PNB: Strong core operating performance - Buy :Religare

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Punjab National Bank
Strong core operating performance
Punjab National Bank (PNB) reported a strong core operating performance in
Q2FY11. NII growth, at 14% QoQ and 49% YoY, was above our and street
estimates due to higher-than-expected growth in advances (6% QoQ, 28% YoY)
and a sequential improvement in NIMs. Asset quality continued to improve with
incremental slippages declining to Rs 9bn (2.2% of advances) from Rs 12bn
(3.1% of advances) in Q1FY11. PAT, however, was marginally below our
estimates due to lower trading gains and above-expected operating expenses.
We believe PNB is amongst the best-placed banks in a rising interest rate regime
due to its strong liability franchise and low dependence on bulk deposits. The
bank is likely to generate above-industry return ratios with an average ROA of
1.4% and ROE of 25.3% over FY11-FY13E. With concerns over asset quality
now allaying, we believe that the stock could trade at ~2x FY12BV. Maintain
BUY with a revised target price of Rs 1,570.

Credit growth robust; margins improve on a higher yield: Credit growth (at 28%
YoY) was broad-based in nature with the industry/retail segments growing
28%/33% YoY (Fig 5). Deposits grew by 7% QoQ with the bank mainly relying
on CDs to fund its growth during the quarter. CASA was stable at ~41%. NIMs
improved by 12bps QoQ (56bps YoY) supported by a 31bps QoQ expansion in
yield on advances (driven by an increase in PLR and base rate in Q2FY11).
Asset quality improving: Sequential decline in slippages was a key positive for
PNB during Q2FY11; however, recoveries and upgrades were on the lower side
(Fig 4). Of the total slippages of Rs 9bn, ~Rs 2.2bn were on account of one large
account in the real estate sector while Rs 1.6bn stemmed from restructured assets.
Gross NPA increased marginally from 1.82% in Q1FY11 to 1.91% in Q2FY11
(Fig 3). Total restructured assets stood at Rs 135bn (6.5% of total advances); of
this, Rs 12bn have already slipped into NPAs (Fig 9-10). We expect asset quality
to improve further in sync with a recovery in the macroeconomic environment.

Core fee income strong; costs up on higher employee expenses: Other income
declined 7% YoY due to a sharp drop in trading gains; however, core fee income
grew by a robust 24% YoY (Fig 7). C/I ratio increased from 39.9% in Q1FY11 to
43.2% in Q2FY11 (41.9% in Q2FY10) due to higher employee expenses (up 12%
QoQ, 53% QoQ on wage hikes, promotions and increase in DAs). The bank
made a provision of Rs 1.25bn each towards second pension liability and gratuity
during the quarter (same provision made in Q1FY11). Total provision liability
from second pension options would be known only in Q3FY11. Liability of
>Rs 25bn could lead to higher provisions from Q3FY11 onwards; however, we
note that gratuity provisions would be fully provided by Q4FY11.