state-of-the-art systems. KMB has also been a pioneer in

tech-based solution. In the standalone bank, synergy

based improvements in cost ratios should emerge


Cost to Assets (%) 7.2% 5.6% 6.0% 6.0% 6.0%

PPP / Assets (%) 3.5% 3.1% 2.8% 2.9% 2.8%


PBT / Assets (%) 3.4% 2.6% 2.5% 2.5% 2.5%

Core ROA (%) 2.3% 1.8% 1.7% 1.7% 1.7% RoA would start trending towards pre-merger ratios as

synergy benefits accrue ROA (%) 2.2% 1.8% 1.7% 1.7% 1.7%


Exhibit 3. KMB: One-year forward P/BV (x) and One-year forward P/E (x)



Exhibit 4. KMB: Deposits mix – high pace of deposit mobilisation continues

Deposits Composition (` bn) FY11 FY12 FY13 FY14 FY15 FY16

Current 55 74 77 87 132 233

Saving 33 51 73 101 140 295

Time 205 261 361 402 476 859

Total Deposits 293 385 510 590 749 1,386

Deposits Mix (%)

Current 18.7% 19.1% 15.0% 14.8% 17.6% 16.8%

Saving 11.4% 13.1% 14.2% 17.1% 18.7% 21.3%

CASA 30.0% 32.2% 29.2% 31.9% 36.4% 38.1%

Time 70.0% 67.8% 70.8% 68.1% 63.6% 61.9%

Total 100% 100% 100% 100% 100% 100%


0.5

1.5

2.5

3.5

4.5

5.5

6.5

7.5

8.5


KMB Fwd. P/BV (x) SD+1 SD-1 Average

4

14

24

34

44

54

64

74


KMB Fwd. P/E (x) SD+1 SD-1 Average



Exhibit 5. KMB: Trends in SA accretion

Source: Company, JM Financial. Note: FY16 includes the additional SA on account of the merger with eING Vysya bank.

Exhibit 6. KMB: Fee income as % of total revenues and assets


Exhibit 7. KMB: SA growth catching up in eIVBL branches


2%

8%

6% 6%

1%

5%4%

6% 6% 6%7%

21%

5%

0%

5%

10%

15%

20%

25%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 1H17

SA accretion as a % of opening deposits

12%

31%

27%

15%

12%13%

17%

20% 20%22%

24%23%

0.7%

2.2%

1.7%

1.1%

0.8%

1.0%

1.1%1.2%

1.2%

1.3%

1.6%1.5%

0%

5%

10%

15%

20%

25%

30%

0.5%

0.7%

0.9%

1.1%

1.3%

1.5%

1.7%

1.9%

2.1%

2.3%

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

Fee income as a % of Revenues (RHS) Fee income to assets (%)

19%

23%

31%34%35%

41%43%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1Q16 2Q16 3Q16 4Q16

eIVBL branches Kotak's branches



Exhibit 8. KMB: Asset quality to be largely in a healthy range


20%

30%

40%

50%

60%

70%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%F

Y07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E









Exchange income 2.1 4.2 2.6 4.7 6.0

Fee & Other Income 15.1 19.8 23.9 29.8 37.1


Total Income 62.5 95.1 111.4 131.0 156.2




Provisions on Investments -1.1 1.4 -0.5 -0.5 0.0



PBT 28.3 31.2 45.7 53.9 65.4

Tax 9.7 10.3 15.5 17.7 20.6




Dividend 1.0 1.1 1.9 2.6 3.7


Source: Company, JM Financial. Note: Numbers until FY15 are for unmerged entity



Equity Capital 3.9 9.2 9.2 9.2 9.2


Deposits 748.6 1,386.4 1,622.1 1,914.1 2,296.9

Borrowings (Incl.

Sub Debt)

121.5 209.8 221.6 233.7 267.4



Investments 304.2 512.6 557.9 634.4 747.4

Net Advances 661.6 1,186.7 1,364.7 1,596.6 1,900.0


Fixed Assets 12.1 15.5 16.7 18.1 20.6

Other Assets 19.6 39.0 65.8 70.1 89.0

Total Assets 1,060.1 1,922.6 2,207.1 2,554.3 3,038.2


Key ratios (%)


Growth (YoY) (%)

Deposits 26.7% 85.2% 17.0% 18.0% 20.0%

Advances 24.8% 79.4% 15.0% 17.0% 19.0%

Total Assets 21.0% 81.4% 14.8% 15.7% 18.9%

NII 13.5% 63.4% 13.3% 16.2% 18.2%





Provisions -46.0% 457.7% -15.1% 22.5% 17.2%

Reported PAT 24.2% 12.0% 44.3% 20.3% 23.6%


Interest Spread (%) 3.46% 3.62% 3.10% 3.22% 3.28%

NIM (%) 4.51% 4.76% 3.92% 3.96% 3.98%

Profitability (%)

Non-IR to Income (%) 32.4% 27.5% 29.8% 30.7% 31.3%

Cost to Income (%) 52.1% 57.5% 52.0% 51.6% 51.0%

ROA (%) 1.93% 1.40% 1.46% 1.52% 1.60%

ROE (%) 14.1% 11.0% 11.9% 12.7% 13.9%

Assets Quality (%)

Gross NPAs (%) 1.85% 2.36% 2.35% 2.20% 2.06%

Net NPAs (%) 0.92% 1.06% 1.11% 1.01% 0.92%


Specific LLP (%) 0.32% 0.76% 0.58% 0.61% 0.56%



Tier I (%) 16.18% 15.28% 15.01% 14.68% 14.10%

CAR (%) 17.17% 16.34% 16.12% 15.74% 15.07%


DuPont Analysis (%)


NII / Assets (%) 4.36% 4.63% 3.79% 3.81% 3.84%



Cost to Assets (%) 3.36% 3.67% 2.80% 2.84% 2.85%

PPP / Assets (%) 3.10% 2.71% 2.59% 2.67% 2.74%


PBT / Assets (%) 2.93% 2.09% 2.21% 2.26% 2.34%

Tax Rate (%) 34.1% 33.1% 34.0% 32.8% 31.5%

ROA (%) 1.93% 1.40% 1.46% 1.52% 1.60%

RoRWAs (%) 2.48% 1.76% 1.84% 1.92% 2.03%

Leverage (%) 7.3 7.8 8.1 8.4 8.7

ROE (%) 14.1% 11.0% 11.9% 12.7% 13.9%


Valuations



EPS (`.) 12.1 11.4 16.4 19.8 24.4

EPS (YoY) (%) 23.9% -5.7% 44.3% 20.3% 23.6%

PE (x) 62.9 66.7 46.2 38.5 31.1

BV (`.) 92 131 146 164 187

BV (YoY) (%) 14.9% 42.7% 11.8% 12.5% 13.6%

P/BV (x) 8.30 5.82 5.21 4.62 4.07

DPS (`.) 0.6 0.6 1.0 1.4 2.0

Div. yield (%) 0.1% 0.1% 0.1% 0.2% 0.3%




Financial Tables (Consolidated)






Exchange Income 2.1 4.9 6.1 7.2 8.5

Fee & Other Income 25.3 31.5 39.3 47.0 56.3


Total Income 145.0 169.1 226.1 263.1 309.4







PBT 45.5 50.2 63.9 75.3 86.5

Tax 14.8 15.9 20.7 24.5 28.1






Dividend 1.0 1.1 1.3 1.7 1.9





Equity Capital 3.9 9.2 9.2 9.2 9.2


Deposits 728.4 1,359.5 1,604.2 1,925.0 2,367.8

Borrowings (Incld.

