Punjab National Bank. CMP: INR760 TP: INR964 Buy Asset quality deteriorates; asset-liability well-matched Highlights of FY12 Annual Report

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1 BSE SENSEX S&P CNX 16,706 5, June 2012 Annual Report Update Sector: Financials Punjab National Bank CMP: INR760 TP: INR964 Buy Asset quality deteriorates; asset-liability well-matched Highlights of FY12 Annual Report Bloomberg PNB IN Equity Shares (m) Week Range (INR) 1,200/703 1,6,12 Rel.Perf.(%) 2/-14/-21 M.Cap. (INR b) M.Cap. (USD b) 4.6 Valuation summary (INR b) Y/E March E 2014E NII OP NP EPS (INR) EPS Gr. (%) P/E (x) BV/Sh. (INR) ,072 P/BV (x) RoE (%) RoA (%) Shareholding pattern % (Mar-12) Foreign, 17.4 Domestic Inst, 21.8 Others, 4.7 Stock performance (1 year) Promoter 56.1 Though growth in overall industrial exposure moderated, funded exposure growth remained high in the Power and NBFC segments. These two segments constituted over 25% of incremental funded exposure and 15% of overall funded exposure. Net slippages increased from 1.5% in FY11 to 1.8%. Outstanding restructured loans increased to 7.9% (of which 3% relate to state government entities) v/s 4.2% in FY11. Discounting factor for pension liability increased to 8.8% and is in line with 8.7-9% for peers. However, salary escalation assumption at 5% is higher than peers 4%. Healthy core operating performance would enable better absorption of credit cost. Expect RoA of 1.1% and RoE of ~19% in FY13/14. Maintain Buy. Strong growth in exposure to Power and NBFC segments: The funded exposure details of Punjab National Bank (PNB) reveal highly concentrated growth in the Power (including electricity - up 28%) and NBFC (up 93%) segments. Growth in other industrial segments moderated/declined, and these two segments constituted over 25% of incremental funded exposure and 15% of overall funded exposure. Since FY08, funded exposure to the Power segment has increased from 4.2% to 9.8%. Funded exposure to Textiles (down 32%) and Gems & Jewelry (down 45%) declined, while exposure to Commercial Real Estate was stable. Exposure to 100%+ risk weight assets (RWAs) increased to 11% v/s 6.9% in FY11. Growth in overall RWAs was 17% v/s 21%+ growth in loans and balance sheet. Net slippages at 1.8%; higher restructuring led by state government entities: Net slippage increased significantly from 1.5% in FY11 to 1.8%, led by sharp rise in slippages in 2HFY12, though recoveries and upgradations improved (INR22b v/s INR15.8b in FY11). Restructuring relating to some large-ticket government entity accounts led to sharp increase in outstanding restructured loans to 7.9% (of which 3% relate to state government entities) v/s 4.2% in FY11. During the year, PNB restructured loans of INR21b under the CDR (corporate debt restructuring) mechanism, on which it took a sacrifice of INR2.9b (14% of loans restructured under CDR). GNPAs increased across segments, with sharp increases in Services (3.5% v/s 1.4% in FY11) and Agriculture (5% v/s 3.6% in FY11). Other highlights: (1) Employee benefit assumption largely in line with peers, with discount rate at 8.8% v/s 8.7-9% for peers and salary escalation at 5% v/s 4% for peers, (2) Concentration of top-20 deposit accounts up from 4.9% to 7.9%; domestic CASA ratio at 36% (v/s 39% in FY11), (3) Well-matched asset-liability 39% of deposits and 35% of loans maturing within a year, (4) Proportion of secured loans up from 87.6% in FY11 to 91.6%, (5) Core tier-i ratio stood at 8.6%. Trades at 0.7x FY14E BV, with RoE of ~19%; maintain Buy: In the current macroeconomic environment, higher upgradations and recoveries would be the key for asset quality. Healthy core operating performance would enable better absorption of higher credit cost. We expect RoA to remain healthy at ~1.1% and RoE at ~19% in FY13/14, led by superior margins and fee income growth. Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com) Sohail Halai (Sohail.Halai@motilaloswal.com)

