Motilal Oswal sees asset quality remaining under pressure for banking sector

1. April 2015 136
Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com); +91 22 3982 5415
Vallabh Kulkarni (Vallabh.Kulkarni@MotilalOswal.com); +91 22 3982 5430
Treasury gains and stable NIMs to aid profitability
Net slippages, restructuring remain high | Employee provisions, weak fees a drag
 Continued weak demand environment (corporate loan growth of 6% YoY as of
February 2015), and capital conservation efforts by state-owned banks will
result in moderate balance sheet growth of 10-11% YoY. Private banks are likely
to grow 18-20%, aided by healthy retail loan growth and refinancing. NIMs are
expected to remain stable QoQ and wholesale-funded entities like YES and IIB
are likely to report marginal improvement.
 Asset quality will remain under pressure, led by (a) no significant improvement
at the ground level, (b) unseasonal monsoon, and (c) last quarter of
restructuring window (to get regulatory forbearance on asset classification). Our
channel check suggests that restructuring levels are likely to be high.
 Employee expenses are likely to be elevated for state-owned banks, led by (a)
closure of wage negotiation (15% hike – some banks have provided for 12-13%
hike), and (b) fall in yields, leading to higher pension provisions on AS-15.
 Treasury gains and reversal of countercyclical provisions would provide relief on
earnings, especially for state-owned banks. Considering the government’s new
criteria (RoA and RoE) for providing capital to state-owned banks, banks may
focus on reporting higher profits (and moderate balance sheet growth) as
against shoring up coverage ratio with one-off gains.
 Valuations are near (for large state-owned banks) or below the long period
average (20-40% discount for mid-sized state-owned banks) and private banks
are trading 21% below peak multiples (26% above LPA). Sharp fall in valuations
(especially state-owned banks and ICICIBC) post 3QFY15, largely factors in
expected weak asset quality performance for the quarter. Our top picks are
AXSB, SBIN, YES, IIB and UNBK.
Exhibit 1: Expected quarterly performance (INR m)
Sector Net Interest Income Operating Profit Net Profit
CMP
(INR)
RECO Mar-15
Var %
YoY
Var %
QoQ
Mar-15
Var %
YoY
Var %
QoQ
Mar-15
Var %
YoY
Var %
QoQ
Private Banks
Axis Bank 569 Buy 37,434 18.2 4.3 38,599 18.9 16.5 21,782 18.2 14.7
DCB Bank 114 Buy 1,268 26.8 4.0 716 42.8 4.8 409 4.6 -3.8
Federal Bank 130 Buy 5,994 -4.1 2.1 4,199 0.0 5.7 2,626 -5.3 -0.8
HDFC Bank 1,031 Buy 60,127 21.4 5.5 47,055 24.5 -1.5 28,017 20.4 0.3
ICICI Bank 321 Buy 49,967 14.7 3.8 49,984 12.2 -0.8 29,061 9.6 0.6
IndusInd Bank 916 Buy 9,118 16.7 5.9 8,762 21.8 13.2 5,104 28.9 14.1
Kotak Mahindra Bank 1,399 Neutral 10,886 12.6 2.8 7,470 23.0 1.3 4,745 16.5 2.1
Yes Bank 846 Buy 9,575 33.1 5.3 8,908 30.9 3.3 5,592 30.0 3.5
Pvt Banking Aggregate 184,369 17.7 4.5 165,693 18.7 3.8 97,336 16.3 4.2
PSU Banks
Bank of Baroda 169 Neutral 33,030 5.7 0.5 23,920 -6.7 2.3 6,630 -42.7 98.5
Bank of India 206 Neutral 29,613 -2.8 6.5 18,802 -5.8 0.8 2,371 -57.5 36.7
Indian Bank 169 Buy 11,601 7.7 5.0 7,752 10.2 -2.4 2,101 -22.5 -24.3
Punjab National Bank 149 Buy 42,969 7.4 1.5 30,763 -3.1 11.8 7,973 -1.1 2.9
State Bank of India 275 Buy 138,989 7.7 0.9 108,346 1.9 16.6 37,889 24.6 30.2
Union Bank of India 159 Buy 22,375 9.0 5.5 15,868 20.2 8.3 4,040 -30.2 33.6
PSU Banking Sector 278,577 6.3 2.0 205,451 0.8 11.0 61,004 -4.9 27.8
Source: Company, MOSL
Technology
Company name
Axis Bank
Bank of Baroda
Bank of India
DCB Bank
Federal Bank
HDFC Bank
ICICI Bank
Indian Bank
Indusind Bank
Kotak Mahindra Bank
Punjab National Bank
State Bank of India
Union Bank of India
Yes Bank
December 2014 Results Preview | January 201
Financials - Banks
March 2015 Results Preview | April 2015

2. April 2015 137
Subdued business growth marred by weak macros
Weak demand environment is likely to result in 10-11% YoY deposit/loan growth in
4QFY15. While state-owned banks are likely to grow in line with or marginally lower
