Sector Update

December 26, 2018

Sector View
Overweight
Banking
Improved earnings visibility, prudent valuation
The financial sector has come off from the turbulence in previous months
PSU Banks taking stride in recent up move led by the NBFC crisis, particularly housing finance companies. The
market has clearly differentiated to favour NBFCs with strong parentage
1-Jan-18 10-Dec-18 19-Dec-18 YTD 9 Days and robust business model. Banks with high CASA like HDFC Bank, Axis
Bank Nifty 25318 26103 27298 3.7% 4.6%
Bank and SBI have clearly outperformed. Being corporate banks and
PSB 3679 2807 3106 -19.1% 10.7%
beneficiaries of NCLT resolutions, Axis, SBI are outperforming along with
Private 14021 14700 15373 6.3% 4.6% other large private banks.
NBFC (incl banks) 10374 11061 11616 5.4% 5.0%
The Indian debt market witnessed a turnaround last month due to a sharp
Source: Capitaline, ICICI Direct Research fall in global crude oil prices, continuous under-shooting of CPI reading
from RBI’s projected path and OMOs leading to G-sec yield falling by ~80
bps to 7.22% from 8.02%. Till H1FY19, PSU banks have provided
Quarterly Performance of recommended stock ~| 20,600 crore while private banks have parked ~| 1400 crore for
investment MTM provision. Given the fall in yields, even a 50% reversal
28-Sep-18 20-Dec-18 Returns will be a huge positive for banks, reporting lower profitability.
SBI 265 298 12.5% Post the change of guard at RBI, anticipated relaxation in PCA norm is
BAJAJ FINANCE 2,167 2,575 18.8% seen boosting lending by PSU banks. Capital infusion of ~| 83000 crore
BAJAJ FINSERV 5,988 6,357 6.2% remains positive as it could lead to early exit of few banks under PCA
framework, which sparked a rally in PSU banks. PSBs have outperformed
Source: Capitaline, ICICI Direct Research Bank Nifty as well as private banks in last few days led by PCA relief
expectation and MTM reversals.

The farm loan waiver post the recently concluded state election could
have a domino effect as expectations of more farm loan waivers, given
general election ahead, are rising. Total farm loan waiver, including recent
three state waivers, is ~| 243100 crore. GNPA for agriculture sector
increased drastically from 4.8% in March 2013 to ~7% in March 2018.
The defaults are largely due to impact of farm loan waivers on credit
culture and lower farm output realisations by farmers apart from rainfall
vagaries in specific years of FY15 and FY16.

In a move towards efficient transmission of monetary policy, RBI

recommended linking retail loans to external benchmark instead of the
current system of using internal benchmark. Benchmarking floating rate
with external benchmark will lead to faster, more efficient transmission of
monetary policy with consumer loans closer to market rates.

Post multiple headwinds, a healthy revival has witnessed in credit growth

in states of Tamil Nadu (13%) & Kerala (12%). As beneficiaries of a revival
in credit growth post normalcy in economy, we are upgrading the target
price of City Union Bank and Federal Bank in our coverage universe.
The two major worries of the Indian banking sector - rising stressed
assets and increasing G-sec yields - are largely behind us. Continuous
effort on part of the government to move PSU banks out of the PCA
framework along with declining MTM losses on G-sec augurs well for
PSU banks. With liquidity measures, NBFCs have witnessed some relief
but we still believe all NBFCs and troubled banks are not yet out of the
woods. Hence, we stick to our stance of preferring businesses with robust
operating model, strong and stable franchise, both on asset as well
liability side and strong management. Within banks, we continue to
Research Analyst recommend SBI and Axis Bank among large caps and City Union Bank in
Kajal Gandhi the midcap space. In the NBFC space, we prefer Bajaj Finance owing to its
kajal.gandhi@icicisecurities.com favourable business attributes.