2 Other highlights Has achieved priority sector lending (PSL) targets: Loans to priority sectors constitute 40.7% of PNB s adjusted net bank credit against the regulatory requirement of 40%. The bank has also met the targets for all the sub-segments. Priority sector lending (%) Achieved Target FY11 FY12 PSL Of which Agri Direct Credit to weaker section Credit to women benficiaries Source: Company/MOSL Continues to focus on expanding international footprint: The share of international loans in PNB s overall loan book has increased from 2.5% in FY09 to 7.4% in FY12. Overseas business (including subsidiaries) grew 40% in FY12 to USD8b, whereas PAT more than doubled to USD49m. The bank is currently present in 10 destinations abroad, and is planning to set up its second wholly-owned subsidiary in Canada and representative offices in other overseas locations. Contract with Metlife to distribute life insurance products: In FY12, PNB entered into a contract with MetLife India Insurance Company as against LIC earlier to distribute life insurance policies. PNB s aggregate premium collection grew 1.5x in FY12 to INR2.9b (64,898 policies sold) and it earned INR212m from this activity. Income of INR550m from debt syndication/appraisal: PNB gave in-principle approvals for debt syndication/appraisal aggregating to INR504b. Income on the syndication/appraisal activities amounted to INR550m. Further, fees of INR290m are receivable out of the mandates in hand. Valuation and view In FY12, PNB s core operating profits grew 18%, led by healthy growth in business and fee income. NIM contracted by just 10bp despite higher slippages and tight liquidity conditions, depicting PNB s strong asset-liability management capabilities. The management has reiterated its NIM guidance of 3.5%+ going forward. We model ~10bp NIM decline in FY13 and estimate ~17% CAGR in NII over FY Slippage ratio increased sharply to 2.8% in FY12 v/s average slippage ratio of 1.9% for FY07-11 a negative surprise. In the current macroeconomic environment, while slippages and restructuring may remain at an elevated level, higher upgradations and recoveries would be the key for asset quality. We model slippage ratio of ~2.3% and credit cost of 100bp/90bp for FY13/14. Superior NIM and healthy fee income growth would enable PNB to absorb the impact of asset quality shocks. Despite factoring in higher credit costs, RoA would remain healthy at ~1.1% and RoE at ~19% over FY13/14. Maintain Buy. 19 June

3 PNB: One year forward P/E PNB: One year forward P/BV Margin to remain one of the best in the industry Fee income to average assets higher than other large PSBs, however ample scope for improvement remains Pressure on asset quality to remain; improvement in upgradation and recoveries - a key Return ratios to moderate but remain healthy Dupont analysis: Return ratios to remain healthy, led by strong core operating performance (%) Y/E March E 2014E Net Interest Income Fee income Fee income to core income Core Operating Income Trading and others Net Income Operating Expenses Cost to Core Income Ratio Employee cost Employee cost to Opex Other operating expenses Core operating Profits Operating Profits Provisions NPA provisions Other Provisions PBT Tax Rate RoA Leverage (x) RoE Source: Company/MOSL 19 June

4 Loan growth above industry average; loan book well-diversified Consistently increasing market share in loans (%) Proportion of international loans increasing at a faster pace (%) Domestic loan growth remains above industry average, driven by strong growth in SME and large corporate segments Increased focus on international operations and partial benefit from currency depreciation in FY12 led to strong growth of 68%+ in international loan book Loan mix shifts in favor of working capital financing and secured loans (%) Proportion of working capital loans has increased by 500bp over the last two years Proportion of secured loan has increased by 840bp+ over the last five years is now one of the highest amongst peers Diversified loan mix (%) Break-up of industrial loans (%) Agriculture (+29%) and SME (+27%) segments drove the strong loan growth in FY12 Industrial exposure is well diversified. Proportion of Infrastructure in overall loans has increased 200bp to 16.6% over the last two years 19 June

5 Liability profile and asset-liability management CASA growth moderates (YoY, %) Incremental CASA ratio at 21% - lowest in 10 years (%) Systemic increase in interest rates led to strong inflow of retail deposits At 18%, incremental SA ratio was significantly below historical average; incremental CA ratio was just 2.5% CASA ratio down 500bp+ in last two years CASA per branch largely in line with large PSBs (INR m) Decline in CASA ratio was offset by similar increase in proportion of retail deposits; proportion of bulk deposits was largely stable Though PNB s CASA per branch has been increasing, it remains significantly lower than SBIN and private sector banks Asset-liability remains well-matched (%) While the proportion of short-term deposits (less than one year) has increased in FY12 (39.4% v/s 36.6% in FY11), loan re-pricing of ~35% in FY12 keeps asset-liability well-matched FY11 FY12 19 June