Sub Debt) 314.1 437.3 459.0 503.9 578.4

Minority Interest 3.4 4.0 4.7 5.7 6.8

Policyholder's

Funds 137.9 151.5 174.2 200.3 230.4



Investments 473.5 702.7 768.1 904.6 1,048.0

Net Advances 886.3 1,447.9 1,657.9 1,923.1 2,307.8


Fixed Assets 13.8 17.6 18.6 20.2 23.1

Other Assets 43.1 63.8 80.1 89.0 127.1

Total Assets 1,485.8 2,408.0 2,746.5 3,201.9 3,828.5


Key ratios (%)


Growth (YoY) (%)

Deposits 28.0% 86.6% 18.0% 20.0% 23.0%

Advances 23.6% 63.4% 14.5% 16.0% 20.0%

Total Assets 21.5% 62.1% 14.1% 16.6% 19.6%

NII 12.0% 46.1% 15.5% 13.1% 16.2%




Core Operating Profits -31.6% 156.4% -23.5% 15.5% 11.6%

Provisions -33.4% 381.9% -11.1% 16.6% 11.8%

Reported PAT 23.5% 13.6% 26.4% 17.7% 14.6%


Interest Spread (%) 2.41% 2.62% 2.57% 2.57% 2.57%

NIM (%) 4.89% 4.94% 4.31% 4.22% 4.16%

Profitability (%)

Non-IR to Income (%) 56.2% 45.1% 52.6% 53.9% 54.5%

Cost to Income (%) 67.2% 64.4% 67.8% 67.5% 68.3%

ROA (%) 2.25% 1.78% 1.70% 1.73% 1.68%

ROE (%) 14.8% 12.5% 12.3% 12.8% 13.0%

Assets Quality (%)

Gross NPAs (%) 1.56% 2.06% 2.45% 2.50% 2.27%

Net NPAs (%) 0.79% 0.93% 1.13% 1.03% 0.85%


Specific LLP (%) 0.28% 0.64% 0.47% 0.48% 0.45%



Tier I (%) 16.80% 16.10% 15.81% 15.24% 14.51%

CAR (%) 17.60% 17.00% 16.59% 15.94% 15.16%


DuPont Analysis (%)


NII / Assets (%) 4.69% 4.77% 4.16% 4.08% 4.01%



Cost to Assets (%) 7.20% 5.60% 5.95% 5.97% 6.01%

PPP / Assets (%) 3.51% 3.09% 2.82% 2.88% 2.79%


PBT / Assets (%) 3.36% 2.58% 2.48% 2.53% 2.46%

Tax Rate (%) 32.6% 31.7% 32.5% 32.5% 32.5%

ROA (%) 2.25% 1.78% 1.70% 1.73% 1.68%

RoRWAs (%) 2.71% 2.14% 2.04% 2.06% 1.99%

Leverage (%) 6.6 7.0 7.3 7.4 7.7

ROE (%) 14.8% 12.5% 12.3% 12.8% 13.0%


Valuations



EPS (`.) 19.7 18.9 23.8 28.0 32.1

EPS (YoY) (%) 23.2% -4.4% 26.4% 17.7% 14.6%

PE (x) 36.9 38.6 30.5 26.0 22.6

BV (`.) 143 182 205 232 263

BV (YoY) (%) 15.8% 26.8% 12.7% 13.2% 13.4%

P/BV (x) 5.07 4.00 3.55 3.13 2.76

DPS (`.) 0.6 0.6 0.7 0.9 1.1

Div. yield (%) 0.09% 0.08% 0.10% 0.12% 0.14%



Fighting battles on multiple fronts

PNB is facing an uphill task of balance sheet repair. Its total impaired loans are

20.7% of loans, as of 2QFY17, with high concentration in power, iron and steel,

textiles, chemicals. Overall loan concentration risk is highest in PNB as

compared to BoB or SBI, its CET 1 ratio is the least (8.26% as of 2QFY17) and its

operating metrics are weak. Its NNPA/Networth ratio was 100% as of 2QFY17.

Sustained dilution is inevitable. The bank is behind SBI or BOB with respect to

technology implementation. Despite aspirations to build up the retail portfolio,

PNB still has a small market share and lacks the retail asset orientation of SBI.

We believe these factors will continue to weigh on return ratios and keep

valuations muted. We value PNB at 0.55x FY19E BV as compared to its current

valuation of 0.63x FY19E BV. We believe PNB will continue to underperform

peers. We Initiate coverage with a SELL rating.

Huge stressed assets pool to tackle, high loan concentration risk: Despite

rapid growth, retail loans still formed 17% of overall advances as of 2QFY17. The

largest sector-wise exposures remain iron and steel (6.4% of fund-based

exposure), power (6.8%), other infrastructure (4.7%), construction (5.8%) and

textiles (2.5%). The stressed loans from iron and steel, power (ex-SEB), textiles

and construction together comprise 37% of GNPAs and 38% of total restructured

loans of the bank. Our analysis suggests that a large amount of non-stressed

assets are still facing an adverse indebtedness situation and could potentially

slip into stressed assets still. Hence, we remain sceptical of the sustainability of

the reduced slippage rates in 1HFY17.

Moderate loan growth, slow recovery in revenues and profitability: We

estimate retail loan growth to remain robust at +20% in the medium term for

PNB. However, growth in corporate loans would remain muted resulting in an

overall loan CAGR of 8.6% over FY16-19E. Margins are likely to remain under

pressure due to income reversals, persistently low LDR, competitive pressure on

lending rates and sharply falling corporate rates. Core fee income to total

income would largely be stable c.13% through FY16-19E. PNB is likely to post

strong recovery numbers though, which has been a strength traditionally, and

this would keep non-interest income contributions high. Stable cost ratios and

high loan loss provisions would result in a weak RoA profile.

Few triggers for sustained rerating: While there might be short spurts in the

stock based on asset resolution or fresh capital infusion, a sustained re-rating

would require an increase in sustainable margins, fee and cost ratios as well as a

reduction in stressed asset ratios. We believe this is unlikely in the near future.

Minority shareholders also face substantial dilution since incremental capital

infusions are BV dilutive. Hence, we would recommend SELL on the stock. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: : (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 277.2 / US$ 4.1




52-week range ` 164.4/69.3


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 4.0 -4.7 41.3

Relative* 1.2 -3.6 29.9

* To the BSE Sensex


Dec-16 Mar-16

Promoters 65.0 62.1

FII 10.4 10.4

DII 18.3 20.8


-60%

-40%

-20%

0%

20%

40%

60%

0

50

100

150

200

250


Punjab National Bank

Punjab National Bank Relative to Sensex (RHS)


SELL

12M Target: ` 113

Punjab National Bank | PNB IN

Exhibit 1. PNB: Financial Summary (standalone) (` bn)


Net Profit 30.6 -39.7 17.3 30.3 34.7

Net Profit (YoY) (%) -8.4% NM NM 75.3% 14.7%

Assets (YoY) (%) 9.6% 10.4% 7.5% 9.1% 9.0%

ROA (%) 0.5% -0.6% 0.3% 0.4% 0.4%

ROE (%) 8.5% -10.9% 4.5% 7.2% 7.7%

EPS (`.) 16.5 -20.2 7.6 13.4 15.4

EPS (YoY) (%) -10.6% NM NM 75.3% 14.7%

P/E (x) 7.9 -6.4 17.1 9.7 8.5

BV (`.) 203.2 180.6 180.3 191.6 204.7

BV (YoY) (%) 6.7% -11.1% -0.2% 6.3% 6.8%

P/BV (x) 0.6 0.7 0.7 0.7 0.6









Certification.

