Union Bank of India NEUTRAL. Performance Highlights CMP. `393 Target Price - 2QFY2011 Result Update Banking. Investment Period -

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1 2QFY2011 Result Update Banking October 27, 2010 Union Bank of India Performance Highlights Particulars (` cr) 2QFY11 1QFY11 % chg (qoq) 2QFY10 % chg (yoy) NII 1,536 1, Pre-prov. profit 1,131 1, PAT (49.6) 505 (39.9) For 2QFY2011, Union Bank reported a disappointing set of numbers, primarily because of a switch over to system-based NPA and provision for pension liability on an ad hoc basis. Consequently, the bank registered a 49.6% qoq and 39.9% yoy decline in net profit to `303cr, substantially below our estimates. We maintain a Neutral rating on the stock. Operating performance on expected lines; slippages disappoint: During 2QFY2011, advances grew by 27.2% yoy but declined marginally by 0.5% qoq, while deposits grew by 19.3% yoy and 3.7% qoq. CASA deposits posted growth of 4.1% qoq and 18.3% yoy, driven by a 5.8% qoq and 29.1% yoy increase in savings deposits. CASA ratio improved marginally to 32.7% in 2QFY2011 (from 32.6% in 1QFY2011). Reported NIM improved by 32bp qoq to 3.35% because of a 48bp qoq improvement in yield on funds to 8.28% and a lower increase of 11bp qoq in cost of funds to 5.06%. Consequently, NII grew by robust 77.9% yoy and 13.9% qoq to `1,536cr. During 2QFY2011, the bank faced substantial asset-quality pressure due to switchover to CBS-based NPA recognition and slippages of ~`727cr in agri and export-oriented industries. Gross NPAs increased by 28.8% qoq to `3,524cr and net NPAs rose by 27.2% qoq to `1,462cr. Gross slippages stood at `1,130cr v/s `623cr in 1QFY2011. Outlook and valuation: In our view, the bank is structurally among the more profitable and competitive PSU banks. We have a positive outlook on the bank due to its robust traction in CASA deposits and relatively fast-expanding branch network, due to which we expect the bank s performance on the NII front to be better than its peers over FY However, at the CMP, the stock is trading at 8.3x EPS of `47.2 and 1.7x ABV of `237.1, which we believe factors in the positives. Hence, we maintain a Neutral rating on the stock. Key financials Y/E March (` cr) FY2009 FY2010 FY2011E NII 3,814 4,192 5,797 6,336 % chg Net profit 1,727 2,075 2,067 2,385 % chg (0.4) 15.4 NIM (%) EPS (`) P/E (x) P/ABV (x) RoA (%) RoE (%) NEUTRAL CMP `393 Target Price - Investment Period - Stock Info Sector Banking Market Cap (` cr) 19,841 Beta Week High / Low 427/237 Avg. Daily Volume 114,309 Face Value (`) 10 BSE Sensex 20,005 Nifty 6,013 Reuters Code UNBK.BO Bloomberg Code UNBK@IN Shareholding Pattern (%) Promoters 55.4 MF / Banks / Indian Fls 11.9 FII / NRIs / OCBs 18.6 Indian Public / Others 14.1 Abs. (%) 3m 1yr 3yr Sensex UBI Vaibhav Agrawal Ext: 333 vaibhav.agrawal@angelbroking.com Amit Rane Ext: 326 amitn.rane@angelbroking.com Shrinivas Bhutda Ext: 316 shrinivas.bhutda@angelbroking.com Please refer to important disclosures at the end of this report 1

2 Exhibit 1: 2QFY2011 performance Particulars (` cr) 2QFY11 1QFY11 % chg (qoq) 2QFY10 % chg (yoy) Interest earned 3,952 3, , Interest expenses 2,416 2, , NII 1,536 1, Non-interest income (8.2) Operating income 2,045 1, , Operating expenses Pre-prov. profit 1,131 1, Provisions & cont PBT (37.2) 675 (21.2) Prov. for taxes (6.8) PAT (49.6) 505 (39.9) EPS (`) (49.6) 10.0 (39.9) Cost-to-income ratio (%) Effective tax rate (%) Net NPA (%) Exhibit 2: 2QFY2011 actual v/s Angel estimates Particulars (` cr) Actual Estimates Var. (%) NII 1,536 1, Non-interest income Operating income 2,045 1, Operating expenses Pre-prov. profit 1,131 1, Provisions & cont PBT (37.5) Prov. for taxes PAT (51.3) Credit and deposit growth subdued sequentially During 2QFY2011, advances increased by 27.2% yoy but declined marginally by 0.5% qoq to `1,24,142cr, while deposits grew by 19.3% yoy and 3.7% qoq to `1,77,778cr, resulting in a decline in credit-deposit ratio to 69.8% (from 72.7% in 1QFY2011). Growth in advances was driven by the medium and large corporates segment (34.2% yoy) and the retail segment (33.7 yoy). However, on a sequential basis, growth in advances was muted, with agricultural loans declining by 3.8% and the MSME segment growing by 2.6%. CASA deposits registered growth of 4.1% qoq and 18.3% yoy, driven by 5.8% qoq and 29.1% yoy growth in savings deposits. Current account deposits declined by 0.3% qoq and 3.1% yoy to `16,073cr. The bank s CASA ratio improved marginally to 32.7% in 2QFY2011 (from 32.6% in 1QFY2011). During the quarter, the bank opened 38 branches and 50 ATMs, taking its total network to 2,869 branches and October 27,

