Karnataka Bank Ltd. Rating: Buy. Bank- Private KBL STOCK IDEA

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1 Karnataka Bank Ltd. Bank- Private STOCK IDEA Rating: Buy Date July 04, 2016 CMP (Rs.) 143 Target (Rs.) 189 Potential Upside 32% BSE Sensex 27,145 NSE Nifty 8,328 Scrip Code Bloomberg IN Reuters KBNK.BO BSE Group A BSE Code NSE Symbol KTKBANK Market Data Market Cap.(Rs. Cr) 2,696 Equity Sh. Cap Wk High/Low 158/85 Avg. Quarterly Volume 21,51,847 Face Value (Rs.) 10 Shareholding Pattern (As on 31 st Mar 2016) FII DII Promoters 00 Public & Others Total Comparative Price Chart Jun-15 Sep-15 Dec-15 Mar-16 Ravikant Sangepag Research Analyst ravikants@systematixshares.com Arun Gopalan VP- Research arungopalan@systematixshares.com Particulars Loan Book BSE Bankex Net Int Inc Karnataka Bank Limited (), a leading 'A' Class Scheduled Commercial Bank in India, was incorporated on February 18th, 1924 at Mangaluru, a coastal town of Dakshina Kannada district in Karnataka State. The bank took shape in the aftermath of patriotic zeal that engulfed the nation during the freedom movement of 20th Century India. Over the years the Bank grew with the merger of Sringeri Sharada Bank Ltd., Chitradurga Bank Ltd. and Bank of Karnataka. With over 9 decades of experience at the forefront of providing professional banking services and quality customer service, now has a national presence with a network of 725 branches spread across 21 states and 2 Union Territories. Today, has emerged as a leading financial service institution in India. With the introduction of new products to augment its loan book and increasing its share of retail portfolio, the bank expects improvement in its NIMs and at the same time aims at continuing to keep its exposure to risky sectors under check. Addition of new products to drive loan book: intend to open 40 new branches and 225 new ATMs and 100 e-lobbies/mini-lobbies in FY17. also aim at rolling out innovative technology based products such as co-branded credit card, student combo card, near field communication card, mobile virtual card, mobile wallet and a host of other technology based products and solutions. On the back of new product launches we expect loan book of to grow at a CAGR of 20% from FY16 to FY18. Retail portfolio to drive growth: has identified retail as the focus area for the bank. During FY12-16, the retail portfolio s share improved to 52.8% from 44%. has a diversified retail product mix, with multiple loan products (Housing loans, Mortgages, Vehicles loans, Gold loans, Educational loans, etc) to grow its retail portfolio. The demand for bank s retail products primarily comes from within Karnataka, where the bank has a strong presence (422 out of total 682 branches). With focus on branch efficiency along with the slower branch expansion (10% CAGR FY12-16) from 3 to 725, retail loan per branch has improved to Rs 24.7 Cr per branch in FY16 from Rs 18.2 in FY12. Management expects loan book to grow at 20% for FY17 with loan composition to move towards retail portfolio in the range of 60% over the next 2-3 years as against 52.8% currently. NIM improvement expected, limited exposure to risky sectors to check asset quality: reported improvement in its NIM from 2.2% in FY12 to 2.5% in FY16. Margins have been low due to lower yields on investments led by RIDF investments. RIDF investments have yields of ~4-5% and were at 4.6% of the total loan book in FY16 (14.4% in FY12). NIM remained flat at ~2.4% for last couple of years due to higher slippages. We expect improvement in NIM going ahead due to a) Decline in RIDF funds: is now meeting the priority sector lending norms, due to which it received Rs 409 Cr from Rural infrastructure Development Fund (RIDF) in FY16. Bank targets to reduce its RIDF investment by Rs Cr per year. Re-deployment of RIDF loans (4-5% yield) into loan assets (11-12% yield) will boost margins going forward. b) Improvement in CASA ratio: Share of CASA deposits have increased to in FY 16 (25.4% in FY14). Improving CASA ratio has helped bank to reduce their base rate to 9.2% in FY16. Cost of borrowing has come down from 7.87% in FY15 to 7.51% in FY16. With continual efforts, management expects to take the ratio to 27.4% by Improvement in CASA ratio should help the bank to curtail cost of deposits and thus support margins going ahead. Management targets NIMs to improve to 3.1% by We expect NIMs to improve from 2.5% in FY16 to 2.6% by FY18. doesn t have much exposure to risky sectors like steel. Management stated that they witnessed good recovery from corporate in 4Q FY16. We expect limited exposure to risky sectors to help to check its asset quality. Valuation & Outlook: We expect loan book to grow better than the industry at 20% CAGR from FY16 to FY18 with improvement in RoA and RoE towards 0.9% and 15.6% by FY18E. At CMP of Rs 140, Karnataka Bank is trading at P/ABV multiple of 0.8x its FY17E ABV of Rs and 0.7x its FY18E ABV of Rs.189. We recommend a BUY rating with a target of Rs 189 calculated using Justified P/BV multiple of 1x for FY18 ABV. To calculate ABV, we have adjusted the Net-worth for total net NPA. NIM PAT PATM EPS (Rs) Adj. BVPS (Rs) FY15 31,680 1, % % % FY16 33,902 1, % % % FY17E 40,683 1, % % % FY18E 48,820 1, % % % P/E P/ABV RoAA