ICICI Securities Ltd | Retail Equity Research

Bank wise Agriculture loan (September 2018)
Farm loan waiver; more pain ahead
Farm loan waivers are the flavour of the season. States have unveiled
loan waivers of ~ | 169000 crore since 2014 before this election. This
Bank Name Agri Loan Amt. % of Total
(Rs Cr) Loan
amount is expected to rise substantially in the backdrop of the recent
state election outcome. Further possibility of loan waivers cannot be ruled
Allahabad Bank 27,548 17.7%
Andhra Bank 33,381 19.8%
out going into general election 2019. The central government may adopt
Axis Bank* 27,636 6.1% populist measures. In these state elections, Chhattisgarh has announced a
Bank of Baroda 51,513 11.9% farm loan waiver of | 6100 crore while in Madhya Pradesh and Rajasthan
Bank of Maharashtra 14,940 16.5% the same has been finalised at ~| 36000 crore & | 18000 crore,
Canara Bank 87,947 21.5% respectively. A sum of | 60100 crore has been announced recently. More
Corporation Bank 21,014 18.1% can be on the cards next year. As of now only 40%of disbursement has
HDFC BANK 36,096 4.8% been done for the waiver announced in past two fiscal year i.e. out of
Indusind Bank* 13,011 8.9% |132600 crore waiver announced only | 54946 crore has been disbursed
Kotak Mahindra bank 22,425 12.1%
as of November end.
Punjab National Bank 73,285 17.7%
State Bank of India 190,731 9.7%
Exhibit 1: Loan waiver of states in past
South Indian Bank 7,887 13.7%
Syndicate Bank 32,640 18.8%
States Year Cost of Loan Waiver
* Data as of FY18 (| in Crore)
Source: Company, ICICI Direct Research
Andhra Pradesh 2014 24,000
Telangana 2014 17,000
Tamil Nadu 2016 6,000
Uttar Pradesh 2017 36,000
Maharashtra 2017 34,000
Punjab 2017 10,000
Karnataka 2018 34,000
Rajasthan 2018 8,000
Madhya Pradesh 2018 36,000
Rajasthan 2018 18,000
Chhattisgarh 2018 6,100
Source: RBI, government estimate, ICICI Direct Research

The Indian agriculture sector has been growing at~12% CAGR for the last
five years. Over the years, the sector has been facing various issues be it
scarce rainfall or poor yield on harvest, lower MSP, etc, leading to debt
burden. GNPA for the sector increased drastically from 4.8% in March
2013 to 7% in March 2018 while the stressed advance ratio increased
from 6.5% in March 2013 to 7.3% in March 2018. The defaults were
largely due to impact of farm loan waivers on credit culture and lower
farm output realisations by farmers apart from rainfall vagaries in specific
years of FY15 and FY16.

Exhibit 2: Agriculture sector GNPA ratio

Year Agri Advances YoY Growth Agri GNPA Agri Stressed Advance Ratio
(| in crore) (in %) (in %) (in %)
Mar-13 589,900 4.8 6.5
Mar-14 669,400 13.5 4.6 6.3
Mar-15 765,900 14.4 4.8 6.4
Mar-16 882,900 15.3 6.0 6.8
Mar-17 992,400 12.4 6.1 6.7
Mar-18 1,030,200 3.8 7.0 7.3

Source: RBI, ICICI Direct Research

We believe the farm loan waivers are largely impacting the credit culture.
As private sector banks have also scaled up their direct credit exposure,
agri NPA ratios are rising for them. PSU banks have always seen some
impact as they hold the major share of the agriculture loan portfolio.

ICICI Securities Ltd | Retail Equity Research Page 2

 External benchmarking of retail loans; more aligned to markets
In a bid to move towards efficient transmission of monetary policy, RBI
has recommended linking loans to external benchmarks instead of the
present system of using internal benchmarks. Accordingly, it is proposed
that new floating rate personal or retail loans (housing, auto, etc) be
benchmarked from April 1, 2019, while micro and small enterprises
(MSME), extended from April 1, 2020, would be linked to an external
benchmark. Banks can choose external benchmark from three options
provided by RBI – repo rate, 91 days T-bill rate or 180 days T-bill. The
spread over the benchmark rate is to be decided at banks discretion at the
inception of the loan. However, such spread needs to remain unchanged
over the tenure of the loan, unless credit worthiness of borrower
undergoes substantial change as agreed upon in the loan contract.
In our view, benchmarking the floating rate with external benchmark will
lead to faster and efficient transmission of monetary policy and consumer
loans will be closer to market rates. At the same time, increase in
earnings volatility in the near term cannot be ruled out as faster
transmission of loans has to be managed by a balanced deposit mix to
avoid asset liability management (ALM) mismatch.
Till a month back, we were in a rising rate cycle. However, once the cycle
turns, as expected, the home loan portfolio (at lower external linked rates)
within the total retail portfolio, would be the most affected as it is a low
spread business. The asset quality risk in the near term could be low.
However, once the complete loan book benchmarking to external rate is
done, the risk could increase. As housing finance is a very competitive
business, chances of housing finance companies following banks could
be a high probability, thereby hurting margins.