6 Asset quality pressure remains high Pressure on asset quality increases (% of opening loans) Restructuring during the year (INR b) Increase in net slippages and restructured loan book was led by stress in the large corporate segment (especially state government entities) NPV loss of ~15% on CDR cases; however, overall NPV loss was contained at ~3% of restructured loans (3.2) (3.7) (3.7) Figures in bracket indicates percentage NPV losses on restructured loan NPAs in sub-standard and doubtful categories increase (%) Segment-wise NPAs (%) Average slippage ratio of 2.5% over FY11-12 led to increase in the proportion of sub-standard and doubtful loans GNPAs increased across segments; Services and Agriculture most impacted PCR declines significantly Though credit cost remained elevated for three years, PCR continued to decline due to increase in net slippages Net slippage ratio one of the highest amongst peers Significant increase in gross slippages (INR67b vs INR43b in FY11) led to pressure on asset quality 19 June

7 Strong growth in power segment continues Proportion of NBFC's exposure has increase from 2.9% in FY10 to 5.2% in FY12 Exposure in textile segment declines sharply Growth in overall industrial exposure moderates Fund-based exposure (% of total and YoY growth) YoY % of % of Gr. (%) overall incremental INR m FY12 FY11 FY12 FY11 FY12 FY11 FY12 Power (including electricity) 293, Infra (ex-power) 225, telecom 78, roads and ports 72, Others 73, Metals 191, NBFCs 153, Trading 113, All engg. 45, Textiles 45, Food processing 37, Construction 36, Petroleum 21, Sugar 20, Chemicals, dyes 19, Other indsutries 306, Total Industries 1,511, Other Loans 1,467, Total Funded Exposure 2,978, Source: Company/MOSL Metals remain as one of the highest contributor Exposure in petroleum segment decline sharply Non-fund-based exposure (% of total and YoY growth) YoY % of % of Gr. (%) overall incremental INR m FY12 FY11 FY12 FY11 FY12 FY11 FY12 Metals 104, Power (includ. electricity) 62, Trading 41, All engg. 39, Infra (ex-power) 33, telecom 24, roads and ports 12, Textiles 6, Chemicals, dyes 5, Food processing 5, Construction 3, NBFCs 1, Petroleum 1, Sugar Other indsutries 87, Total Industries 395, Other Loans 370, Total Non-Funded Exposure 765, Source: Company/MOSL 19 June

8 Capitalization, risk-weighted assets and concentration Adequately capitalized - core tier-i at 8.6% Proportion of RWAs falls after three years (YoY growth, %) Equity infusion of INR22.5b and strong internal accruals (INR40.1b) led to higher core tier-i capital The growth in RWAs remains lower than the growth in balance sheet and loans Proportion of off-balance sheet in RWA increases YoY (%) Credit risk exposure (%) Strong growth in off-balance sheet (+64% YoY), led by 94% and 28% growth in forex contract and guarantees Since FY09, there has been a significant increase in the proportion (+700bp) of loans with more than 100% risk weight Concentration of loans and exposure becomes Top 4 GNPA accounts (%) more granular (%) Rising delinquency in large corporate portfolio led to increasing proportion of top 4 accounts in overall GNPA While the proportion of deposits in top-20 accounts has increased significantly in FY12, it remains in line with peers of 19 June

9 Expanding franchise Strong expansion in branch network continues PNB has added 1,500+ branches over FY08-12; ~480 branches were added in FY12 itself ATM network expanding rapidly ATM to branch ratio improved from 0.5x to 1.1x over the last three years, despite continuous expansion in branch network (x) Rapid franchise expansion led to strong customer additions Card base has increased 2.5x PNB's customer base has increased nearly 1.9x over the last three years Increase in customer base and rapid expansion in ATM network has led to significant growth in card base Net addition of 5,000+ employees v/s flat/declining employee base since FY03 Improving productivity (INR m) In view of higher retirement in the coming years and strong branch expansion, PNB has been building its workforce to support future growth There has been significant increase in profitability per branch and per employee despite continous expansion 19 June