2 1.2% 1.0% 3.0% 2.0% 3.4% 2.4% 3.5% 2.3% 3.5% 2.3% Total business is expected to grow at a CAGR of 20% from FY16 to FY18. Story in charts Trend in business 200, ,000 1, , , , ,000 68,928 77,689 84,390 72,703 60,586 40,583 46,009,488,000 28,345 31,680 33,902 40,683 48,820 80,000 FY14 FY15 FY16 FY17E FY18E CY2020E Advances Deposits Total Business Trend in RIDF and contribution of RIDF to total loan book Contribution of low yield RIDF to total loan book is expected to come down to 1.8% in FY18 from 4.6% in FY16 4,0 3,0 2,0 1, FY 12 FY13 FY 14 FY 15 FY 16 FY 17E FY 18E RIDF Contribution Contribution of retail customers to total loan book is expected to increase to 55% in FY18 from 52.8% in FY16 Composition of loan book FY14 FY15 FY16 FY17E FY18E CY2020E Retail Corporate With increasing utilization of resources, cost to income ratio is expected to decline to 45.6% in FY18 from 53.7% in FY16 Trend in cost to income ratio NPA s are expected to remain stable from FY16 to FY FY 14 FY 15 FY 16 FY 17E FY 18E Trend in NPA 4.0% 3.0% 2.0% 1.0% 0.0% FY 14 FY 15 FY 16 FY17E FY18E GNPA NNPA

