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UNION BANK 2QFY11: Below est; Asset quality, fees and opex disappoint; Margins improve QoQ; Downgrading estimates
Union Bank of India (UNBK IN, Mkt Cap US$4.5b, CMP Rs393, Buy) 2QFY11 earnings disappointed with PAT decline of 40% to Rs3b (44% below estimates) despite NII growth of 73% YoY (10% higher than est). Higher provisions on NPAs and higher opex (due to higher than guided 2nd Pension provisions and gratuity) led significantly lower than estimated profitability. However, margins improvement of 18bp QoQ despite higher slippages in the quarter is a positive surprise.
Key highlights
- Sharp deterioration in asset quality a negative surprise: Slippages in 2QFY11 were Rs11.3b led by recognition of NPA under agri-debt relief (Rs4.2b) and slippages in three large corporate accounts (~Rs3b) besides normal slippages. Mgmt is guiding for lower slippages in 2HFY11 and expects strong up-gradations and recoveries. Management targets to bring down GNPA ratio to 2.3% by end FY11 v/s 2.8% in 2QFY11.
- Pension provisions a bigger negative surprise: Employee expenses during the quarter increased sharply as bank provided ~Rs2.5b towards pension and gratuity related liability. UNBK has estimated pension related liability of Rs24b to be amortized over 5 years (Rs2.4b provided till 1HFY11) and Rs2.5b towards gratuity to be provided in FY11 (Rs1.27b provided till 1HFY11). Earlier bank had guided for Rs12b of liability. Sharp increase in the pension liability is a cause of concern for the bank and sector in particular. Union bank has total employee base of 27,000 and assuming 50% will opt for 2nd pension option, per employee liability comes to Rs1.8-2m which is a big negative surprise in our view. We would seek details from other banks also on this liability, which is not factored in our estimates.
- Loan growth higher than industry: Loans grew 27% YoY but remain muted on a sequential basis (1.3% QoQ, in line with industry trend) to Rs1.26t. On the back of strong pipeline of sanctioned loans management target loan growth of 25% in FY11.
- Margins a positive surprise: NII grew 73% YoY and 14% QoQ lead by 93bp YoY and 32bp QoQ improvement in NIMs to 3.35%. Adjusted for one-offs NIMs improved 18bp QoQ to 3.21% - A positive surprise considering higher slippages during the quarter.
- Fee income disappoints again: Fee income grew 8% YoY in 2QFY11, flat YoY in 1HFY11. Mgmt has toned down its guidance on fees from 20%+ to 15% now.
Valuation and view
- Increase in operating expenses and higher credit cost is leading to sharp downgrades in our earning estimates. We had earlier built-in pension liability of Rs2.4b p.a. for 5 years from FY11 but current management guidance of Rs4.8b liability p.a., would result in higher operating expenses. Further, we are also increasing the provisioning expenses by 12% and 15% respectively for FY11 and FY12 to account for higher credit costs. Higher than expected reduction on account of strong recoveries and up gradations can provide positive surprise on asset quality.
- Strong business growth and improvement in margins will drive NII growth for UNBK. We model NII growth of 47% YoY for FY11 and 19% for FY12 respectively.Overall, we have downgraded our earnings estimates for FY11 by 15% and for FY12 by 12% to Rs21.4b and Rs26.9b respectively. Return ratios are likely to contract with RoAs of ~1% and RoE of 22-23% over FY11-12. Stock trades at 1.6x FY12 BV and 7.4x FY12E EPS. Maintain Buy with a target price of Rs425 (1.7x FY12E BV)
Asset Quality deteriorates sharply QoQ; Upgradation and recoveries lower QoQ
- GNPAs in absolute terms increased by 29% QoQ to Rs35b, whereas in % terms GNPA increased to 2.8% v/s 2.2% in 1QFY11 and 1.93% in 2QFY10. NNPA in % terms increased to 1.18% v/s 0.94% in 1QFY11. PCR incl technical write-off decline marginally to 70% v/s 71% in 1QFY11.
- Slippages in 2QFY11 were Rs11.3b led by recognition of NPA under agri. debt relief (Rs4.2b) and three large accounts (~Rs3b) falling into NPA besides slippages in normal course of business.
