Union Bank of India : 2Q FY11 – Asset quality disappoints: HSBC

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Union Bank of India (UNBK)
N: 2Q FY11 – Asset quality disappoints
􀀗 2Q profit declines 40% y-o-y due to higher staff cost and
sharp spike in slippages; however, NIM remains healthy
􀀗 We cut our earnings estimates by 19% and 7% for FY11 and
FY12 due to weaker asset quality outlook and higher
operating costs
􀀗 Downgrade to Neutral, raise target price to INR428 (from
INR378), implying a potential return of 10%; remove V-flag






2Q FY11 results. Union disappointed our profit estimate as well as the Street’s 2Q
consensus by c50% due a sharp spike in slippages leading to a rise in the gross NPL ratio to
2.8% (from 2.2% in 1Q). Higher provisions for staff pension and gratuity also affected the
bottom-line growth. However, core performance improved, with a stable CASA ratio at 33%
and deposit cost helping margin expansion by 18bp q-o-q to 3.21% (up 70bp y-o-y).
Key themes. Higher slippages and staff costs nullified the core earnings gains. The bank
reported incremental slippages of INR11.3bn (3.64% of loans). These included one-off
slippages of INR4.2bn related to farm debt waiver and INR3.1bn from three export-linked
accounts. However, the bank is yet to ascertain slippages arising from shifting to its CBSbased
NPL recognition system.

Expectations. Loan growth is likely to pick up, with the bank sitting on ample liquidity to
meet its growth targets. NIM is likely to remain stable despite rising rates. However, we
are now cautious on asset quality given the steep negative surprise in 2Q. Staff costs are
likely to remain elevated due to pension provisions.

Earnings outlook. With the above change in our view, we cut our earnings esimates by
19% and 7% for FY11 and FY12. Accordingly, we expect earnings to grow at a 20%
CAGR over FY10-13, more slowly than peers.

Valuation and risks. Our revised 12-month target price is INR428. We continue to value
Union Bank using a weighted average combination of PE, PB and EPM methodologies.
For PE and PB, we set our target multiples on the basis of historical trading patterns and,
hence, use 12- and 24-month forward EPS and BV to value the same. Accordingly, we
value Union Bank at 6.8x PE and 1.2x PB. At these multiples, the shares would trade at
14% and 8% discounts to peers on PE and PB, respectively, and we therefore expect these
valuations to be sustained unless similar asset quality problems surface in other banks. With
a potential return of 10%, we downgrade to Neutral from Overweight (V). Key upside
risks to our rating and estimates: (1) A sharp reversal in asset quality trends; (2) lowerthan-
estimated pension liability. Key downside risk: Chairman retiring in FY13.