10 Earnings Margins remain superior Cost of deposits rises faster than yield on loans (%) Tight liquidity conditions and higher slippages led to 15bp decline in NIM Cost of deposits increased at a faster pace due to higher reliance on term deposits, while yield on loans was impacted due to reversal of interest income Fee income growth below balance sheet growth (%) Significant improvement in cost to average assets (%) Fee income growth has moderated, as a percentage to average assets and remains well below SBIN and private sector peers Absence of one-off provisions for employee expenses (INR5.5b for retired employees) as in FY11 and containment of opex led to improvement in cost to average assets (ex-forex) Core profitability remains healthy (%) Return ratios moderate (%) While core-operating performance remains strong, higher credit cost over past three years have led to moderation in PAT growth Even though return ratios has moderated it remains as one of the best among peers (in bps) 19 June

11 Financials and Valuation Income Statement (INR Million) Y/E March E 2014E Interest Income 191, , , , , ,260 Interest Expense 122, , , , , ,930 Net Interest Income 68,319 84, , , , ,330 Change (%) Non Interest Income 30,647 36,101 36,126 42,026 45,351 51,260 Net Income 98, , , , , ,590 Change (%) Operating Expenses 42,062 47,619 63,642 70,028 80,685 92,590 Pre Provision Profits 56,904 73,263 90, , , ,000 Change (%) Provisions (excl tax) 9,235 14,215 24,920 35,773 42,309 45,252 PBT 47,669 59,048 65,637 70,375 78,854 95,748 Tax 16,760 19,994 21,302 21,528 25,233 30,639 Tax Rate (%) PAT 30,909 39,054 44,335 48,847 53,621 65,109 Change (%) Equity Dividend (Incl tax) 7,378 8,101 8,101 8,672 8,658 10,665 Core PPP* 46,957 62,069 82,432 97, , ,916 Change (%) *Core PPP is (NII+Fee income-opex) Balance Sheet (INR Million) Y/E March E 2014E Equity Share Capital 3,153 3,153 3,168 3,392 3,392 3,392 Reserves & Surplus 143, , , , , ,186 Net Worth 146, , , , , ,578 Deposits 2,097,605 2,493,298 3,128,987 3,795,887 4,403,229 5,239,843 Change (%) of which CASA Dep 814,599 1,018,500 1,203,250 1,341,293 1,528,250 1,778,280 Change (%) Borrowings 124, , , , , ,368 Other Liabilities & Prov. 100, , , , , ,509 Total Liabilities 2,469,186 2,966,328 3,783,252 4,581,940 5,316,794 6,307,298 Current Assets 214, , , , , ,193 Investments 633, , ,623 1,226,295 1,410,239 1,621,775 Change (%) Loans 1,547,030 1,866,012 2,421,067 2,937,748 3,466,542 4,159,851 Change (%) Fixed Assets 23,971 25,135 31,056 31,689 32,328 32,462 Other Assets 50,202 63,201 82,594 97, , ,017 Total Assets 2,469,186 2,966,328 3,783,252 4,581,940 5,316,794 6,307,298 Asset Quality (%) GNPA (INR m) 25,069 32,144 43,794 87, , ,350 NNPA (INR m) 2,639 9,817 20,386 44,542 53,275 65,669 GNPA Ratio NNPA Ratio PCR (Excl Tech. write off) PCR (Incl Tech. Write off) E: MOSL Estimates 19 June

12 Financials and Valuation Ratios Y/E March E 2014E Spreads Analysis (%) Avg. Yield-Earning Assets Avg. Yield on loans Avg. Yield on Investments Avg. Cost-Int. Bear. Liab Avg. Cost of Deposits Interest Spread Net Interest Margin Profitability Ratios (%) RoE RoA Int. Expense/Int.Income Fee Income/Net Income Non Int. Inc./Net Income Efficiency Ratios (%) Cost/Income* Empl. Cost/Op. Exps Busi. per Empl. (INR m) NP per Empl. (INR lac) * ex treasury and recoveries Asset-Liability Profile (%) Loans/Deposit Ratio CASA Ratio Investment/Deposit Ratio G-Sec/Investment Ratio CAR Tier Valuation Book Value (INR) ,071.7 Change (%) Price-BV (x) Adjusted BV (INR) Price-ABV (x) EPS (INR) Change (%) Price-Earnings (x) Dividend Per Share (INR) Dividend Yield (%) E: MOSL Estimates 19 June

13 N O T E S 19 June

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