18 January 201719

January 2017

Punjab National Bank 18 January 2017 11 Nov 2016


Exhibit 2. PNB: DuPont Analysis (%)


NII / Assets (%) 2.93% 2.47% 2.25% 2.27% 2.30%

NIM recovery to be muted. Drop in

wholesale rates and funding costs would be

offset by pressure on yields

Core other income / Assets (%) 0.79% 0.92% 1.02% 1.03% 1.04% Higher recoveries and trading gains would

drive other income. Core fee income

contribution could increase only marginally Other income / Assets (%) 0.97% 1.03% 1.32% 1.23% 1.23%


Employee Cost to Assets (%) 1.27% 1.01% 1.10% 1.09% 1.07% With no meaningful cost rationalization

underway, we do not expect a sharp

improvement in cost/assets


Cost to Assets (%) 1.82% 1.57% 1.66% 1.65% 1.64%

PPP / Assets (%) 2.08% 1.93% 1.91% 1.85% 1.89%

Provisions / Assets (%) 1.39% 2.84% 1.56% 1.27% 1.29% LLP would remain elevated due to the

already high provision shortfall

PBT / Assets (%) 0.69% -0.91% 0.36% 0.58% 0.60%

Core ROA (%) 0.53% -0.63% 0.25% 0.41% 0.42% Do not expect adequate improvement in

sustainable RoA ROA (%) 0.53% -0.63% 0.25% 0.41% 0.42%


Exhibit 3. PNB: One-year forward P/BV (x)



A broader corporate recovery, especially in sectors such as iron and steel or

power: PNB’s large sector exposures are to 5-6 large sectors of which the two

above are the largest. In 1HFY17, a rally in commodity prices has led to a jump

in realization for iron and steel companies and improved their indebtedness.

Despite this, their debt/equity and debt/EBITDA ratios remain beyond stressed

levels. However, a sustained rally in these sectors or a recovery in power

companies could improve stressed asset levels, lead to loan work-outs and

reduce loan loss provisions for PNB.

0.3

0.5

0.7

0.9

1.1

1.3

1.5

1.7

1.9

2.1


PNB Fwd. P/BV (x) SD+1 SD-1 Average




Exhibit 3. PNB: Outstanding standard restructured assets

FY14 FY15 FY16 2Q17

Major industries/sectors (`bn)

Iron & Steel 61 56 26 23

Power 112 137 56 61

Other Infrastructure 30 24 31 30

Textiles 20 14 10 3

Sugar 6 14 14 15

Chemicals/ Fertilizers/ Drugs 11 19 6 6

Manufacturing 1 16 8 4

Others 114 103 50 40

O/S Standard Restructured loans (`bn) 355 383 201 181

Mix (%)

Iron & Steel 17% 15% 13% 13%

Power 32% 36% 28% 33%

Other Infrastructure 9% 6% 16% 17%

Textiles 6% 4% 5% 2%

Sugar 2% 4% 7% 8%

Chemicals/ Fertilizers/ Drugs 3% 5% 3% 3%

Manufacturing 0% 4% 4% 2%

Others 32% 27% 25% 22%


Exhibit 4. PNB – Exposure to key stressed sectors

Industry (` bn) Loans GNPA Restruc-

tured

Total

Stressed

As a % of

loans

Iron & Steel 277 141 26 167 60.2%

Infrastructure 551 89 88 177 32.2%

- Power 326 74 56 131 40.1%

Chemicals & Products 70 25 6 31 44.2%

Construction 36 10 12 22 60.5%

Textiles 121 23 10 33 27.7%

All Engineering 48 10 0 10 21.1%

Cement 23 11 4 15 63.9%

Total 1,126 310 145 455 40.4%

Total for Bank 4,328 558 201 760 17.6%

% Share in total banks 26.0% 55.5% 72.0% 59.9%


Exhibit 5. PNB: Stressed asset resolutions to improve


30%

40%

50%

60%

70%

80%

90%

100%

0%

2%

4%

6%

8%

10%

12%

14%

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E


10.9%

14.0%15.2%

16.4%

20.7%

18.3%

14.3%12.6%

11.3%

0%

5%

10%

15%

20%

25%


Gross NPLs (%) Restructured standard Other impaired



Exhibit 6. PNB: Outstanding impaired asset break up (1H17) (%)

Outstanding as on FY16 (` bn) FY16

GNPA 558.1

Restructured 201.4

5/25 scheme 76.0



Watchlist 40.0

Overlaps (Ex-5/25, SDR , GNPA and restructured) -46.2











Exchange Income 5.0 4.3 5.8 6.5 7.2

Fee & Other Income 40.4 53.7 64.5 70.7 77.6


Total Income 224.5 221.9 246.3 261.2 288.2




Provisions on Investments -5.7 3.5 -4.0 0.0 0.0

Other Provisions 1.8 -9.8 0.0 -4.5 1.0


PBT 39.6 -57.4 24.7 43.2 49.6

Tax 9.0 -17.6 7.4 13.0 14.9

PAT (Pre-Extra ordinaries) 30.6 -39.7 17.3 30.3 34.7


Reported Profits 30.6 -39.7 17.3 30.3 34.7

Dividend 7.4 0.0 2.6 4.5 5.2

Retained Profits 23.2 -39.7 14.7 25.7 29.5




Equity Capital 3.7 3.9 4.5 4.5 4.5


Deposits 5,013.8 5,530.5 6,083.6 6,691.9 7,294.2

Borrowings 456.7 597.6 496.3 503.2 550.0



Investments 1,512.8 1,578.5 1,748.2 1,950.5 2,123.2

Net Advances 3,805.3 4,123.3 4,329.4 4,805.7 5,286.2


Fixed Assets 21.6 23.8 28.6 31.2 25.5

Other Assets 120.3 168.7 279.1 209.2 204.9

Total Assets 6,019.5 6,645.5 7,141.9 7,790.6 8,493.6


Key ratios (%)


Growth (YoY) (%)

Deposits 11.1% 10.3% 10.0% 10.0% 9.0%

Advances 9.0% 8.4% 5.0% 11.0% 10.0%

Total Assets 9.6% 10.4% 7.5% 9.1% 9.0%

NII 3.3% -7.3% -1.0% 9.1% 11.1%


Operating Expenses 12.4% -4.9% 14.6% 7.8% 8.2%



Provisions 19.5% 124.5% -40.2% -11.7% 11.1%

Reported PAT -8.4% -229.8% -143.4% 75.3% 14.7%


Interest Spread (%) 2.6% 2.2% 2.1% 2.1% 2.1%

NIM (%) 3.0% 2.5% 2.3% 2.4% 2.4%

Profitability (%)

Non-IR to Income (%) 24.8% 29.4% 37.1% 35.3% 34.8%

Cost to Income (%) 46.7% 44.9% 46.4% 47.2% 46.2%

ROA (%) 0.5% -0.6% 0.3% 0.4% 0.4%

ROE (%) 8.5% -10.9% 4.5% 7.2% 7.7%

Assets Quality (%)

Slippages (%) 4.9% 11.6% 9.0% 6.5% 6.5%

Gross NPAs (%) 6.6% 12.9% 13.3% 11.1% 10.3%

Net NPAs (%) 4.0% 8.6% 8.7% 6.8% 6.0%


Specific LLP (%) 2.2% 4.7% 2.6% 2.1% 2.0%



Tier I (%) 9.3% 8.4% 8.9% 8.7% 8.5%

CAR (%) 12.2% 11.3% 11.7% 11.4% 11.2%


DuPont Analysis (%)