We assume 12%, incremental growth in new floating rate loans and a 50

bps cut in lending rate, led by external benchmark. FY20E PAT is seen
getting impacted by 0.3-1.6%. Banks with higher proportion of home loan
(including SBI, BoB) are seen witnessing ~1% impact on the bottomline.
Private banks, with a relatively lower proportion of home loans, are seen
witnessing a marginal impact on FY20E PAT.

Exhibit 3: Marginal impact seen on PAT in the near term (as its on incremental loans)
Impact of 50
bps cut in
benchmark
Q2FY19 Incremental new floating loans FY20E rate

Non-Home Home Non-Home Retail

in | crore Home Loan loan Retail Loan Loan loan Loan NII PAT NII PAT
SBI 328,248 248,346 576,594 39390 5960 45350 100,640 13,804 0.2% 1.6%
Axis Bank 86,467 135,243 221,710 10376 3246 13622 25,146 9,868 0.3% 0.7%
HDFC Bank 47,861 365,100 412,961 5743 8762 14506 56,645 25,117 0.1% 0.3%
BOB 49,345 26,907 76,252 5921 646 6567 19,690 4,469 0.2% 0.7%
PNB 44,232 36,966 81,198 5308 887 6195 18,822 2,450 0.2% 1.3%
Canara Bank 31,316 44,737 76,053 3758 1074 4832 16,270 3,085 0.1% 0.8%
Source: RBI, ICICI Direct Research

Recent moderation in G-sec yields to aid earnings

ICICI Securities Ltd | Retail Equity Research Page 3

 The Indian debt market witnessed a sort of turnaround in the last two
months with G-sec yields falling around 80 bps to 7.22% from 8.02%. The
sharp fall in global crude oil prices (from ~US$85 per barrel to under
US$60 per barrel), continuous under-shooting of CPI reading from RBI’s
projected path and OMOs were factors leading to a turnaround in the G-
sec yield. The cooling of yields will help banks reduce their MTM losses
with higher investment gains compared to the previous quarter.

PSU banks are more sensitive to any change in yield compared to private
banks. A 50 bps moderation in G-sec yield would benefit SBI and Bank of
Baroda most in PSU and IDBI Bank, Canara Bank and OBC in non
coverage can add 15-20 bps to RoA. J&K Bank among private banks can
see benefits.

Till H1FY19, PSU banks have provided | 20600 crore while private banks
provided | 1400 crore for investment MTM provision. Even a 50%
reversal will be huge for banks reporting lower profitability.

Also, a decline in yield is directly feeding into interest rates in the

corporate bond market, CP, etc. Therefore, this can reduce interest rates
for NBFCs and provide them some relief.

Exhibit 4: Sensitivity of various banks to 30 and 50 bps reduction in 10 year G-sec yields

Absolute Impact Increase in ROA Increase in ROA

Modified of yield Absolute Impact led by 30 bps led by 50 bps
duration (in movement of 30 of yield movement decline in yield decline in yield
Q2FY19 Investment book years) bps (| crore) of 50 bps (| crore) Average Asset(| crore) (bps) (bps)
Banks (| crore) AFS (| crore) AFS
Public sector banks
Bank of India* 131,286 40,455 3.2 385.9 643.2 601,052 6 11
Bank of Baroda 1,76,997 76,339 1.1 261.1 435.1 727,918 4 6
PNB*^ 209,837 76,656 NA NA NA 750,422 NA NA
Canara Bank* 149,872 54,448 4.5 728.5 1,214.2 633,560 11 19
SBI 1,050,702 513,582 2.4 3,759.4 6,265.7 3,415,235 11 18
Indian Bank 68,023 25,782 3.3 252.1 420.2 261,642 10 16
Vijaya bank* 42,705 9,112 2.3 61.5 102.5 182,913 3 6