than industry average (led by capital conservation effort and weak corporate loan
growth of 6% YoY as of February 2015) of 10-11%, growth should remain healthy for
private banks at 18-20% (helped by strong retail growth and refinancing). Corporate
lenders are likely to report moderate growth, as disbursements are just matching
repayments. For the industry, the large corporate segment grew by just 6% YoY as of
February 2015. Our interactions with bankers suggest that though inquiries for new
projects have started, sanctions are not picking up.
Is asset quality bottoming out? Not yet! Focus to be on recoveries
Asset quality trend is expected to remain weak, led by (a) challenging macros, (b)
poor monsoon, (c) weak recovery, and (d) last quarter of asset classification
forbearance on restructured loans. Our interactions with bankers and media reports
suggest that RBI may consider the date of reference as against date of approval for
the restructuring forbearance ending on March 31. We continue to factor high
slippages (2.4% in 4QFY15 v/s 2.1% in 3Q). For most banks, we believe it would take
at least couple of quarters for the delinquencies to subside significantly, especially in
the new environment of asset classification upon restructuring. Relapse from
restructured loans, a key factor for weak 3QFY15 earnings, remains a key for 4QFY15
earnings as well. Guidance on stress loans addition for FY16 will be the key thing to
watch out for.
Margins to remain largely stable; bulk borrowers might surprise positively
Pricing at the industry level remains disciplined. Banks refrained from cutting base
rate during the quarter (banks cut base rate in the first week of April 2015). Deposit
rate cuts taken by banks in 2HFY15 will help in reduction in cost of deposits and in
turn support margins. Our interactions with private bank managements also suggest
that growth in high yielding unsecured loans and vehicle loans has picked up during
the quarter, which will also support margins. Overall, we expect stable margins QoQ
for both private and state-owned banks. NII growth for state-owned banks in
4QFY15 is expected to be 6.3% YoY (trailing loan growth), while private banks'
growth is expected to be 17.7% YoY (4.5% higher QoQ).
Trading gains, MTM and countercyclical provisions reversal to aid earnings
Bond yields have declined by 10-30bp since end-3QFY15. While the fall is not that
high in 4Q, over the last six months, the decline has been 50-70bp, which will aid
earnings (either via trading gains or MTM reversals). Some banks with high equity
portfolio can benefit from positive capital market performance in 4Q. During the
quarter, RBI allowed banks to utilize 50% of the countercyclical/floating provisions
available, which will help to shore up profits but will reduce PCR.
Retail fees healthy, corporate fees muted; opex a drag on earnings
Lack of new sanctions, moderate corporate loan growth and incremental corporate
growth largely by refinancing continue to impact corporate fees. Retail fees is
expected to be healthy, led by third-party distribution income, higher disbursements
Weak corporate loan
growth (6% YoY as of
February 2015) leading to
overall loan growth
moderation, especially for
state-owned banks
Stress addition to be high
for state-owned banks;
slippage ratio at 2.4%;
restructuring to rise, as
asset classification norms
relaxation came to an end
at March 2015
NII growth is expected to be
6.3% YoY for state-owned
banks, whereas private
banks are expected to grow
17.7% YoY
Core fees to remain under
pressure; trading gains and
recoveries from written-off
accounts to help operating
profit growth
March 2015 Results Preview | April 2015

3. April 2015 138
in vehicle loans and unsecured loans, and continued momentum in housing loan
growth. For state-owned banks, employee expenses would be a drag on earnings,
led by AS-15 pension-related provisioning (fall in yields) and higher than expected
wage negotiation (15% hike v/s 12-13% factored by some) related settlement.