NII / Assets (%) 2.93% 2.47% 2.25% 2.27% 2.31%



Cost to Assets (%) 1.82% 1.57% 1.66% 1.65% 1.64%

PPP / Assets (%) 2.08% 1.93% 1.91% 1.85% 1.90%


PBT / Assets (%) 0.69% -0.91% 0.36% 0.58% 0.61%

Tax Rate (%) 22.6% 30.7% 30.0% 30.0% 30.0%

ROA (%) 0.53% -0.63% 0.25% 0.41% 0.43%

RoRWAs (%) 0.80% -0.97% 0.39% 0.63% 0.66%

Leverage (x) 15.9 17.3 18.1 17.8 18.2

ROE (%) 8.5% -10.9% 4.5% 7.2% 7.7%


Valuations


Shares in issue (mn)* 1,854.6 1,963.6 2,260.6 2,260.6 2,260.6

EPS (`.) 16.5 -20.2 7.6 13.4 15.4

EPS (YoY) (%) -10.6% NM NM 75.3% 14.7%

PE (x) 7.9 -6.4 17.1 9.7 8.5

BV (`) 203 181 180 192 205

BV (YoY) (%) 6.7% -11.1% -0.2% 6.3% 6.8%

P/BV (x) 0.6 0.7 0.7 0.7 0.6

DPS (`.) 4.0 0.0 1.1 2.0 2.3

Div. yield (%) 3.1% 0.0% 0.9% 1.5% 1.8%



A bet worth taking

SBI provides a balanced investment opportunity whereby one can derive value

from a strong retail franchise and at the same time benefit from a recovery in

corporate asset quality. SBI is well capitalized with a CET1 ratio of 10.3% as of

2QFY17. The bank has a robust liability franchise, high share of retail loans,

lower concentration risk as compared to other PSBs and strong handle on

operating expenses. It has implemented several technology based

improvements in its products and is a close competitor to larger private banks

in its alternate channel offerings. The merger of associate banks creates a

much larger entity which would benefit from economies of scale. Performance

of its insurance, credit card and asset management subsidiaries has improved.

These add considerable value to the group and offer stake monetisation

opportunities which can be used to shore up capital. We initiate coverage on

SBI with a BUY rating and a target price of `309/share (1.1x FY19E Consol BV).

Loan growth to remain ahead of peers, core revenues to improve: SBI’s loan

growth is currently driven by retail loans which are growing at c.20% YoY and are

broad-based. Growth in the corporate credit portfolio is currently muted due to

risk aversion and lack of demand. SBI’s loan growth would be ahead of PSBs

owing to its better retail distribution and ability to refinance better rated

corporates. Margins would remain muted due to persistent interest reversals,

yield compression, low loan-deposit ratio (LDR) and more than warranted MCLR

cuts. Integration of subsidiaries, which have lower NIMs, would also impact NII

growth. The core fee income should improve due to synergies after the merger.

Integration is a near term challenge, a long-term benefit: Addition of

associate banks would provide scale, large customer base, better information

sharing about corporate exposures and an opportunity to rationalize costs at the

group level. The associate banks, which together make up c.21% of loans as of

FY16, have weaker balance sheet and operating metrics than SBI. They would

stand to benefit through better processes and compensation as well as better

stressed asset resolution capabilities. Operating metrics would reflect the

adverse impact of a merger in FY17E-18E but would begin to improve thereon.

Favorable risk-reward, though challenges continue: SBI is currently trading at

0.9x FY19E consolidated BV. Given an outlook of RoA improvement from 0.3% to

0.6% over FY17E-19E, RoE improvment from 5% to c.10% and strong

capitalization, we believe valuation multiples can expand further. Increasing

contribution of Non-banking entities in the group, such as insurance, asset

management, credit cards etc. to group profits (6.3% as of FY16 versus 0.8% as

of FY11), stake monetisation opportunity in these subsidiaries and improvement

of operating metrics in the bank would further drive value. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: : (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 1987.3 / US$ 29.2




52-week range ` 288.8/148.3


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute -3.3 1.1 38.9

Relative* -6.1 2.2 27.5

* To the BSE Sensex


Dec-16 Mar-16

Promoters 60.2 60.2

FII 11.1 9.1

DII 19.4 18.8


-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0

50

100

150

200

250

300

350

400


State Bank of India

State Bank of India Relative to Sensex (RHS)

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage Price: `258

BUY

12M Target: `309

State Bank of India | SBIN IN

Exhibit 1. SBI: Financial Summary (Consolidated) (` bn)


Net Profit 169.9 122.2 94.6 128.3 218.3

Net Profit (YoY) (%) 19.9% -28.1% -22.6% 35.6% 70.2%

Assets (YoY) (%) 12.7% 10.0% 10.6% 9.3% 10.5%

ROA (%) 0.7% 0.4% 0.3% 0.4% 0.6%

ROE (%) 11.0% 7.2% 5.1% 6.4% 10.2%

EPS (`.) 22.8 15.7 11.9 16.1 27.4

EPS (YoY) (%) 19.9% -30.8% -24.7% 35.6% 70.2%

P/E (x) 11.3 16.4 21.8 16.1 9.4

BV (`.) 216.2 230.9 244.2 257.8 280.8

BV (YoY) (%) 9.5% 6.8% 5.8% 5.5% 8.9%

P/BV (x) 1.2 1.1 1.1 1.0 0.9






Please see Appendix I at the end of

this report for Important Disclosures

and Disclaimers and Research Analyst

Certification.

State Bank of India 18 January 2017


Exhibit 2. : DuPont Analysis (Consolidated) (%)


NII / Assets (%) 2.9% 2.8% 2.5% 2.6% 2.7%

Margins would dip in FY17E and recover

thereafter. Positive impact of declining funding

costs and better revenue recognition would be

partly offset by sharp MCLR cuts and

integration issues

Core other income / Assets (%) 1.5% 1.6% 1.6% 1.7% 1.7% Growth in core fee should accelerate post

integration due to synergy benefits Other income / Assets (%) 1.9% 1.8% 2.0% 1.9% 2.0%


Employee Cost to Assets (%) 1.2% 1.1% 1.1% 1.1% 1.1% Increase in employee compensation, spends on

technology in associate banks would counter

cost rationalization measures


Cost to Assets (%) 2.9% 2.6% 2.5% 2.6% 2.6%

PPP / Assets (%) 2.0% 2.0% 2.0% 2.0% 2.0%

Provisions / Assets (%) 1.0% 1.3% 1.6% 1.4% 1.2% Despite gradual improvement asset quality, LLP

would be elevated in the near term

PBT / Assets (%) 1.0% 0.6% 0.4% 0.6% 0.9%

Core ROA (%) 0.7% 0.4% 0.3% 0.4% 0.6% RoA would improve in the medium term, closer

to long term average RoA of 0.8% ROA (%) 0.7% 0.4% 0.3% 0.4% 0.6%


Exhibit 3. SBI: One-year forward P/BV (x) & One-year forward PE (x)



Sharper than estimated reduction in stressed asset formation: A

recovery in corporate asset quality would result in lower-than-estimated

stressed asset formation. This would have the dual impact of better

revenue recognition, higher corporate fee income and lower loan loss

provisions. Risk appetite and internal capital generation would improve,

leading to a pick-up in loan growth and better operating revenues. In

such case, we would see a strong upside to our estimates.