Private sector banks

Axis Bank^ 155,685 54,490 NA NA NA 711,616 NA NA
City Union Bank 8,174 1,965 1.2 7.0 11.7 41,531 2 3
DCB 7,003 1,758 0.6 3.2 5.3 31,844 1 2
J&K Bank 20,542 5,384 1.4 22.0 36.6 91,592 2 4
Source: Company, Bloomberg ICICI Direct Research, * Not under coverage- used consensus, AFS- Available for Sale,^ - Modified Duration Not Available

Credit growth picks up pace; gradual recovery in corporate seen

The economy has seen a gradual pick-up in credit led by the retail and
services sector. Industry growth, which has been muted for some time,
has seen an uptick. Growth in non-food bank credit increased 15.07%
YoY as of December 2018 compared to an increase of 8.4% as of FY18.
Credit to industry, which had grown 0.7% in FY18, witnessed gradual
growth in Q1FY19 & Q2FY19 while industry growth was at 3.7% as of
October 2018. Ex-NBFC growth of the service segment was at ~18%.

Among peers, some PSU banks witnessed good growth but overall banks
under PCA witnessed de-growth. Private retail centric banks witnessed
healthy growth of 18%+ in advances while banks with substantial
corporate exposure, have seen some uptick in corporate capex.

ICICI Securities Ltd | Retail Equity Research Page 4

 Refinance demand from resolutions at NCLT have also led to credit
pickup by large corporates.

The services segment continues to grow at a healthy pace of ~23-27%

from June 2018. Non-banking financial companies (NBFCs), which grew
~56% YoY in October 2018, have mainly driven such high growth. Ex-
NBFC, growth of the service segment is at ~18%.
The industry sector has seen healthy growth as it grew 3.7% in October
2018 compared to de-growth of 0.2% in October 2017. This growth was
on the back of demand from infrastructure, engineering chemical and the
food processing sector.
The retail loan segment is growing at a steady pace of ~16-17% YoY as
of October 2018. However, housing loans and other personal loans have
grown the most among retail loans with 17.6% and 22.1% YoY growth in
October 2018, respectively. The agricultural and allied activities segment
have grown at a normal pace of ~8% YoY in October 2018.

Going ahead, after the NBFC debacle, most NBFCs would have used their
unused banking line credits while post October they have moved on to
securitisation to fund their growth. Therefore, growth in the service
segment, coming from NBFCs is expected to moderate, going ahead, in
FY19E. The large industrial sector is poised to grow steadily compared to
small & medium industry in FY19-20E. MSME focus from the government
is pushing up the disbursements.
Bankers raising their credit growth estimates for FY19, considering
improving credit scenario and shifting demand from NBFC’s to Banks.
Accordingly, we expect FY19 banking sector credit growth to increase to
15-16% vs ~13% earlier.

Exhibit 5: Retail and services segment continue to propel credit growth

| crores FY15 FY16 FY17 FY18 Jun-18 Jul-18 Aug-18 Sep-18
Non-Food Credit 6,002,952 6,546,903 7,094,490 7,688,423 7,632,544 7,627,600 7,770,400 7,977,444
Agriculture & Allied Activities 765,880 882,942 992,386 1,030,215 1,035,461 1,038,500 1,041,900 1,054,439
Industry 2,657,629 2,730,679 2,679,831 2,699,268 2,641,702 2,637,052 2,662,066 2,701,649
Services 1,413,097 1,541,067 1,802,237 2,050,471 2,021,782 2,007,500 2,074,000 2,201,392
Personal Loans 1,166,348 1,392,216 1,620,034 1,908,469 1,933,598 1,944,500 1,992,400 2,019,963

YOY growth (%)

Non-Food Credit 8.1% 9.1% 8.4% 8.4% 11.1% 10.6% 12.4% 11.3%
Agriculture & Allied Activities 9.2% 15.3% 12.4% 3.8% 6.5% 6.6% 6.6% 5.8%
Industry 5.9% 2.7% -1.9% 0.7% 0.9% 0.3% 1.9% 2.3%
Services 7.3% 9.1% 16.9% 13.8% 23.3% 23.0% 26.7% 24.0%
Personal Loans 13.8% 19.4% 16.4% 17.8% 17.9% 16.7% 18.2% 15.1%