3 2,420 ATMs. The steadily growing network, is expected to help the bank in sustaining the CASA. Reported NIM improved by 32bp qoq to 3.35% on account of a 48bp qoq improvement in yield on funds to 8.28% and a lower increase of 11bp qoq in cost of funds to 5.06%. Consequently, NII grew by robust 77.9% yoy and by 13.9% qoq to `1,536cr. During the quarter, the bank had a net extraordinary income of `62cr on account of interest on income tax refunds. After adjusting this one-off, reported NIM would stand at 3.21% and NII would be higher by 65.7% yoy. For FY2011E, management has given the guidance of advances and deposits growth of 25% and 20%, respectively. The deposits guidance has been revised downward from 22% in 1QFY2011 to 20%. We are presently factoring in 17% loan growth and 15% deposits growth for FY2011E. Exhibit 3: Advances and deposits growth muted qoq Deposits (` cr) Advances (` cr) CD ratio (%, RHS) 200, , , , , Exhibit 4: CASA improves marginally (%) QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 Exhibit 5: Advances break-up Medium & Large Corporates 56% MSME 18% Agri 15% Educational Personal 0% 1% Auto 1% Retail12% Housing 7% Others 2% Exhibit 6: Decent pace of network expansion 3,000 2,800 2,600 2,400 2,200 2,000 Branches ATMs (RHS) 2,327 2,369 2,420 2,249 2,130 1,995 1,790 2,661 2,638 2,713 2,759 2,805 2,831 2,869 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 2,500 2,300 2,100 1,900 1,700 1,500 October 27,

4 Non-interest income muted During the quarter, non-interest income declined by 8.2% yoy to `510cr. Apart from the high base effect of treasury gains in 2QFY2010, forex income declined by 44.9% yoy and 15.7% qoq and recoveries from written-off accounts were subdued, growing by 3.8% yoy to `44cr. Going forward, we expect core fee income to remain moderate. Exhibit 7: Break-up of non-interest income Particulars (` cr) 2QFY11 1QFY11 % chg (qoq) 2QFY10 % chg (yoy) CEB Treasury (14.2) Forex (15.7) 78 (44.9) Recoveries Total (8.2) Operating costs up, led by higher employee-related provisions During the quarter, operating expenses increased by 23.7% qoq and 50.3% yoy to `915cr. Growth was driven by a 93.5% yoy increase in employee expenses and 6.6% rise in other operating expenses. The increase in employee expenses in 1HFY2011 was mainly because of `240cr provision on account of second pension option and `127cr provision for higher gratuity limits. Management expects a similar charge on account of pension and gratuity liability in 2HFY2011. As a result of higher operating expenses outpacing the increase in operating income, the cost-to-income ratio deteriorated to 44.7% in 2QFY2011 from 41.5% in 1QFY2011 and 42.9% in 2QFY2010. We have increased our opex estimates for FY2011 and FY2012 by 17.5% and 14.5%, respectively, to factor in the enhanced employee benefit provisions. Exhibit 8: Opex rises because of employee-related provisions Staff exps (` cr) Other opex (` cr) Cost-to-income ratio (%, RHS) 1, QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 October 27,