Management change could affect the integration process: The current

chairperson, Mrs Arundhati Bhattacharya, is due to retire on October 7,

2017. She has already received a one-year extension after her retirement

last year and nearly one and a half years since she superannuated to

oversee the process of consolidation. Following her retirement, the new

strategies of growth, revenue generation, cost rationalization, capital

raising, etc. could undergo a change under the new management. This

would remain an overhang on the stock

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8


SBI Fwd. P/BV (x) SD+1 SD-1 Average

4

6

8

10

12

14

16

18

20

22


SBI Fwd. P/E (x) SD+1 SD-1 Average




Exhibit 3. SBI: Stressed asset resolutions to improve, but absolute level of stressed assets would be high still

Source: Company, JM Financial. Note: # SDR and 5/25 outstanding as well as outstanding watchlist amount of associates

has been added as on 1Q17 data provided by bank

Exhibit 4. SBI Consolidated: O/s impaired asset break up (FY16) (%)


Mar 2016 (` bn) FY16

GNPA 1,234.6

Restructured 615.9

5/25 scheme 286.0




Total Impaired asset 2,737.4



Exhibit 5. SBI Standalone: Stressed assets portfolio as on FY16 (` mn)

Industry

Exposure

under Stress

(O/S)

Of Which % Share in

Total credit 5/25 & SDR Restructured

Power 47,480 0 14,240 0.31

Iron & Steel 42,990 6,440 26,280 0.28

Engineering 35,740 19,360 9,240 0.24

Oil & Gas 33,960 0 0 0.22

Construction 26,080 0 14,790 0.17

Chemicals 23,260 0 21,430 0.15

Textiles 11,810 0 10,240 0.08

Transport 9,150 0 7,390 0.06

Food Processing & Beverage 8,150 0 0 0.05

Telecom 8,070 0 2,050 0.05

Ceramic 4,280 0 4,280 0.03

Roads 3,820 0 3,820 0.03

Trading 1,270 0 0 0.01

Others 57,470 0 2,800 0.38

Total 313,530 25,800 116,560 2.08


0%

10%

20%

30%

40%

50%

60%

70%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

FY

20E


8.3%7.7%

8.9% 9.1%

14.2%#

13.2%

10.8%

8.9%

7.3%

0%

2%

4%

6%

8%

10%

12%

14%

16%





Exhibit 6. SBI Standalone: Exposure in top stressed assets - FY16 (` bn)

Industry FB O/S as on

Mar '16

Already NPA

(%)

5/25 &

SDR (%)

Restructured

(%)

Remaining

Stressed (%)

Power 1,365 1.94

1.04 2.43

Iron & Steel 825 32.71 0.78 3.18 1.24

Textiles 436 20.27

2.35 0.36

Constructio

n 307 19.38

4.82 3.68

Roads 189 19.26

2.02

Total 3,122 15.40 0.21 2.22 1.81


Exhibit 7. SBI Standalone: Power sector exposure breakup- 2Q17 (` bn)

SBI Power sector Exposure (` bn)

Public Sector 560.8

Private Sector 766.9

- Rated A & Above 352.0

- Other Investment grade 204.2

- Others## 210.7

Already NPA 35.2

Total Exposure 1362.9

##Break up of Other Private sector Power Exposure (` bn)

Under 5/25 scheme 14.2

Under SDR scheme 13.2

Std. Restructured 98.7

Under Watch List 28.8

Low Stress accounts 84.7

Total 239.5

Overlap among above schemes 28.8

Net Total exposure 210.7




Exhibit 8. SBI: Post-merger key metrics (` bn)

SBI

Associates

(cumulative) Merged Entity

Key metrics (` mn)

Total Assets 23,855.1 5,992.1 29,847.2

Net worth 1,809.2 363.0 2,172.2

Deposits 18,590.0 5,194.0 23,784.0

CASA 7,558.1 1,793.6 9,351.6

Net Advances 14,335.5 3,697.7 18,033.2

Investments 6,482.0 1,597.9 8,080.0

Performance - 1H17 (` mn)

Net Interest income 287.5 72.8 360.3

Non-interest income 157.6 35.6 193.2

Total Income 445.1 108.4 553.5

Operating cost 222.3 52.4 274.7

Pre-provisioning profit 222.8 56.0 278.7

Provisions 153.1 123.0 276.1

PBT 69.7 -67.1 2.6

Tax 19.1 -15.9 3.2

PAT 50.6 -51.2 -0.6

Asset Quality

GNPA (` mn) 1,058 540 1,598

GNPA (%) 7.2% 13.8% 8.5%

Restructured (` mn) 366 140 505

Restructured (%) 2.5% 3.6% 2.7%

Total Impaired (` mn) 1,424 680 2,103

Total Impaired (%) 9.6% 17.3% 11.2%

PCR 43.3% 40.1% 42.2%

Key ratios

Loan-Deposit ratio 77.1% 71.2% 75.8%

CASA ratio 40.7% 34.5% 39.3%

Tier 1 capital 10.9% 8.7% 10.4%

Capital Adequacy Ratio 13.9% 11.2% 13.4%

RWA/total assets 60.7% 65.0% 61.6%

RWA/Loans 101.0% 105.3% 101.9%

NIM 49.9% 48.4% 49.6%

Cost to Income ratio 0.9% 0.9% 0.9%

Cost/Assets 2.1% 6.7% 3.1%

LLP / credit cost 77.1% 71.2% 75.8%

Other metrics

Branches 17,142 7,145 24,287

Employees 2,01,783 71,366 2,73,149

CASA/Branch (` mn) 440.9 251.0 385

Employee/Branch 11.8 10.0 11.2




Financial Tables: SBI Consolidated



Net Interest Income 748.0 788.1 792.1 897.1 1,025.1



Exchange Income 23.9 25.4 27.7 29.9 32.9

Fee & Other Income 218.4 268.7 288.6 318.9 353.1


Total Income 1,241.1 1,298.2 1,408.1 1,564.8 1,769.9




Provisions on Investments -6.6 3.2 4.0 -0.5 0.0



PBT 258.5 181.8 122.5 194.1 329.2

Tax 83.4 54.3 40.8 64.6 109.6











Equity Capital 7.5 7.8 8.0 8.0 8.0

Reserves 1,606.4 1,784.4 1,939.4 2,047.2 2,230.6

Deposits 20,529.6 22,538.6 25,694.0 28,777.3 32,518.3

Borrowings 2,446.6 2,582.1 2,135.6 1,797.3 1,546.1

Minority Int. 55.0 62.7 70.8 80.0 90.4

Insurance fund 328.6 396.3 479.6 556.3 639.8

Other Liab. 2,027.4 2,323.3 2,509.2 2,634.6 2,634.6

Total Liab. 27,001.1 29,695.2 32,836.6 35,900.7 39,667.7

Investments 6,735.1 7,051.9 8,278.7 9,214.3 10,341.1

Net Advances 16,922.1 18,702.6 20,011.8 22,213.1 24,878.7

Cash & Equiv. 1,884.8 2,041.6 2,497.7 2,395.6 2,557.3

Fixed Assets 123.8 138.8 74.4 111.2 77.0

Other Assets 1,335.3 1,760.3 1,974.1 1,966.5 1,813.6

Total Assets 27,001.1 29,695.2 32,836.6 35,900.7 39,667.7


Key ratios (%)


Growth (YoY) (%)