Proportion (%)
Agriculture & Allied Activities 12.8% 13.5% 14.0% 13.4% 13.6% 13.6% 13.4% 13.2%
Industry 44.3% 41.7% 37.8% 35.1% 34.6% 34.6% 34.3% 33.9%
Services 23.5% 23.5% 25.4% 26.7% 26.5% 26.3% 26.7% 27.6%
Personal Loans 19.4% 21.3% 22.8% 24.8% 25.3% 25.5% 25.6% 25.3%

Source: RBI, ICICI Direct Research

ICICI Securities Ltd | Retail Equity Research Page 5

 Outlook on PCA banks; early exit from PCA on the cards

Prompt corrective action (PCA) has been taken by RBI to ensure that
banks manage risks and capital concerns in a better way while timely
corrective actions are taken to revive the bank. Currently, 11 banks have
been placed under PCA due to lower capital and deteriorating asset
quality.

Exhibit 6: PCA framework as was announced by RBI for inclusion of banks

Criterion Indicator Threshhold 1
CRAR+ CCB less than regulatory Level CRAR+CCB <10.875%
Capital and/or AND/OR
CET 1+CCB less than regulatory level CET 1+CCB<7.375%

Asset Quality Net NPA Net NPA >6%

Profitability Return on asset (RoA) Negative for two consecutive years

Leverage Total Exposure/Tier 1 Leverage ratio >4%

Source: ICRA, ICICI Direct Research

Bank that breaches any of the above parameters results in invocation of

PCA. This leads to restriction on opening new branches, incremental
lending, etc.
Exhibit 7: List of banks under PCA
Q2FY19 PAT CAR (%) Tier 1 (%) NNPA (%) ROA (%)
Corporation Bank 103.0 11.0% 8.9% 11.7% 0.2%
Bank of Maharashtra 27.0 9.9% 7.9% 10.6% 0.1%
Bank of India -1156.0 10.9% 7.7% 7.6% -0.7%
Allahabad Bank -1823.0 710.0% 5.1% 8.0% -3.1%
Dena Bank -417.0 10.1% 7.6% 11.7% -1.4%
UCO Bank -1136.0 760.0% 5.6% 12.0% -2.0%
United Bank (I) -883.0 7.8% 5.8% 14.4% -2.4%
Central Bank -924.0 870.0% 6.7% 10.4% -1.1%
IOB -487.0 9.2% 7.1% 14.3% -0.7%
Source: ICICI Direct Research

Due to deteriorating asset quality and lower than required capital

prescribed by RBI, these 11 banks were placed under PCA. Due to this,
the banks faced restricted in incremental lending, which dampened the
credit growth in the economy. Post the change of guard at the RBI, the
government anticipates relaxation in PCA norms to boost lending.

Further additional infusion of | 40000-50000 crore among these PCA

banks could shore up the capital adequacy ratio of these banks. Out of
| 2.11 lakh crore-recapitalisation plan by the government in 2017, | 58000
crore was to be raised by banks. However, with banks only able to raise
~| 17000 crore of capital, the balance amount of | 41000 crore is going to
be infused as additional recapitalisation by the government.

This capital infusion in PCA, banks would definitely shore up their CAR.
With CET 1 capital above 7.375%, banks such as Corporation Bank, Bank
of Maharashtra, Bank of India are likely candidates to be out of PCA soon.
NPA norms and profitability norms to come out of the threshold may be
difficult in a shorter timeframe for these banks.

ICICI Securities Ltd | Retail Equity Research Page 6

 Post capital infusion, three to four banks, as discussed above under PCA,
will be excluded while another two being merger candidates would leave
the PCA framework soon. Only three to four banks will be left under PCA.
Therefore, the overall scenario is positive for PSU banks.

Recent developments
Changes at RBI: Shaktikanta Das, a former IAS officer who was a part of
the Fifteenth Finance Commission, Economic Affairs Secretary as well as
Revenue Secretary was appointed the 25th RBI Governor post Urjit Patel’s
exit on an immediate basis.

Kotak Bank promoter stake: According to banking guidelines, RBI

instructed Kotak Mahindra Bank (KMB) to reduce its promoter holding to
20% from 30% by 31st December. To comply with that, KMB had issued
100 crore non-convertible perpetual noncumulative preference shares
(PNCPS) of face value | 5 each aggregating to | 500 crore. RBI had
rejected that. Post no communication from the central bank, KMB had
filed a petition in the Bombay High Court against RBI’s rejection order.