3 Company Background Karnataka Bank Ltd, a premier private sector bank, is a leading 'A' Class Scheduled Commercial Bank in India. The Bank offers a total value package, a one-stop shop for all the banking needs. They provide Working Capital Finance, Term Loans and Infrastructure Finance to help the Business grow. The Bank operates in four business segments, namely treasury, corporate and wholesale banking, retail banking and other banking operations. Karnataka Bank Ltd was incorporated on February 18, 1924 as The Karnataka Bank Ltd at Mangalore in Karnataka. The Bank was established to cater to the banking needs of the South Kanara Region. In May 23, 1924, the Bank obtained the certificate to commence business. In April 4, 1966, they received their license to carry on the banking business in India.The Bank was promoted by B R Vysarayachar and other leading members of the South Kanara Region. Under the able guidance of K S N Adiga, the second chairman of the Bank who held the post for a period of 21 years, the Bank made significant progress thereby providing a strong foundation and as a result grew in stature in terms of number of branches, deposits, advances etc.in the year 1964, the Bank took over the assets and liabilities of the Chitaldurg Bank Ltd. In the 1966, they took over the assets and liabilities of the Bank of Karnataka Ltd, Hubli and opened 14 new branches in places where the Bank of Karnataka Ltd was formerly functioned. With over 9 decades of experience at the forefront of providing professional banking services and quality customer service, now has a national presence with a network of 725 branches spread across 21 states and 2 Union Territories. Managed by a dedicated & professional management team, has over 7,669 employees, 1,22,000 shareholders and over 9.2 million customers. Today, has emerged as a leading financial service institution in India. Branch Network: Andhra Pradesh 4% Maharashtra 6% Tamil Nadu 7% Others 21% Karnataka 62% Key Management Personnel : Key Management personnel Mr. Ananthakrishna Mr. P Jayarama Bhat Mr. S. V. Manjunath Mr. Mahabaleshwara Bhat Designation n Executive Chariman MD & CEO Director Chief General Manager Comparison with peers Key Risks: Undue delay in credit growth can result in slower-than-expected margin improvement. Higher-than-expected slippage in restructured assets can result in deterioration in asset quality. 62% of branches are located in Karnataka state. Any adverse change in economic, social or political scenario may impact business. Price MCap Total Biz CASA PAT NIM P/B P/ABV P/E RoA FY 16 (Rs) (Rs Bn) Karnataka Bank 143 2, South Indian Bank 20 2, City Union Bank 120 7, Federal Bank 59 10,142 1, Karur Vysya Bank 0 6,

4 FINANCIAL PERFORMANCE PROFIT & LOSS RATIO ANALYSIS Particulars FY15 FY16 FY17E FY18E Particulars FY15 FY16 FY17E FY18E Interest Income 4,698 4,992 5,710 6,919 Return Ratios Interest Expenses 3,530 3,689 4,247 5,096 Avg yield on advances 11.7% 11.3% 11.4% 11.5% Net Interest Income 1,169 1,303 1,463 1,823 Avg cost of borrowings 8.2% 7.6% 7.6% 7.6% n interest income NIM 2.4% 2.5% 2.5% 2.6% Operating Income 1,676 1,846 2,036 2,426 RoAE 14.0% 11.7% 12.1% 15.6% Operating Expenses ,051 1,107 RoAA 0.9% 0.8% 0.8% 0.9% PPP ,319 Prov & Cont Asset Quality Ratios Profit Before Tax Gross NPA to Advances 3.0% 3.5% 3.5% 3.5% Tax Net NPA to Advances 2.0% 2.3% 2.3% 2.3% PAT Growth Ratios BALANCE SHEET NII 10.7% 11.5% 12.3% 24.6% Particulars FY15 FY16 FY17E FY18E PAT 45.1% -8.0% 12.3% 43.1% Share Capital Advances 11.8% 7.0% 20.0% 20.0% Reserves & Surplus 3,201 3,2 3,845 4,336 Total Shareholder funds 3,389 3,691 4,034 4,525 Valuation Ratios Borrowings 47,046 51,540 61,848 74,217 EPS Other Liab & Prov. 1,590 1,270 1,270 1,270 P/E SOURCES OF FUNDS 52,026 56,0 67,151 80,012 Adj. BVPS P/ABV Cash & Bank Balance 2,614 3,045 3,482 4,123 Investment 15,988 16,257 19,8 23,410 Other Ratios Advances 31,680 33,902 40,683 48,820 Cost-Income 56.8% 53.7% 51.6% 45.6% Fixed Assets Dividend Yield 3.5% 3.5% 3.9% 5.6% Other Assets 1,452 2,990 3,155 3,320 TOTAL ASSETS 52,026 56,0 67,151 80,012

5 DISCLOSURES/ APPENDIX I. ANALYST CERTIFICATION I, Ravikant Sangepag, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report, (2) part of our compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research report by Systematix Shares & Stocks (I) Limited or its Group/associates companies. (3) have taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. Disclosure of Interest Statement Response Analysts holding in the stock Served as an officer, director or employee II. ISSUER SPECIFIC REGULATORY DISCLOSURES, UNLESS SPECIFICALLY MENTIONED IN POINT NO. 9 BELOW: 1. 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