Deposits 11.6% 9.8% 14.0% 12.0% 13.0%

Advances 7.2% 10.5% 7.0% 11.0% 12.0%

Total Assets 12.7% 10.0% 10.6% 9.3% 10.5%

NII 10.7% 5.4% 0.5% 13.2% 14.3%





Provisions 20.5% 51.5% 30.5% -2.5% -7.8%

Reported PAT 19.9% -28.1% -22.6% 35.6% 70.2%


Interest Spread (%) 2.27% 2.21% 2.17% 2.26% 2.36%

NIM (%) 3.07% 2.96% 2.70% 2.78% 2.86%

Profitability (%)

Non-IR to Income (%) 39.7% 39.3% 43.7% 42.7% 42.1%

Cost to Income (%) 59.0% 56.8% 56.1% 56.7% 56.3%

ROA (%) 0.67% 0.43% 0.30% 0.37% 0.58%

ROE (%) 11.0% 7.2% 5.1% 6.4% 10.2%

Assets Quality (%)

Gross NPAs (%) 4.32% 6.42% 8.20% 7.06% 5.97%

Net NPAs (%) 2.23% 3.73% 5.02% 4.04% 3.21%


Specific LLP (%) 1.36% 1.97% 2.40% 2.15% 1.75%



Tier I (%) 9.49% 9.87% 10.40% 10.01% 9.83%

CAR (%) 12.00% 12.92% 13.72% 12.94% 12.48%


DuPont Analysis (%)


NII / Assets (%) 2.94% 2.78% 2.53% 2.61% 2.71%



Cost to Assets (%) 2.87% 2.60% 2.53% 2.58% 2.64%

PPP / Assets (%) 2.00% 1.98% 1.98% 1.97% 2.05%


PBT / Assets (%) 1.01% 0.64% 0.39% 0.56% 0.87%

Tax Rate (%) 32.2% 29.9% 33.3% 33.3% 33.3%

ROA (%) 0.67% 0.43% 0.30% 0.37% 0.58%

RoRWAs (%) 1.09% 0.72% 0.51% 0.62% 0.96%

Leverage (%) 16.5 16.6 16.7 17.2 17.6

ROE (%) 11.0% 7.2% 5.1% 6.4% 10.2%


Valuations



EPS (`.) 22.8 15.7 11.9 16.1 27.4

EPS (YoY) (%) 19.9% -30.8% -24.7% 35.6% 70.2%

PE (x) 11.3 16.4 21.8 16.1 9.4

BV (`.) 216 231 244 258 281

BV (YoY) (%) 9.5% 6.8% 5.8% 5.5% 8.9%

P/BV (x) 1.19 1.12 1.06 1.00 0.92

DPS (Rs.) 3.5 2.6 1.9 2.6 4.4

Div. yield (%) 1.37% 1.01% 0.73% 1.00% 1.70%




Financial Tables: SBI Parent (Standalone)





Exchange Income 19.4 21.1 26.8 30.3 35.8

Fee & Other Income 170.2 210.3 205.1 252.6 296.7


Total Income 775.9 850.4 891.9 986.2 1,117.1







PBT 193.1 137.7 133.2 203.9 294.7

Tax 62.1 38.2 38.6 61.2 98.4








Y/E March FY14 FY15 FY16 FY17E FY18E

Equity Capital 7.5 7.8 8.0 8.0 8.0

Reserves 1,276.9 1,435.0 1,597.1 1,711.3 1,868.3

Deposits 15,767.9 17,307.2 19,730.2 22,147.2 24,971.0

Borrowings 2,051.5 2,241.9 2,433.0 2,648.2 2,916.0

Other Liab. 1,377.0 1,598.8 1,438.9 1,582.8 1,741.0

Total Liab. 20,481 22,591 25,207 28,097 31,504

Investments 4,950.3 4,771.0 5,933.4 6,588.7 7,346.5

Net Advances 13,000.3 14,637.0 15,823.8 17,920.4 20,258.6

Cash & Equiv. 1,748.6 2,198.7 2,473.4 2,481.6 2,792.1

Fixed Assets 93.3 103.9 126.0 137.7 151.2

Other Assets 688.4 880.1 850.5 969.0 955.8

Total Assets 20,481 22,591 25,207 28,097 31,504


Key ratios (%)


Growth (YoY) (%)

Deposits 13.1% 9.8% 14.0% 12.3% 12.8%

Advances 7.5% 12.6% 8.1% 13.3% 13.0%

Total Assets 14.2% 10.3% 11.6% 11.5% 12.1%

NII 11.6% 3.4% 5.5% 10.5% 12.3%





Provisions 26.9% 45.8% 1.8% -8.6% -8.1%

Reported PAT 20.3% -24.0% 8.8% 31.9% 37.5%


Interest Spread (%) 2.42% 2.21% 2.13% 2.15% 2.17%

NIM (%) 2.96% 2.75% 2.62% 2.59% 2.59%

Profitability (%)

Non-IR to Income (%) 29.1% 33.1% 32.7% 32.7% 33.3%

Cost to Income (%) 49.0% 49.1% 51.4% 51.5% 51.0%

ROA (%) 0.68% 0.46% 0.45% 0.54% 0.66%

ROE (%) 10.6% 7.3% 7.1% 8.6% 10.9%

Assets Quality (%)

Slippages (%) 2.50% 5.05% 3.40% 2.80% 2.50%

Gross NPAs (%) 4.27% 6.52% 7.39% 6.36% 5.18%

Net NPAs (%) 2.12% 3.81% 4.12% 3.38% 2.55%


Specific LLP (%) 1.43% 1.95% 1.85% 1.50% 1.20%



Tier I (%) 9.60% 9.92% 10.78% 10.20% 9.78%

CAR (%) 12.00% 13.12% 14.94% 14.22% 13.61%


DuPont Analysis (%)


NII / Assets (%) 2.86% 2.64% 2.51% 2.49% 2.50%



Cost to Assets (%) 1.98% 1.94% 1.92% 1.91% 1.91%

PPP / Assets (%) 2.06% 2.01% 1.81% 1.79% 1.84%


PBT / Assets (%) 1.01% 0.64% 0.56% 0.77% 0.99%

Tax Rate (%) 32.2% 27.8% 29.0% 30.0% 33.4%

ROA (%) 0.68% 0.46% 0.45% 0.54% 0.66%

RoRWAs (%) 1.12% 0.78% 0.76% 0.88% 1.06%

Leverage (%) 15.6 15.8 15.7 16.0 16.6

ROE (%) 10.6% 7.3% 7.1% 8.6% 10.9%


Valuations


Shares in issue (mn) 7,466 7,763 7,973 7,973 7,973

EPS (`.) 17.5 12.8 13.6 17.9 24.6

EPS (YoY) (%) 20.3% -27.0% 5.9% 31.9% 37.5%

PE (x) 14.7 20.1 19.0 14.4 10.5

BV (`.) 172 186 201 216 235

BV (YoY) (%) 8.6% 8.0% 8.3% 7.1% 9.1%

P/BV (x) 1.50 1.39 1.28 1.20 1.10

DPS (`.) 4.1 3.0 2.7 3.6 4.9

Div. yield (%) 1.6% 1.2% 1.1% 1.4% 1.9%



Steady evolution underway

YES Bank (YES) has been on a successful journey to diversify its business model

and emerge into a holistic lender. It has developed a meaningful branch

footprint, is building its retail liability franchise and is gradually developing

retail assets. Development of a retail franchise will substantially reduce

concentration risks and capital consumption, aid ALM and diversify the fee

income profile. YES offers state-of-the-art products and services, is

implementing cutting-edge-technology based solutions and has attracted talent

from across the industry. The bank can deliver c.1.9% RoA and 28% earnings

CAGR over FY16-19E. YES is pressed to raise capital though. We initiate coverage

with BUY rating and a target price of `1606/share (without building in dilution)

at 2.8x FY19E BV. Capital raising of c.$1bn would lead to a revision in our

estimates (pro-forma numbers in Financial tables).