5 Asset quality deteriorates considerably During the quarter, the bank faced substantial asset-quality pressure with gross NPAs increasing by 28.8% qoq to `3,524cr and net NPAs rising by 27.2% qoq to `1,462cr. Gross slippages during the quarter stood at `1,130cr as compared to `623cr in 1QFY2011. Slippages came from agricultural advances (`417cr) and export-oriented corporates (`310cr). During the quarter, the bank substantially implemented CBS-based NPA recognition. Management expects slippages from agricultural and export-oriented corporates to be a one-off and expects the gross NPA ratio to be below 2.3% by the end of FY2011 from 2.8% at the end of 2QFY2011. The provision coverage ratio, including technical write-offs, stood at 70.0%, down from 71.1% in 1QFY2011. Total restructured assets (under facility-wise method of classification) at the end of 1QFY2011 were `4,977cr, to which there was an addition of `140cr in 2QFY2011, taking restructured assets to `5,117cr at the end of quarter. There were slippages of `36cr from restructured assets during the quarter, taking total slippages from restructured assets to `711cr. Management is expecting slippages to be below 15.0% from the restructured book (under the borrower-wise method of classification) of ~`7,200cr during FY2011E. Exhibit 9: Trend in asset quality Gross NPA (` cr) Net NPA (` cr) NPA coverage (%, RHS) 4,000 3,000 2, ,000 1, , , , , , , ,736 1,150 3,524 1, QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 ; Note: NPA coverage % excluding write-offs till 3QFY2010 Stable capital adequacy During the quarter, the bank s capital adequacy ratio (CAR) stood at 12.5%, with Tier-1 capital of 7.9%. In July 2010, the bank received `111cr from the Government of India in the form of PCNPS. Further, management is in talks with the government for an infusion of `1,800cr to meet its expansion plans. October 27,

6 Exhibit 10: Stable capital adequacy (%) 16.0 Tier-I CAR Tier-II CAR QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 Investment arguments Strong traction visible in CASA deposits We are relatively positive on the bank s CASA growth outlook, owing to the bank s larger branch expansion plans compared to its peers. The bank has been able to sustain CASA above 32% over the past few quarters. During 2QFY2011, the bank registered strong 29.1% yoy growth in savings account deposits, reflecting the strong traction in more sustainable SA deposits. Outlook and valuation In our view, Union Bank is structurally among the more profitable and competitive PSU banks. We have a positive outlook on the bank due to its robust traction in CASA deposits and relatively fast-expanding branch network, due to which we expect the bank s performance on the NII front to be better than its peers over FY However, at the CMP, the stock is trading at 8.3x EPS of `47.2 and 1.7x ABV of `237.1, which we believe factors in the positives. Hence, we maintain a Neutral rating on the stock. October 27,

7 Exhibit 11: Key assumptions Particulars (%) Earlier estimates Revised estimates FY2011E FY2011E Credit growth Deposit growth CASA ratio NIM Other income growth (10.8) 14.9 (11.1) 14.8 Growth in staff expenses Growth in other expenses Slippages Coverage ratio Treasury gain/(loss) (% of investments) Exhibit 12: Change in estimates FY2011E Particulars (` cr) Earlier Revised estimates estimates % chg Earlier Revised estimates estimates % chg NII 5,524 5, ,118 6, Non-interest income 1,761 1,756 (0.2) 2,022 2,016 (0.3) Operating income 7,284 7, ,141 8, Operating expenses 2,858 3, ,373 3, Pre-prov. profit 4,426 4,196 (5.2) 4,768 4,490 (5.8) Provisions & cont , PBT 3,514 2,996 (14.8) 3,895 3,597 (7.6) Prov. for taxes (1.2) 1,042 1, PAT 2,574 2,067 (19.7) 2,853 2,385 (16.4) Exhibit 13: P/ABV band Price (`) 0.6x 0.9x 1.2x 1.5x 1.8x Oct-02 Mar-03 Aug-03 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06 Dec-06 May-07 Oct-07 Mar-08 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Source: Company, Bloomberg, Angel Research October 27,

8 Exhibit 14: Recommendation summary CMP Tgt. Company Reco. (`) price (`) Upside (%) P/ABV (x) Tgt P/ABV (x) P/E (x) FY10-12E EPS CAGR (%) RoA (%) RoE (%) AxisBk Buy 1,446 1, FedBk Accumulate HDFCBk Accumulate 2,256 2, ICICIBk* Buy 1,106 1, SIB Neutral YesBk Accumulate BOI Neutral CorpBk Neutral DenaBk Accumulate IndBk Accumulate IOB Accumulate OBC Neutral PNB Neutral 1, SBI* Accumulate 3,193 3, UcoBk Neutral UnionBk Neutral Source: Angel Research; Note: *Target multiples=sotp target price/abv (including subsidiaries) October 27,