State-owned banks’ core profitability to remain under pressure
State-owned banks’ PPP/PAT is likely to grow 1%/-5% YoY, despite a low base,
higher net trading gains and one-off provision reversals during the quarter. Higher-
than-expected NPAs (especially relapse from restructured loans) and restructuring
related provisioning and employee expenses will be a drag on earnings. Over the last
year, Indian banks, mainly state-owned banks, have sold ~INR500b worth assets to
ARCs. We believe write-downs and resultant MTM provisioning for the same (as per
RBI guidelines) would begin over the next one/two quarters. For private banks,
healthy core operating performance and one-off income (repatriation of capital and
dividend from subsidiaries) will help to manage earnings. We expect PPP and PAT
growth of ~19% YoY and ~16% YoY, respectively.
Sector strategy
Unlike the 2003-08 cycle, this cycle is likely to see a gradual reduction in interest
rates (rates were rising over FY04-08, led by higher inflation), providing healthy
capital gains to banks (in turn, supporting earnings). Growth improvement coupled
with lower interest rates and improving capital markets (in turn de-leveraging)
would lead to deceleration in stress addition for banks.
Private banks have emerged stronger from the downcycle, with (a) strong capacity
in place for growth, (b) decadal high RoAs and RoEs, (c) strong improvement in
liability profile, and (d) much diversified and granular loan book. While PSU banks
are still grappling with the asset quality issues, reforms in the sector, focus on
balance sheet consolidation and profitability are positive signs.
Valuations are near (for large state-owned banks) or below the long period average
(20-40% discount for mid-sized state-owned banks) and private banks are trading
21% below peak multiples (26% above LPA). Sharp fall in valuations (especially state-
owned banks and ICICIBC) post 3QFY15, largely factors in expected weak asset
quality performance for the quarter. Our top picks are AXSB, SBIN, YES, IIB and
UNBK.
High provisions and tax rate
to dent profitability for
state-owned banks; expect
PAT decline of 5% YoY
Top picks: AXSB, SBIN, YES,
IIB and UNBK
March 2015 Results Preview | April 2015

4. April 2015 139
Exhibit 2: State-owned banks – one-year forward P/BV
Source: MOSL, Company
Exhibit 3: Private banks – one-year forward P/BV
Source: MOSL, Company
Exhibit 4: Loan growth continues to moderate…
Source: MOSL, Company
Exhibit 5: …as does deposit growth
Source: MOSL, Company
Exhibit 6: CD rates declined further during the quarter (%)
Source: MOSL, Company
Exhibit 7: Decline in short-term yields to result in re-pricing
benefit (%)
Source: MOSL, Company
1.9
0.5
0.8
1.1
0.3
0.8
1.3
1.8
2.3
Mar-
05
Jun-
06
Sep-
07
Dec-
08
Mar-
10
Jun-
11
Sep-
12
Dec-
13
Mar-
15
PSU Banks Sector PB (x) LPA (x)
3.8
1.0
3.0
2.4
0.5
1.5
2.5
3.5
4.5
Mar-
05
Jun-
06
Sep-
07
Dec-
08
Mar-
10
Jun-
11
Sep-
12
Dec-
13
Mar-
15
Pvt Banks Sector PB (x) LPA (x)
34.1
34.3
37.7
39.4
40.9
41.5
43.7
46.9
47.6
48.1
50.3
53.5
54.0
56.5
57.6
60.1
61.2
62.7
63.5
63.9
64.4
65.6
21.9
19.2
24.5
21.5
20.0
19.5
16.0
18.7
16.5
15.9
15.1
14.0
13.5
17.5
14.5
14.3
13.3
11.0
10.5
10.7
10.4
9.5
1QFY11
2QFY11
3QFY11