Strong loan growth, robust core revenue growth to follow: YES is likely to

deliver a CAGR of 27% in loans driven by a deepening share of wallet in highly

rated corporate, acquisition of retail loans off a small base and higher risk-

appetite as compared to other lenders. The move to MCLR has also made

medium-sized lenders more competitive due to lower spread over MCLR of

larger banks. This would allow them to gain foothold in better rated accounts.

NIMs are likely to expand due to the rising mix of CASA and fixed rate loans,

reduction in SA rates in the medium term and repricing of wholesale

borrowings.

Asset quality is the key concern: Asset quality concerns legitimately stem from

high loan concentration and exposure to sensitive sectors and highly levered

groups. YES has the capability to manage such exposures swiftly since it i) was

not a part of consortium-based lending and ii) had ring-fenced its exposures

with adequate exit-clauses. An Increasing mix of retail loans, reduction in lumpy

corporate exposure through loan work-outs and increasing mix of highly-rated

corporate would incrementally mitigate concentration and credit risks.

Nevertheless, we build in GNPA ratios increasing from 0.76% in FY16 to 1.1% in

FY19E and estimate loan loss provisions of 60bps over FY16-19E.

Capital raise on the horizon, strong long term prospects: With a CET 1 ratio

(including 6MFY17 profits) of 9.7% and a 25-30% YoY credit growth outlook, YES

would need to raise capital soon; this would be significantly book value

accretive, add c.370bps to Tier 1 CAR and would provide necessary growth

capital. We have not factored in a capital raise. Our estimates factor in 27% Cagr

in loans and 30% in operating profits over FY16-19E. A capital raise would lead

us to revisit our estimates. YES is among our top picks for its ability to deliver

superior growth and profitability metrics through well-thought out strategies. 1.

Abhishek Murarka

[email protected]

Tel: (91 22) 6630 3263

Jayant Kharote

[email protected]

Tel: (91 22) 6630 3099

Karan Singh

[email protected]

Tel: (91 22) 6630 3082

Nikhil Walecha

[email protected]

Tel: (91 22) 6630 3027

Key Data

Market cap (bn) ` 559.9 / US$ 8.2

Shares in issue (mn) 420.5

Diluted share (mn) 420.5


52-week range ` 1450.0/631.6


`/US$ 68.0

Daily Performance

% 1M 3M 12M

Absolute 12.0 5.9 99.5

Relative* 9.2 6.9 88.1

* To the BSE Sensex


Sep-16 Mar-16

Promoters 21.9 21.9

FII 43.1 41.3

DII 23.1 24.3


-50%

0%

50%

100%

150%

200%

0

200

400

600

800

1000

1200

1400

1600


Yes Bank

Yes Bank Relative to Sensex (RHS)

Yes Bank | YES IN

18 January 2017

India | Banking & Financial Services | Re-Initiating Coverage Price: `1,324

BUY

12M Target: `1,606

Exhibit 1. Yes Bank: Financial Summary (Standalone) (` bn)


Net Profit 20 25 33 42 53

Net Profit (YoY) (%) 24.0% 26.6% 30.2% 26.9% 26.8%

Assets (YoY) (%) 24.9% 21.4% 23.6% 22.1% 23.2%

ROA (%) 1.6% 1.7% 1.8% 1.8% 1.9%

ROE (%) 21.3% 19.9% 21.9% 23.2% 24.2%

EPS (`) 48.0 60.4 78.6 99.8 126.5

EPS (YoY) (%) 7.0% 25.8% 30.2% 26.9% 26.8%

PE (x) 27.6 21.9 16.8 13.3 10.5

BV (`) 280 328 390 470 574

BV (YoY) (%) 41.6% 17.3% 19.1% 20.4% 22.0%

P/BV (x) 4.7 4.0 3.4 2.8 2.3









Certification.

Yes Bank 18 January 2017




NII / Assets (%) 2.8% 3.0% 3.2% 3.3% 3.4% Higher CASA, lower SA rates, higher fixed rate loan book would drive margin

expansion

Core other income / Assets (%) 1.6% 1.6% 1.8% 1.8% 1.8% Expect more retail contribution in fee income from 22-23% currently and hence

more sustainability to fee growth Other income / Assets (%) 1.7% 1.8% 2.0% 2.1% 2.1%




Cost to Assets (%) 1.9% 2.0% 2.1% 2.1% 2.1%

PPP / Assets (%) 2.7% 2.9% 3.1% 3.3% 3.4%


PBT / Assets (%) 2.4% 2.5% 2.7% 2.8% 2.9%

Core ROA (%) 1.6% 1.7% 1.8% 1.8% 1.9% Stronger core profitability and well-maintained asset quality would drive return

ratios ROA (%) 1.6% 1.7% 1.8% 1.8% 1.9%


YES is currently trading at 2.9x one yr fwd P/B and 13.8x one yr fwd EPS.

Exhibit 3. Yes Bank: One-year forward P/BV (x) and one-year forward PE (x)


Key data and Outlook

Exhibit 4. Yes Bank: Sensitive sector ratings disclosure

Sensitive sector disclosures Q2FY16 Q3FY16 Q4FY16 Q1FY17 Q2FY17

(A) Electricity 9.8% 9.1% 8.7% 9.3% 9.1%

AAA/AA rated investments 1.9% 1.6% 1.2% 1.0% 0.7%

T&D 1.8% 1.3% 1.3% 1.5% 1.3%

Renewable Exposures(Green-Financing) 3.4% 3.1% 2.5% 2.8% 2.8%

- of which operational 1.3% 1.5% 2.1% 2.2% 2.5%

Non-Renewable 2.6% 3.1% 3.6% 4.0% 4.3%

- of which operational 2.4% 2.9% 3.6% 4.0% 4.3%

Exposure to SEBs 0.0% 0.0% 0.0% 0.0% 0.0%

(B) Iron & Steel 3.8% 3.2% 2.2% 1.9% 1.7%

A or above rated 3.2% 2.3% 1.4% 1.3% 1.1%

(C) EPC 6.3% 6.1% 6.0% 5.6% 5.8%

A or above rated 4.3% 4.1% 4.0% 3.8% 3.8%


0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5


Yes Fwd. P/BV (x) SD+1 SD-1 Average

0

5

10

15

20

25

30

35


Yes Fwd. P/E (x) SD+1 SD-1 Average



Exhibit 5. Yes Bank: Impaired asset movement - we estimate normalization in GNPAs as YES becomes larger in size


Exhibit 6. Yes Bank: CASA accretion has been much stronger post deregulation

of SA interest rates


Exhibit 7. Yes Bank: Capital needs are becoming pressing

Source: Company, JM Financial; ratios do not include profits for 6MFY17, including profits, Tier 1 ratio is 10.1%

0.2% 0.2%

0.3%0.4%

0.8%0.9%

1.0%1.1% 1.1%

0%

20%

40%

60%

80%

100%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%


Gross NPLs (%) Net NPLs (%) Coverage (%) (RHS)

