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Union Bank of India
Trends Improve, but Credit Costs Still Elevated
What's Changed
Price Target Rs500 to Rs445
% EPS Change F11/12/13 +1%/-6%/-6%
Union Bank reported profits of Rs5.8 bn for
QE-Dec-10. Profits were up 9% QoQ and 91% YoY. Our
estimate was Rs5.3 bn.
The key highlights from the results include:
a) Volume growth was robust. Loans grew by 6% QoQ
and 26% YoY. Deposits grew by 5% QoQ and 24%
YoY. CASA moved 58 bps higher QoQ to 33.3%.
b) Adjusted NIM expanded 23 bps QoQ to 3.44%. NII
grew by 10% QoQ / 48% YoY.
c) Total costs were down 7% QoQ but rose 38% YoY.
The bank has provided Rs1.2 bn this quarter
towards the second pension related liability (in line
with 2Q guidance).
d) Credit costs moved lower to 111 bps vs. 200 bps in
2Q. Adjusted for the one-off agri debt waiver related
provisions in 2Q, credit costs were up 7 bps QoQ.
New NPL formation was lower QoQ, though still
elevated at 2.4% of op. loans (annualized) – the
bank had material write-offs this quarter of 1.4%.
Maintain OW: Slippages remained elevated – but we
expect trends to improve. Further, core revenue trends
improved this quarter. We believe that current valuations of
5.8x F2012e earnings and 3.9x PPOP are still attractive.
Reducing price target to reflect higher bear case
probability, estimate changes: We are reducing our
price target from Rs500 to Rs445. We now apply a
higher probability to our bear case scenario (20%) to
factor in increased uncertainty about economic growth
following recent developments with regard to inflation
(we will revisit the weight if macro conditions change).
We have also reduced our earnings estimates slightly
Revenue Trends Were Robust
Adjusted NIMs expanded 23 bps QoQ to 3.44%
• Reported NII growth was 5% QoQ / 48% YoY. However,
Union Bank received some interest on income tax refund
in F2Q11 – adjusted for this, NII was up 10% QoQ / 48%
YoY.
• Margins were up 23 bps QoQ, 67 bps YoY to 3.44% (after
adjusting for IT refund in F2Q11). Cost of funds was up 10
bps QoQ.
• Loans grew by 6% QoQ and 26% YoY; deposits grew by
5% QoQ and 24% YoY.
• CASA deposits grew by 7% QoQ / 27% YoY -- faster than
total deposits, thereby leading to sequential improvement
in CASA ratio.
Costs Moved Down Sequentially Owing to Lower One-Off Provisions
• Operating costs were down 7% QoQ but rose 38% YoY.
• In line with its guidance for the second pension option
related liability of Rs24 bn (to be amortized over a fiveyear
period), the bank has provided Rs1.2 bn this quarter.
Union had already raised its guidance for the second
pension option in the results declared in F2Q11.
• In addition, the bank has provided Rs635 mn for gratuity
this quarter. Management indicated that with an additional
provision of Rs635 mn in 4Q, the bank would have fully
provided for gratuity.
• Outside of the above, other staff expenses were up 17%
YoY and flat QoQ. Non-employee expenses were also
stable, growing 2% QoQ and 13% YoY.
Core Non-Interest Income Trends Improved This Quarter
• Core non-interest income (ex-cap gains and recoveries)
was up 19% YoY vs. 8% YoY in the previous quarter.
• Net capital gains contribution ticked lower to Rs0.7 bn from
Rs1.5 bn for the QE Sept-10
• The bank’s effective tax rate moved sharply lower to 33%
as it wrote off loans aggressively this quarter (Rs452 mn
vs. Rs153 mn in 2Q & Rs414 in 1H)
NPL Provisions Remained Elevated, Albeit Minus Last Quarter’s One-Offs
• Credit costs moved lower to 111 bps vs. 200 bps in 2Q. Though New NPL formation was stable QoQ
excluding agri debt waiver related provisions, they were higher vs.
104 bps in 2Q. Management has guided for provisions to be
significantly lower at 50-60 bps in F2012. We have built 70 bps for
F2012 into our estimates.
• New NPL slippages remained high at Rs7.65 bn (2.4% of op.
loans, annualized) though lower from Rs11.3 bn (3.6%) in the
previous quarter, which had one-off agri debt waiver related
slippages.
• The bank saw additional slippage of Rs2.2 bn (0.7% of op loans,
ann.) from restructured loans. This takes the total slippages from
restructured loans to ~15% so far on our computations.
• Benefit from recoveries and upgrades of NPLs was at 0.8% of
op.loans (ann.) vs. 0.6% in 2Q. The bank wrote off aggressively
this quarter (Rs 45.2 bn) at 1.4% of opening loans vs. 0.5% in 2Q
and 0.9% in 1Q. Provisions coverage (including technical writeoffs)
was stable at 70% (in line with the RBI requirement of 70%).