The Bombay High Court on December 17 denied an interim stay to Kotak

Mahindra Bank (KMB) with respect to its December 31 deadline to dilute
its promoter holding. The ongoing debate is on using non-convertible
PNCPS as a means for dilution. According to RBI commentary now,
PNCPS has no voting rights. The next hearing by the HC is scheduled on
January 17, 2019 while the December 31, 2018 deadline to reduce the
promoter’s stake below 20% still stands.

In our view, a promoter stake sale seems to be the only option for Uday
Kotak in the given period. A 10% stake sale will result in ~| 23,000 crore
transaction. Unless it is sold to one or two strategic buyers, it will result in
a good amount of stock supply in the market. Also, | 23,000 crore will be
coming in the hands of promoter Mr Kotak. Another possibility could be
that KMB may be ready to accept regulatory restrictions in terms of
branch expansion, etc, and await the verdict of the high court scheduled
on January 17, 2019.

ILFS defaults & liquidity measures: Liquidity troubles for NBFCs started
post the debacle of IL&FS where it defaulted on interest payment on
borrowings from the banking & NBFC sector that had collective exposure
of | 91000 crore. Post issues, RBI had to issue various liquidity measures
to safeguard the NBFC sector. The measures taken are as follow:
 to increase liquidity to the NBFC sector, RBI was permitted to
reckon that government securities held by them up to an equal
amount to their incremental outstanding credit to NBFC & HFCs,
was over and above the amount of outstanding credit on their
book as ‘Level 1 High quality liquid asset (HQLA) within
mandatory SLR requirement
 to ease credit crunch for NBFCs & HFCs and develop sustainable
liability franchise for sector, RBI relaxed its norm for securitisation.
Companies can now securitise loans of more than five-year
maturity after holding those loans for a minimum of six month vs.
a year earlier. These relaxations would be permitted if minimum
retention requirement for NBFCs for such securitisation was
maintained at 20% of book value of the loans being securitised
 to ensure enough liquidity for NBFCs, RBI has been carrying out
OMOs on a timely basis. Post the NBFC crisis, RBI has infused |
1000 billion of liquidity in the system through OMOs. To provide
incremental liquidity, the RBI may Increase the quantum of OMOs.

ICICI Securities Ltd | Retail Equity Research Page 7

 South based banks; Picking up momentum
Due to multiple factors viz. floods, demonetisation and GST, credit growth
in the southern region was muted with states like Tamil Nadu & Kerala
growing at a sluggish pace of 4.4% & 7.6% CAGR in FY15-17. Post that,
we have seen a revival in credit growth in Tamil Nadu (13%) and Kerala
(12%). Regional banks are seen as major beneficiaries of a revival in credit
growth post normalcy in economy (after demonetisation, GST & floods).
Therefore, with an improving credit outlook, we upgrade the target price
of City Union Bank and Federal Bank.

City Union Bank: With an improving business growth and best in class
RoA of ~1.6% among its peers, CUB is well placed to grow faster than its
peers. The bank has tier 1 capital ratio of 14.7%, which provides comfort
for further growth. Due to better return ratio and consistency in earning,
the bank is trading at a premium to its peers. CUB is maintaining its
growth trajectory and decremental pressure on asset quality. We upgrade
our price multiple to 3.0xFY20E BV vs. 2.7xFY20E BV earlier with a target
Price Chart price of | 225 (| 200 earlier).
Exhibit 8: Key Financials & Valuation
16000 250.0 | Crore FY17 FY18 FY19E FY20E
200.0 NII 1,199 1,430 1,593 1,902
12000
PPP 994 1,208 1,279 1,501
150.0 503 592 653 780
8000 PAT
100.0 PE 22.5 21.2 21.3 17.8
4000 Target PE 26.9 25.2 25.4 18.9
50.0
P/ABV 3.6 3.4 3.2 2.8
0 0.0 Target P/ABV 4.3 4.1 3.8 2.9
Oct-15