0.5%

0.8%

0.5% 0.5%

0.9%

1.6% 1.5% 1.6%1.5%

1.4%

0.0%

0.5%

1.0%

1.5%

2.0%

FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

Gross NPLs (%) Restructured standard(%) Outstanding SR, SDR etc

8.7%7.2%

5.7%

10.8%

5.5%6.4%

11.3%12.7% 12.3%

0%

2%

4%

6%

8%

10%

12%

14%

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E

CASA accretion as a % of opening deposits

8.0%9.5%

12.8%

8.6% 8.8% 8.4% 9.1%11.0%

10.3%8.9%

8.5%9.5%

12.8%

9.7% 9.9%9.5% 9.8%

11.5%10.7%

9.2%

0%

2%

4%

6%

8%

10%

12%

14%

FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 2Q17

CET1 (%) AT-1 (%)








Exchange Income -0.7 -0.2 0.4 0.4 0.5

Fee & Other Income 19.7 24.7 32.5 40.6 50.3


Total Income 55.3 72.8 96.6 121.9 152.3







PBT 29.1 37.7 50.1 63.6 81.2

Tax 9.0 12.3 17.0 21.6 28.0




Dividend 4.5 5.1 6.7 8.4 9.7





Equity Capital 4.2 4.2 4.2 4.2 4.2


Deposits 911.8 1,117.2 1,452.4 1,859.0 2,379.5

Borrowings 262.2 316.6 337.5 348.7 363.7



Investments 432.3 488.4 598.6 707.1 847.9

Net Advances 755.5 982.1 1,257.1 1,583.9 1,995.8


Fixed Assets 3.2 4.7 6.0 7.4 9.4

Other Assets 95.2 95.3 73.1 74.1 72.2

Total Assets 1,361.7 1,652.6 2,042.3 2,494.6 3,074.5


Key ratios (%)


Growth (YoY) (%)

Deposits 22.9% 22.5% 30.0% 28.0% 28.0%

Advances 35.8% 30.0% 28.0% 26.0% 26.0%

Total Assets 24.9% 21.4% 23.6% 22.1% 23.2%

NII 28.4% 30.9% 28.7% 28.2% 26.0%





Provisions -6.1% 58.0% 40.0% 36.3% 24.9%

Reported PAT 24.0% 26.6% 30.2% 26.9% 26.8%


Interest Spread (%) 2.52% 2.73% 2.80% 2.90% 3.00%

NIM (%) 3.05% 3.24% 3.34% 3.44% 3.51%

Profitability (%)

Non-IR to Income (%) 37.0% 37.3% 39.1% 38.2% 37.6%

Cost to Income (%) 41.3% 40.9% 40.4% 39.5% 38.3%

ROA (%) 1.64% 1.68% 1.79% 1.85% 1.91%

ROE (%) 21.3% 19.9% 21.9% 23.2% 24.2%

Assets Quality (%)

Slippages (%) 0.70% 1.21% 1.25% 1.10% 1.00%

Gross NPAs (%) 0.41% 0.76% 0.85% 1.00% 1.10%

Net NPAs (%) 0.12% 0.29% 0.38% 0.43% 0.43%


Specific LLP (%) 0.20% 0.57% 0.52% 0.60% 0.60%



Tier I (%) 11.48% 10.73% 10.36% 10.22% 10.10%

CAR (%) 15.62% 16.45% 15.30% 14.76% 14.06%


DuPont Analysis (%)


NII / Assets (%) 2.85% 3.03% 3.18% 3.32% 3.41%



Cost to Assets (%) 1.86% 1.97% 2.11% 2.12% 2.10%

PPP / Assets (%) 2.65% 2.85% 3.12% 3.25% 3.38%


PBT / Assets (%) 2.37% 2.50% 2.71% 2.80% 2.92%

Tax Rate (%) 31.1% 32.6% 34.0% 34.0% 34.5%

ROA (%) 1.64% 1.68% 1.79% 1.85% 1.91%

RoRWAs (%) 2.23% 2.15% 2.22% 2.30% 2.37%

Leverage (x) 13.0 11.8 12.2 12.5 12.7

ROE (%) 21.3% 19.9% 21.9% 23.2% 24.2%


Valuations


Shares in issue (mn) 417.7 420.5 420.5 420.5 420.5

EPS (`) 48.0 60.4 78.6 99.8 126.5

EPS (YoY) (%) 7.0% 25.8% 30.2% 26.9% 26.8%

PE (x) 27.6 21.9 16.8 13.3 10.5

BV (`) 280 328 390 470 574

BV (YoY) (%) 41.6% 17.3% 19.1% 20.4% 22.0%

P/BV (x) 4.74 4.04 3.39 2.82 2.31

DPS (`.) 10.8 12.0 16.0 20.0 23.0

Div. yield (%) 0.8% 0.9% 1.2% 1.5% 1.7%




APPENDIX I


Corporate Identity Number: U65192MH1995PLC092522

Member of BSE Ltd. and National Stock Exchange of India Ltd. and Metropolitan Stock Exchange of India Ltd.

SEBI Registration Nos.: BSE - INZ010012532, NSE - INZ230012536 and MSEI - INZ260012539, Research Analyst – INH000000610

Registered Office: 7th Floor, Cnergy, Appasaheb Marathe Marg, Prabhadevi, Mumbai 400 025, India.

Board: +9122 6630 3030 | Fax: +91 22 6630 3488 | Email: [email protected] | www.jmfl.com

Compliance Officer: Mr. Sunny Shah | Tel: +91 22 6630 3383 | Email: [email protected]

Definition of ratings

Rating Meaning

Buy Total expected returns of more than 15%. Total expected return includes dividend yields.

Hold Price expected to move in the range of 10% downside to 15% upside from the current market price.

Sell Price expected to move downwards by more than 10%

Research Analyst(s) Certification

The Research Analyst(s), with respect to each issuer and its securities covered by them in this research report, certify that:

All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities;

and

No part of his or her or their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in

this research report.

Important Disclosures

This research report has been prepared by JM Financial Institutional Securities Limited (JM Financial Institutional Securities) to provide information

about the company(ies) and sector(s), if any, covered in the report and may be distributed by it and/or its associates solely for the purpose of

information of the select recipient of this report. This report and/or any part thereof, may not be duplicated in any form and/or reproduced or

redistributed without the prior written consent of JM Financial Institutional Securities. This report has been prepared independent of the

companies covered herein.

JM Financial Institutional Securities is registered with the Securities and Exchange Board of India (SEBI) as a Research Analyst, Merchant Banker

and a Stock Broker having trading memberships of the BSE Ltd. (BSE), National Stock Exchange of India Ltd. (NSE) and Metropolitan Stock

Exchange of India Ltd. (MSEI). No material disciplinary action has been taken by SEBI against JM Financial Institutional Securities in the past two

financial years which may impact the investment decision making of the investor.

JM Financial Institutional Securities provides a wide range of investment banking services to a diversified client base of corporates in the

domestic and international markets. It also renders stock broking services primarily to institutional investors and provides the research services

to its institutional clients/investors. JM Financial Institutional Securities and its associates are part of a multi-service, integrated investment

banking, investment management, brokerage and financing group. JM Financial Institutional Securities and/or its associates might have provided

or may provide services in respect of managing offerings of securities, corporate finance, investment banking, mergers & acquisitions, broking,

financing or any other advisory services to the company(ies) covered herein. JM Financial Institutional Securities and/or its associates might have

received during the past twelve months or may receive compensation from the company(ies) mentioned in this report for rendering any of the

above services.

JM Financial Institutional Securities and/or its associates, their directors and employees may; (a) from time to time, have a long or short position

in, and buy or sell the securities of the company(ies) mentioned herein or (b) be engaged in any other transaction involving such securities and

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