4QFY11
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
Jan-15
Feb-15
Mar-15
Loans (INR t) Chg YoY (%)
46.4
47.1
49.9
52.1
54.9
56.3
58.3
61.0
62.3
64.1
64.7
69.0
70.7
73.3
75.0
77.4
79.5
82.9
83.4
84.0
84.6
85.9
15.0
14.4
16.8
15.9
18.5
17.5
17.0
14.4
13.5
13.9
11.0
13.1
13.5
14.4
15.9
14.6
12.4
13.1
11.5
11.6
11.8
11.4
1QFY11
2QFY11
3QFY11
4QFY11
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
Jan-15
Feb-15
Mar-15
Deposits (INR t) Chg YoY (%)
8.3
8.6
8.9
9.2
9.5
Mar-14
Apr-14
May-14
Jun-14
Jul-14
Aug-14
Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
6 month CD (%) 12 month CD (%)
8.60
8.47
8.88
8.80
8.40
8.35
8.63 8.758.61
8.35
8.52 8.47
8.27 7.98 7.94
7.86
7.88
7.79 7.75 7.74
1 Yr - Gsec 3 Yr - Gsec 5 Yr - Gsec 10 Yr - Gsec
31-Mar-14 27-Jun-14 30-Sep-14
31-Dec-14 31-Mar-15

5. April 2015 140
Exhibit 8: Net slippages (state-owned) to remain high (%,
annualized)
Source: MOSL, Company
Exhibit 9: NIMs expected to remain stable (%)
Source: MOSL, Company
Exhibit 10: Relative performance - three-month (%)
Source: Bloomberg, MOSL
Exhibit 11: Relative performance – one-year (%)
Source: Bloomberg, MOSL
Exhibit 12: Comparative valuation
Sector / Companies CMP EPS (INR) PE (x) PB (x) ROE (%)
(INR) Reco FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E
Banks-Private
Axis Bank 569 Buy 31.3 37.5 44.0 18.2 15.2 12.9 3.0 2.6 2.2 17.8 18.4 18.5
DCB Bank 114 Buy 6.0 7.3 9.4 18.8 15.6 12.1 2.1 1.8 1.6 12.8 12.5 14.2
Federal Bank 130 Buy 11.5 13.0 15.6 11.3 10.0 8.4 1.4 1.3 1.2 13.5 13.7 14.7
HDFC Bank 1,031 Buy 41.1 51.3 62.6 25.1 20.1 16.5 4.2 3.6 3.1 19.5 19.3 20.2
ICICI Bank 321 Buy 19.3 23.0 27.1 16.6 14.0 11.9 2.4 2.1 1.9 15.1 15.8 16.4
IndusInd Bank 916 Buy 34.4 43.7 54.7 26.6 20.9 16.8 4.8 4.0 3.3 19.3 20.7 21.7
J&K Bank 103 Neutral 11.1 13.6 18.1 9.3 7.6 5.7 0.8 0.8 0.7 9.1 10.4 12.6
Kotak Mahindra Bank 1,399 Neutral 37.7 46.1 56.9 37.1 30.4 24.6 4.9 4.3 3.6 14.2 15.0 16.0
South Indian Bank 26 Buy 2.8 3.7 4.7 9.2 7.1 5.6 1.0 0.9 0.8 11.2 13.3 15.2
Yes Bank 846 Buy 48.5 60.4 76.2 17.4 14.0 11.1 3.0 2.6 2.2 21.4 19.7 21.1
Private Bank Aggregate 21.2 17.4 14.4 3.5 3.0 2.7 16.7 17.5 18.4
Banks-PSU
Andhra Bank 79 Buy 11.0 17.9 22.5 7.2 4.4 3.5 0.5 0.5 0.4 7.3 11.0 12.7
Bank of Baroda 169 Neutral 16.1 24.1 30.8 10.5 7.0 5.5 1.0 0.9 0.8 10.1 13.7 15.7
Bank of India 206 Neutral 31.1 50.3 64.3 6.6 4.1 3.2 0.5 0.5 0.4 7.9 11.6 13.3
Corporation Bank 55 Neutral 9.0 16.5 21.9 6.1 3.4 2.5 0.4 0.4 0.4 7.3 12.3 14.7
Dena Bank 52 Neutral 5.7 9.7 13.6 9.1 5.3 3.8 0.4 0.4 0.4 4.7 7.7 10.0
IDBI Bank 72 Neutral 10.5 14.4 19.7 6.9 5.0 3.7 0.5 0.5 0.4 7.4 9.5 11.9
Indian Bank 169 Buy 21.7 28.7 33.5 7.8 5.9 5.1 0.6 0.6 0.5 8.5 10.4 11.2
Punjab National Bank 149 Buy 19.6 26.8 36.2 7.6 5.5 4.1 0.7 0.6 0.6 9.9 12.2 14.6
State Bank of India 275 Buy 23.2 29.0 36.2 11.8 9.5 7.6 1.3 1.2 1.1 12.0 13.5 15.0
Union Bank of India 159 Buy 27.4 36.6 47.1 5.8 4.4 3.4 0.6 0.5 0.4 9.9 12.0 13.9
PSU Bank Aggregate 10.0 7.4 5.8 1.0 0.9 0.8 9.9 12.2 14.0
Source: MOSL, Company
1.7
3.1
2.0
1.1
2.7 2.7
2.0
1.1
3.3
1.9 2.1
1.1
1.9
1.6
2.1
2.4
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15E
Net Slippage Ratio (%)
3.1
3.3
3.4
3.3
3.0
3.0
3.0
2.9
2.8
2.8
2.8
2.7
2.7
2.7
2.7
2.6
3.4
3.5
3.6