Oct-16

Oct-17

Oct-18
Apr-16

Apr-17

Apr-18

ROA (%) 1.5 1.6 1.5 1.6

ROE (%) 15.4 15.5 14.7 15.2

Nifty City Union Bank

Source: Company, ICICI Direct Research

Federal Bank: With flood related stress subsiding, the bank is well poised
to witness a pick-up in credit growth. Therefore, we factor in healthy
credit growth of 23.6% CAGR in FY18-20E. A moderation in stressed
asset accretion to previous lower run rate and decline in restructured
assets will lead to an improvement in margins and limit credit cost. The
management guidance on moderation, going ahead, is panning out.
Price Chart Therefore, we upgrade our target price to | 110 (earlier | 95) valuing the
stock at 1.7x FY20E ABV. Further, value unlocking of stakes in the life
insurance JV and NBFC subsidiary (Fed Fina) would be positive.
16000 140.0
120.0
12000 Exhibit 9: Key financials & valuation
100.0
80.0 | Crore FY17 FY18 FY19E FY20E
8000
60.0 NII 3,048 3,583 4,368 5,187
4000 40.0 PPP 1,919 2,291 2,741 3,165
20.0 PAT 831 880 1,246 1,493
0 0.0 19.5 21.0 14.9 12.4
P/E
Oct-15

Oct-16

Oct-17

Oct-18
Apr-16

Apr-17

Apr-18

Target P/E 22.8 24.6 17.4 14.5

P/ABV 2.0 1.7 1.6 1.4
Nifty Federal Bank Target P/ABV 2.4 2.0 1.9 1.7
RoA (%) 0.8 0.7 0.8 0.9
RoE (%) 9.6 8.2 9.6 10.6
Source: Company, ICICI Direct Research

ICICI Securities Ltd | Retail Equity Research Page 8

 Annexure

Exhibit 10: Asset quality trend- Q2FY19 declining trend continues

GNPA (| crore) NNPA (| crore)
Asset quality trend Q3FY18 Q4FY18 Q1FY19 Q2FY19 Q3FY18 Q4FY18 Q1FY19 Q2FY19
PSU coverage
Bank of Baroda 48,480 56,480 55,875 57,375 19,852 23,483 22,384 23,184
SBI 199,141 223,427 216,127 205,864 102,370 110,855 107,705 94,810
Private coverage
Axis Bank 25,001 34,249 32,662 31,029 11,769 16,592 14,902 14,007
City Union Bank 860 857 851 877 448 475 473 483
Development Credit Bank 354 369 401 421 161 147 154 162
IndusInd Bank 1,499 1,705 1,741 1,828 592 746 762 800
HDFC Bank 8,235 8,607 9,539 9,639 2,774 2,601 2,907 3,007
Jammu & Kashmir Bank 6,232 6,007 6,242 6,442 2,488 2,791 2,782 2,882
Yes Bank 2,974 2,627 2,824 3,226 1,595 1,313 1,263 1,439
Source: Company, ICICI Direct Research

Exhibit 11: Asset quality of sector

FY14 FY15 FY16 FY17 FY18 Q1FY19 Q2FY19
GNPA 242000 303978 575313 776835 1024586 1002682 997247
NNPA 136000 158211 331340 430173 517775 485181 463082
GNPA ratio 4.1 4.5 7.6 9.6 11.6 11.3 10.8
NNPA ratio 2.2 2.4 5.1 5.3 5.8 5.5 5.0
GNPA of PSU banks 523398 684733 896601 874071 868812
GNPA of Private banks 51915 92102 127985 128611 128435
Source: Company, ICICI Direct Research

Exhibit 12: Quarterly margin trend

NIM (%) Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19
PSU coverage
Bank of Baroda 2.2 2.1 2.3 2.7 2.5 2.7 2.6
SBI 2.7 2.4 2.4 2.5 2.5 2.8 2.7

Private coverage
Axis Bank 3.8 3.6 3.5 3.4 3.3 3.5 3.4
City Union Bank 4.2 4.5 4.5 4.4 4.4 4.2 4.3
Development Credit Bank 4.0 4.2 4.2 4.1 4.1 3.9 3.8
IndusInd Bank 4.0 4.0 4.0 4.0 4.0 3.9 3.8
HDFC Bank 4.3 4.4 4.3 4.3 4.3 4.2 4.3
Jammu & Kashmir Bank 3.5 3.7 3.8 4.0 3.2 3.7 3.7
Yes Bank 3.6 3.7 3.7 3.5 3.4 3.3 3.3
Source: Company, ICICI Direct Research