- Mgmt is guiding for lower slippages in 2HFY11 and expects strong upgradations and recoveries. Management targets to bring down GNPA ratio to 2.3% by end FY11 v/s 2.8% in 2QFY11. We model in slippages of 2.25% for FY11 and credit cost of 0.9% vs 0.65% in FY10.
- O/s restructured loan stood at Rs51.2b (4% of the loan book, facility-wise) out of which 11.3% have already slipped in to NPA and management expects cumulative slippages to be less than 15% of the overall restructured book.
High pension and gratuity related liability to increase operating expenses – a key negative for sector as well as bank
- Operating expense grew by 50% YoY and 24% QoQ to Rs9.1b. Employee expenses during the quarter increased sharply as bank provided ~Rs2.5b towards pension (Rs1.2b) and gratuity related liability (~Rs1.3b in 1HFY11, bulk of which was provided in 2QFY11).
- UNBK has estimated pension related liability of Rs24b to be amortized over 5 years (Rs2.4b provided till 1HFY11) and Rs2.5b towards gratuity to be provided in FY11 (Rs1.27b provided till 1HFY11).
- Union bank has total employee base of 27,000 and assuming 50% will opt for 2nd pension option. Per employee liability comes to Rs1.8-2m which is a negative surprise in our view for the sector and bank.
- Cost to income ratio increased to 45% v/s 41% in 1QFY11 and 43% in 2QFY10.
- Management expects employee expenses to decline from 2QFY11 levels; this in our view would be on the back of relatively lower gratuity related expenses.
Loans growth remains muted QoQ; in line with industry trend
- Loans grew 27% YoY (on a lower base) and 1.3% QoQ to Rs1.26t, while deposits grew by 18% YoY and 4% QoQ to Rs1.8t.
- Savings deposits grew 29%YoY and 6% QoQ (a positive factor), however due to lower growth in current deposits overall CASA grew by 19% YoY. CASA ratio remained stable at 32.7%.
- CD ratio declined to 71.1% v/s 73% in 1QFY11 (however improved by 441bp YoY).
- On the back of strong pipeline of sanctioned loans management target loan growth of 25% in FY11.
Strong margin QoQ; Adj. for one off NIM at 3.21%- positive surprise
- NII grew 73% YoY and 14% QoQ to Rs15.4b. During the quarter, UNBK accounted Rs1.2b of interest income on income tax refunds and there was reversal of Rs620mn due to classification of agri-debt relief amount as NPAs. Even adjusting for this NII growth would have been higher at 66% YoY (6% higher than our est)
- Reported margins improved 93bp YoY and 32bp QoQ to 3.35%. Adjusting for the one-off income in interest, margins were at 3.21% (up 18bp QoQ). This improvement is a positive surprise considering the deterioration in asset quality.
- Cost of deposits increased by 6bp QoQ to 5.4% whereas yield on loan were up by 24bp QoQ to 9.6% driving the NIM expansion. Strong expansion in margins despite higher slippages during the quarter instills confidence in us of bank maintaining strong margin in FY11. Management targets NIM of 3.1%+ for FY11.
Core fee income growth muted but management expects it to recover
- Other income grew by 17% QoQ but declined by 4% YoY.
- Fee income (including forex) growth remained muted. It grew 8% YoY to Rs2.8b Trading gains were Rs1.9b vs Rs1.4b in 1QFY11 and Rs2.3b in 2QFY10.
- Recoveries during the quarter were Rs440m v/s Rs380m in 1QFY11 and Rs420m in 2QFY10
- Although fee income growth for 1HFY11 is merely 4% YoY, mgmt expects it to grow ~15% for FY11 driven by pick up in loan growth.
Valuations and view
- Overall, we have downgraded our earnings estimates for FY11 by 15% and for FY12 by 12% to Rs21.4b and Rs26.9b. Return ratios are likely to contract with RoAs of ~1% and RoE of 22-23% over FY11-12. Stock trades at 1.6x FY12 BV and 7.4x FY12E EPS. Maintain Buy with a target price of Rs425 (1.7x FY12E BV)
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