3.7
3.6
3.7
3.7
3.8
3.8
3.8
3.8
3.8
3.9
4.0
3.9
3.9
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15E
PSU Private
93
96
99
102
Jan-15 Feb-15 Mar-15 Apr-15
Sensex Index MOSL Financials Index
90
110
130
150
170
Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15
Sensex Index MOSL Financials Index
March 2015 Results Preview | April 2015

6. 9 April 2015 4
Metals | Coal auction
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United States. Accordingly, in the absence of specific exemption under the Acts, any brokerage and investment services provided by MOSL, including the products and services described herein are not available to or
intended for U.S. persons.
This report is intended for distribution only to "Major Institutional Investors" as defined by Rule 15a-6(b)(4) of the Exchange Act and interpretations thereof by SEC (henceforth referred to as "major institutional
investors"). This document must not be acted on or relied on by persons who are not major institutional investors. Any investment or investment activity to which this document relates is only available to major
institutional investors and will be engaged in only with major institutional investors. In reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the
"Exchange Act") and interpretations thereof by the U.S. Securities and Exchange Commission ("SEC") in order to conduct business with Institutional Investors based in the U.S., MOSL has entered into a chaperoning
agreement with a U.S. registered broker-dealer, Motilal Oswal Securities International Private Limited. ("MOSIPL"). Any business interaction pursuant to this report will have to be executed within the provisions of this
chaperoning agreement.
The Research Analysts contributing to the report may not be registered /qualified as research analyst with FINRA. Such research analyst may not be associated persons of the U.S. registered broker-dealer, MOSIPL,
and therefore, may not be subject to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading securities held by a research analyst account.
For Singapore
Motilal Oswal Capital Markets Singapore Pte Limited is acting as an exempt financial advisor under section 23(1)(f) of the Financial Advisers Act(FAA) read with regulation 17(1)(d) of the Financial Advisors
Regulations and is a subsidiary of Motilal Oswal Securities Limited in India. This research is distributed in Singapore by Motilal Oswal Capital Markets Singapore Pte Limited and it is only directed in Singapore to
accredited investors, as defined in the Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time.
In respect of any matter arising from or in connection with the research you could contact the following representatives of Motilal Oswal Capital Markets Singapore Pte Limited:
Anosh Koppikar Kadambari Balachandran
Email : anosh.Koppikar@motilaloswal.com Email : kadambari.balachandran@motilaloswal.com
Contact : (+65)68189232 Contact : (+65) 68189233 / 65249115
Office Address : 21 (Suite 31),16 Collyer Quay,Singapore 04931
Motilal Oswal Securities Ltd
Motilal Oswal Tower, Level 9, Sayani Road, Prabhadevi, Mumbai 400 025
Phone: +91 22 3982 5500 E-mail: reports@motilaloswal.com

7. Motilal Oswal India Strategy Gallery