Union Bank: Transition exercise completes; post-correction, play for recoveries: Kotak Sec,

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Union Bank (UNBK)
Banks/Financial Institutions
Transition exercise completes; post-correction, play for recoveries. Union Bank’s
reported earnings were below our expectations primarily due to higher slippages. We
expect recoveries to pick up as the bank has completed the last leg of transition (to
system-based NPL recognition) which has driven high (3.5%) slippages from small-ticket
loans even as trends in core slippages will likely be weaker than expected. We revise our
earnings by 7-14% for FY2012-14E primarily to factor higher provisions and lower fees.
Maintain BUY with a TP of `340 (from `425 earlier).
Slippages nearing peak; shifting focus to recoveries; maintain BUY
We believe that Union Bank is close to peak slippages as its NPL transition exercise has been
completed. Akin to Indian Bank (post 1QFY11 results), we expect Union Bank to shift focus to
recoveries/upgrades. Large slippages at Union Bank for the quarter are definitely disappointing;
however, we believe that the overhang of the transition exercise is behind us.
We have revised down our earnings by 7-14% for FY2012-14E largely due to higher loan-loss
provisions and lower core fee income. We expect loan-loss provisions at 1% levels (from about
0.7-0.8% levels earlier) to build in risk to core slippages in the current environment. Expect
margins to remain strong but overall loan growth will likely moderate at 15% CAGR for FY2011-
13E. On revised earnings, we expect the bank to report 19% CAGR in EPS for FY2011-13E and
RoEs in the range of 20%. The stock is trading at 0.9X book and 5X FY2013E EPS. We have
revised our TP to `340 (from `425 earlier) primarily factoring the above changes.
A bitter pill towards the end as the last leg of migration gets completed; gross NPLs rise 37% qoq
Union Bank completed the last leg of NPL transition which resulted in the sharp rise in slippages,
primarily driven by small-ticket and agriculture loans. Slippages rose to 5% (annualized, 3.5%
pertaining to small-ticket loans) for the quarter. The bank reported `7 bn from agriculture, `4 bn
from various government-related schemes and the balance were normal slippages (1.5% levels).
We expect trends to improve (similar to Indian Bank which reported the transition exercise in
1QFY11). On the back of 1HFY12 performance, we expect slippages at 2.3% for FY2012-13E as
underlying NPLs in segments like priority-sector loans (agriculture etc.) look fairly weak. We are
broadly expecting loan-loss provisions at 1% levels for FY2011-13E from 0.8% levels.
Gross NPLs increased sharply—37% qoq to `51.4 bn (3.5% of loans) while net NPLs increased
56% qoq to `29.6 bn (2% of loans). Provision coverage ratio is at 42% (61% including technically
w/off as compared to 68% in 1QFY12) as slippages was not fully provided at current coverage
ratio levels. Loan-loss provisions were at 1.4% (annualized) for the quarter.


NIMs improve 10 bps qoq to 3.2%; comfort to rising credit costs
NIMs improved 10 bps qoq to 3.2% despite a sharp rise in slippages largely driven by
improvement in asset yields. NII grew by 8% yoy (5% qoq) to `16.6 bn. Lending yields
improved 40 bps to 11.3% while cost of deposits increased by 30 bps to 6.9%. Investment
yields improved by 30 bps during the quarter.
Improvement in NIMs is giving some headroom for the bank to make higher provisions for
the underlying slippages being reported by the bank. We have marginally revised our
estimates for FY2012-13E, factoring the strong performance in 1HFY12.
Loan growth slower than industry at 17% yoy; CASA ratio stable qoq at 32%
Loan growth for the quarter slowed down to 17% yoy (1% qoq) to `1.5 tn. During the
quarter, corporate loan growth was at 20+% yoy and retail loans were flat yoy. SME loans
have slowed in recent months at 6% yoy. Given the sharp rise in slippages, we expect the
management focus to shift from loan growth to strengthening balance sheet. Hence, we are
revising loan growth to 15% CAGR (from 18% levels) for FY2011-13E.
Deposit growth was lower than industry average at 10% yoy (2% qoq decline) to `2 tn.
CASA ratio was flat at 32%. Current deposits declined 7% yoy while savings deposits grew
by 14% yoy.
Other highlights of the quarter
􀁠 Non-interest income was flat at `5 bn mainly due to weak core fee income performance.
Core fee income growth was muted at 4% yoy while exchange income grew by 27% yoy.
Treasury profit declined 24% to `1 bn.
􀁠 Overall CAR is at 12.5% with Tier-1 ratio at 8.5% (including profit is about 9%). As
compared to the previous quarter, we note that Tier-1 ratio declined 40 bps primarily due
to marginal deterioration of the underlying loan book resulting in higher risk-weights for
similar exposure. We note that the bank will be one of the likely beneficiaries of capital
infusion from GoI in FY2012E. However, given the current growth projections and healthy
return ratios (about 20% levels) we don’t see this acting as an impediment for growth.