9 Income statement Y/E March (` cr) FY06 FY07 FY08 FY09 FY10 FY11E FY12E NII 2,374 2,790 3,086 3,814 4,192 5,797 6,336 - YoY Growth (%) Other Income ,233 1,483 1,975 1,756 2,016 - YoY Growth (%) (18.4) (11.1) 14.8 Operating Income 2,999 3,632 4,319 5,296 6,167 7,554 8,352 - YoY Growth (%) Operating Expenses 1,402 1,476 1,593 2,214 2,507 3,358 3,861 - YoY Growth (%) Pre - Provision Profit 1,597 2,156 2,726 3,082 3,660 4,196 4,490 - YoY Growth (%) Prov. & Cont , YoY Growth (%) (27.0) (16.2) (25.6) Profit Before Tax 895 1,380 1,860 2,357 2,833 2,996 3,597 - YoY Growth (%) Prov. for Taxation ,212 - as a % of PBT PAT ,387 1,727 2,075 2,067 2,385 - YoY Growth (%) (6.1) (0.4) 15.4 Balance sheet Y/E March (` cr) FY06 FY07 FY08 FY09 FY10 FY11E FY12E Share Capital Reserves & Surplus 4,053 4,685 6,843 8,235 9,919 11,542 13,396 Deposits 74,094 85, , , , , ,788 - Growth (%) Borrowings 3,974 4,216 4,760 3,885 3,125 3,594 4,205 Tier 2 Capital 2,770 2,370 3,750 4,890 6,090 7,125 8,408 Other Liab. & Prov. 3,729 5,509 4,356 4,757 5,483 6,123 7,288 Total Liabilities 89, , , , , , ,590 Cash Balances 4,387 5,918 9,455 8,992 12,468 13,688 17,159 Bank Balances 2,003 2, ,993 3,308 3,805 4,452 Investments 25,918 27,982 33,822 42,997 54,404 60,908 68,812 Advances 53,380 62,386 74,348 96, , , ,727 - Growth (%) Fixed Assets ,201 2,335 2,305 2,572 2,919 Other Assets 2,628 2,845 3,604 3,124 3,361 3,865 4,522 Total Assets 89, , , , , , ,590 - Growth (%) October 27,

10 Ratio analysis Y/E March FY06 FY07 FY08 FY09 FY10 FY11E FY12E Profitability ratios (%) NIMs Cost to Income Ratio RoA RoE B/S ratios (%) CASA Ratio Credit/Deposit Ratio CAR Tier I Asset Quality (%) Gross NPAs Net NPAs Slippages Loan Loss Prov./Avg. Assets Provision Coverage Per Share Data (`) EPS ABVPS DPS Valuation Ratios PER (x) P/ABVPS (x) Dividend Yield DuPont Analysis (%) NII (-) Prov. Exp Adj. NII Treasury Int. Sens. Inc Other Inc Op. Inc Opex PBT Taxes RoA Leverage (x) RoE October 27,

11 Research Team Tel: Website: DISCLAIMER This document is solely for the personal information of the recipient, and must not be singularly used as the basis of any investment decision. Nothing in this document should be construed as investment or financial advice. Each recipient of this document should make such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks of such an investment. Angel Broking Limited, its affiliates, directors, its proprietary trading and investment businesses may, from time to time, make investment decisions that are inconsistent with or contradictory to the recommendations expressed herein. The views contained in this document are those of the analyst, and the company may or may not subscribe to all the views expressed within. Reports based on technical and derivative analysis center on studying charts of a stock's price movement, outstanding positions and trading volume, as opposed to focusing on a company's fundamentals and, as such, may not match with a report on a company's fundamentals. The information in this document has been printed on the basis of publicly available information, internal data and other reliable sources believed to be true, but we do not represent that it is accurate or complete and it should not be relied on as such, as this document is for general guidance only. Angel Broking Limited or any of its affiliates/ group companies shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. Angel Broking Limited has not independently verified all the information contained within this document. Accordingly, we cannot testify, nor make any representation or warranty, express or implied, to the accuracy, contents or data contained within this document. While Angel Broking Limited endeavours to update on a reasonable basis the information discussed in this material, there may be regulatory, compliance, or other reasons that prevent us from doing so. This document is being supplied to you solely for your information, and its contents, information or data may not be reproduced, redistributed or passed on, directly or indirectly. Angel Broking Limited and its affiliates may seek to provide or have engaged in providing corporate finance, investment banking or other advisory services in a merger or specific transaction to the companies referred to in this report, as on the date of this report or in the past. Neither Angel Broking Limited, nor its directors, employees or affiliates shall be liable for any loss or damage that may arise from or in connection with the use of this information. Note: Please refer to the important `Stock Holding Disclosure' report on the Angel website (Research Section). Also, please refer to the latest update on respective stocks for the disclosure status in respect of those stocks. Angel Broking Limited and its affiliates may have investment positions in the stocks recommended in this report. Disclosure of Interest Statement Union Bank of India 1. Analyst ownership of the stock No 2. Angel and its Group companies ownership of the stock No 3. Angel and its Group companies' Directors ownership of the stock No 4. Broking relationship with company covered No Note: We have not considered any Exposure below ` 1 lakh for Angel, its Group companies and Directors. Ratings (Returns): Buy (> 15%) Accumulate (5% to 15%) Neutral (-5 to 5%) Reduce (-5% to 15%) Sell (< -15%) October 27,