• On the loan segments which are potentially under stress –
management indicated that the bank’s exposure is :
a) MFIs – Rs2 bn (0.1% of loans)
b) Commercial real estate – Rs23 bn (1.7%);
c) Aviation – Insignificant exposure (the bank wasn’t a part of the
consortium that approached RBI for restructuring)
d) Telecom – Rs70 bn in credit commitments (Rs. 20-30 bn (1.5%-
2.2%) in actual exposure with no exposure to licensing)
Target Price Discussion
We arrive at our revised price target of Rs445 (down 11% from
Rs500) using a probability-weighted three-phase residual
income model – a five-year high growth period, a 10-year
maturity period, followed by a declining period.
The key reasons for the change are:
a) Earnings estimate revisions. We have cut our EPS
forecasts for F2012 & F2013 by 6% each. There are two key
reasons for the estimate changes:
1) We now assume lower loan growth of 21% in F2012 and
20% in F2013.
2) We are also building in a Rs11.5 equity infusion in Union
Bank in F2012 by the government (see
http://www.business-standard.com/india/news/union-bank
-to-get-rs-1150-crgov-by-march-2011/120362/on)
b) Probability weightings. We are also now using the
following probability weightings:
• 20% weight to bear case scenario. We factor in the
increased economic growth uncertainty following recent
developments with regard to inflation. There is a risk that if
inflation were to be sustained at a higher level for longer,
there may be a disruptive rise in interest rates – hence
leading to asset quality issues. We believe that until
inflation expectations are brought under control, the
market is likely to continue to assign a reasonable
probability to this outcome.
• 20% weight to bull case scenario. We factor in the
potential of stronger than expected economic growth and
better than expected performance of underlying
businesses at Union Bank.
We have trimmed our bull case value by 7%, to Rs540 per
share, and our base case value by 4%, to Rs280 per share.
Our bear case value is unchanged at Rs250 per share.
We use a cost of equity of 14.1% (up from 13.2%), assuming a
beta of 1.0, a risk-free rate of 8.1% (current Indian 10-year
government bond yield), and a market risk premium of 6%.
Risks to Our Price Target
Key risks to our price target include slower-than-expected loan
growth, sharp compression in NIMs and significant
deterioration in asset quality (restructured loans slippages).
Upside catalysts include: fee income being stronger than
expectations and credit costs being lower than expectations
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Union Bank of India
Trends Improve, but Credit Costs Still Elevated
What's Changed
Price Target Rs500 to Rs445
% EPS Change F11/12/13 +1%/-6%/-6%
Union Bank reported profits of Rs5.8 bn for
QE-Dec-10. Profits were up 9% QoQ and 91% YoY. Our
estimate was Rs5.3 bn.
The key highlights from the results include:
a) Volume growth was robust. Loans grew by 6% QoQ
and 26% YoY. Deposits grew by 5% QoQ and 24%
YoY. CASA moved 58 bps higher QoQ to 33.3%.
b) Adjusted NIM expanded 23 bps QoQ to 3.44%. NII
grew by 10% QoQ / 48% YoY.
c) Total costs were down 7% QoQ but rose 38% YoY.
The bank has provided Rs1.2 bn this quarter
towards the second pension related liability (in line
with 2Q guidance).
d) Credit costs moved lower to 111 bps vs. 200 bps in
2Q. Adjusted for the one-off agri debt waiver related
provisions in 2Q, credit costs were up 7 bps QoQ.
New NPL formation was lower QoQ, though still
elevated at 2.4% of op. loans (annualized) – the
bank had material write-offs this quarter of 1.4%.
Maintain OW: Slippages remained elevated – but we
expect trends to improve. Further, core revenue trends
improved this quarter. We believe that current valuations of
5.8x F2012e earnings and 3.9x PPOP are still attractive.
Reducing price target to reflect higher bear case
probability, estimate changes: We are reducing our
price target from Rs500 to Rs445. We now apply a
higher probability to our bear case scenario (20%) to
factor in increased uncertainty about economic growth
following recent developments with regard to inflation
(we will revisit the weight if macro conditions change).
We have also reduced our earnings estimates slightly
Revenue Trends Were Robust
Adjusted NIMs expanded 23 bps QoQ to 3.44%
• Reported NII growth was 5% QoQ / 48% YoY. However,
Union Bank received some interest on income tax refund
in F2Q11 – adjusted for this, NII was up 10% QoQ / 48%
YoY.
• Margins were up 23 bps QoQ, 67 bps YoY to 3.44% (after
adjusting for IT refund in F2Q11). Cost of funds was up 10
bps QoQ.
• Loans grew by 6% QoQ and 26% YoY; deposits grew by
5% QoQ and 24% YoY.
