Union Bank of India -Improving but still lags the sector; initiate with IN-LINE:: Standard Chartered Research,

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Union Bank of India
Improving but still lags the sector; initiate with IN-LINE


 We initiate coverage with an IN-LINE rating and price
target of Rs370 based on 1.4x FY12E P/BV.
 Union Bank’s slippages have remained substantially
higher than the sector for the past six quarters.
 Slippage from restructured loans triggered by the
economic downturn, aggressive loan growth in FY05-06
and shift in recognition of NPLs from the manual system
to the CBS platform are the key reasons for high NPLs.
 We believe Union Bank will continue to trade at current
multiples till it demonstrates consistent and substantial
improvement in asset quality over the next few quarters.
Slippages to improve but remain higher than sector –
We do expect Union Bank’s slippages to improve from the
current high level of 3% in 3Q FY11, but we believe
slippage will still be higher than the sector average. We
expect slippage of 2.5% in 4Q FY11. We expect slippages
to remain higher than the sector aggregates over FY12-13E
at 1.5-1.7%.
Margin improvement unlikely to sustain – Union Bank’s
core NIMs expanded by 23bps qoq to 3.4% in 3Q FY11 as
loan and investment yields rose faster than cost of funds.
We believe margin expansion is unsustainable as the hike
in deposit rates will reflect in margins in FY12E with a lag.
Management has guided to NIMs stabilizing at 3.1%.
Recent capital infusion – The government recently infused
capital of Rs11bn into Union Bank, which will likely increase
its Tier I ratio to 9.1% from the reported 7.7% in 9M FY11.
The new infusion has diluted equity by 6%.
Valuation – We value Union Bank at 1.4x FY12E P/BV,
which is close to the current multiple of 1.3x. While we
believe that asset quality issues are well known, we do not
see any immediate positive triggers for the stock to re-rate.
Risks – Slower-than-expected improvement in asset
quality, rapid deterioration of CASA due to aggressive
competition and rising rates are key downside risks. Lower
slippages and higher NIMs are key upside risks.


Valuation
Our price target of Rs370 is based on 1.4x FY12E P/BV. We have used sustainable RoE of 16%,
cost of equity of 13% and sustainable growth rate of 6%. Our target multiple is close to the
current multiple of 1.3x. While asset quality concerns are well known and factored into the price,
we do not see any immediate triggers for the stock to re-rate. Over the past five years the stock
has traded at a high of 1.64x one-year forward P/BV, a low of 0.6x and an average multiple of
1.1x.


Company profile
Union Bank is a public sector bank. As of Dec ’10, the government held 55.4% of the bank’s total
share capital. With the recent capital infusion, the government’s equity stake has improved to
58%. It operates through a branch network of 2,993 branches. The bank has joint ventures in life
insurance (Star Union Dai-ichi Life Insurance Co) and asset management (Union KBC Asset
Management Company Ltd).
Management team
Chairman & Managing Director – M.V. Nair
Appointed as CMD on 1 Apr ’06, he previously was with Corporation Bank and most recently at
Dena Bank - initially as the Executive Director, and later taking over as Chairman and Managing
Director. He holds a number of industry leadership positions including the Chairman of the Indian
Banks Association, Director on the Board of Agricultural Finance Corporation Ltd, Director on the
Board of the GIC Re., and member of the College Advisory Committee of Reserve Bank of India,
College of Agricultural Banking, Pune.
Executive Director – S. C. Kalia
Appointed Executive Director of Union Bank of India on November 21, 2009, he has over 30
years of experience - most recently with Dena Bank as the Executive Director and earlier with
Bank of Baroda.