• CASA deposits grew by 7% QoQ / 27% YoY -- faster than
total deposits, thereby leading to sequential improvement
in CASA ratio.
Costs Moved Down Sequentially Owing to Lower One-Off Provisions
• Operating costs were down 7% QoQ but rose 38% YoY.
• In line with its guidance for the second pension option
related liability of Rs24 bn (to be amortized over a fiveyear
period), the bank has provided Rs1.2 bn this quarter.
Union had already raised its guidance for the second
pension option in the results declared in F2Q11.
• In addition, the bank has provided Rs635 mn for gratuity
this quarter. Management indicated that with an additional
provision of Rs635 mn in 4Q, the bank would have fully
provided for gratuity.
• Outside of the above, other staff expenses were up 17%
YoY and flat QoQ. Non-employee expenses were also
stable, growing 2% QoQ and 13% YoY.
Core Non-Interest Income Trends Improved This Quarter
• Core non-interest income (ex-cap gains and recoveries)
was up 19% YoY vs. 8% YoY in the previous quarter.
• Net capital gains contribution ticked lower to Rs0.7 bn from
Rs1.5 bn for the QE Sept-10
• The bank’s effective tax rate moved sharply lower to 33%
as it wrote off loans aggressively this quarter (Rs452 mn
vs. Rs153 mn in 2Q & Rs414 in 1H)
NPL Provisions Remained Elevated, Albeit Minus Last Quarter’s One-Offs
• Credit costs moved lower to 111 bps vs. 200 bps in 2Q. Though New NPL formation was stable QoQ
excluding agri debt waiver related provisions, they were higher vs.
104 bps in 2Q. Management has guided for provisions to be
significantly lower at 50-60 bps in F2012. We have built 70 bps for
F2012 into our estimates.
• New NPL slippages remained high at Rs7.65 bn (2.4% of op.
loans, annualized) though lower from Rs11.3 bn (3.6%) in the
previous quarter, which had one-off agri debt waiver related
slippages.
• The bank saw additional slippage of Rs2.2 bn (0.7% of op loans,
ann.) from restructured loans. This takes the total slippages from
restructured loans to ~15% so far on our computations.
• Benefit from recoveries and upgrades of NPLs was at 0.8% of
op.loans (ann.) vs. 0.6% in 2Q. The bank wrote off aggressively
this quarter (Rs 45.2 bn) at 1.4% of opening loans vs. 0.5% in 2Q
and 0.9% in 1Q. Provisions coverage (including technical writeoffs)
was stable at 70% (in line with the RBI requirement of 70%).
• On the loan segments which are potentially under stress –
management indicated that the bank’s exposure is :
a) MFIs – Rs2 bn (0.1% of loans)
b) Commercial real estate – Rs23 bn (1.7%);
c) Aviation – Insignificant exposure (the bank wasn’t a part of the
consortium that approached RBI for restructuring)
d) Telecom – Rs70 bn in credit commitments (Rs. 20-30 bn (1.5%-
2.2%) in actual exposure with no exposure to licensing)
Target Price Discussion
We arrive at our revised price target of Rs445 (down 11% from
Rs500) using a probability-weighted three-phase residual
income model – a five-year high growth period, a 10-year
maturity period, followed by a declining period.
The key reasons for the change are:
a) Earnings estimate revisions. We have cut our EPS
forecasts for F2012 & F2013 by 6% each. There are two key
reasons for the estimate changes:
1) We now assume lower loan growth of 21% in F2012 and
20% in F2013.
2) We are also building in a Rs11.5 equity infusion in Union
Bank in F2012 by the government (see
http://www.business-standard.com/india/news/union-bank
-to-get-rs-1150-crgov-by-march-2011/120362/on)
b) Probability weightings. We are also now using the
following probability weightings:
• 20% weight to bear case scenario. We factor in the
increased economic growth uncertainty following recent
developments with regard to inflation. There is a risk that if
inflation were to be sustained at a higher level for longer,
there may be a disruptive rise in interest rates – hence
leading to asset quality issues. We believe that until
inflation expectations are brought under control, the
market is likely to continue to assign a reasonable
probability to this outcome.
• 20% weight to bull case scenario. We factor in the
potential of stronger than expected economic growth and
better than expected performance of underlying
businesses at Union Bank.
We have trimmed our bull case value by 7%, to Rs540 per
share, and our base case value by 4%, to Rs280 per share.
Our bear case value is unchanged at Rs250 per share.
We use a cost of equity of 14.1% (up from 13.2%), assuming a
beta of 1.0, a risk-free rate of 8.1% (current Indian 10-year
government bond yield), and a market risk premium of 6%.
Risks to Our Price Target
Key risks to our price target include slower-than-expected loan
growth, sharp compression in NIMs and significant
deterioration in asset quality (restructured loans slippages).
Upside catalysts include: fee income being stronger than
expectations and credit costs being lower than expectations
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