ICICI Securities Ltd | Retail Equity Research Page 9

 Exhibit 13: Key financials of industry as on Q2FY19 (listed banks)
(| crore) Q4FY17 Q1FY18 Q2FY18 Q3FY18 Q4FY18 Q1FY19 Q2FY19
NII 83763 73905 82808 85714 84835 94144 92132
Growth YoY 9.1 2.2 9.0 14.8 1.3 27.4 11.3
Other income 47039 41877 52189 38218 47391 37110 37019
Growth YoY 12.2 14.6 9.2 -16.7 0.7 -11.4 -29.1
Total operating exp. 58557 54053 59536 61162 69366 64525 64068
Staff cost 27968 29149 29088 30128 34342 32053 32749
Operating profit 72246 61729 75460 62771 62860 66730 65084
Growth YoY 27.5 6.9 12.2 1.6 -13.0 8.1 -13.8
Provision 72627 45540 65521 76618 148276 77236 70471
PBT -418 16149 9899 -13888 -85460 -10552 -5437
PAT 557 11376 6221 -6943 -55648 -7130 -4404
Growth YoY NA 35.6 -42.4 NM NM NM NM
GNPA 776835 829336 840250 885788 1024586 1002682 997247
Growth YoY 31.3 26.8 19.2 20.9 31.9 20.9 18.7
NNPA 430173 467013 452523 469278 517775 485181 463082
Growth YoY 22.0 11.2 12.4 20.4 3.9 2.3
Source: Capitaline, Company, ICICI Direct Research

ICICI Securities Ltd | Retail Equity Research Page 10

ICICI Direct Research coverage universe (BFSI)
CMP M Cap EPS (|) P/E (x) P/ABV (x) RoA (%) RoE (%)
Sector / Company (|) TP(|) Rating (| Cr) FY18 FY19E FY20E FY18 FY19E FY20E FY18 FY19E FY20E FY18 FY19E FY20E FY18 FY19E FY20E
Bank of Baroda (BANBAR) 115 135 Buy 30,450 -9.2 10.0 17.0 -12.6 11.5 6.8 1.0 0.9 0.8 -0.3 0.4 0.6 -5.8 6.1 9.8
State Bank of India (STABAN) 291 340 Buy 259,929 -7.3 26.0 17.3 -39.7 11.2 16.9 2.4 1.4 1.8 -0.2 0.7 0.4 -3.0 9.7 6.5
Axis Bank (AXIBAN) 622 725 Buy 159,936 1.1 22.2 38.2 579.6 28.0 16.3 3.4 2.9 2.3 0.0 0.8 1.2 0.0 0.8 1.2
City Union Bank (CITUNI) 189 225 Buy 13,807 8.9 8.5 10.3 21.2 22.1 18.3 3.5 3.3 2.5 1.6 1.5 1.6 15.6 14.5 14.2
DCB Bank (DCB) 163 170 Hold 5,035 7.9 10.2 13.9 20.7 15.9 11.7 2.1 1.8 1.6 0.9 1.0 1.1 10.9 11.7 14.0
Federal Bank (FEDBAN) 94 110 Buy 18,597 4.5 6.2 7.4 21.0 15.2 12.6 1.7 1.5 1.4 0.7 0.8 0.9 8.2 9.3 10.4
HDFC Bank (HDFBAN) 2,085 2,300 Buy 566,819 67.4 75.5 91.3 30.9 27.6 22.8 5.4 4.0 3.5 1.8 1.8 1.8 18.1 16.6 16.2
IndusInd Bank (INDBA) 1,570 1,900 Buy 94,502 60.1 81.5 106.1 26.1 19.3 14.8 4.1 3.5 2.9 1.8 2.0 2.1 16.2 18.8 20.6
Jammu & Kashmir Bk(JAMKAS) 37 58 Buy 2,046 3.6 5.0 8.9 10.1 7.4 4.2 0.7 0.7 0.6 0.2 0.3 0.5 3.4 4.4 7.5
Kotak Mahindra Bank (KOTMAH) 1,228 1,400 Buy 234,241 21.4 26.5 33.0 57.3 46.3 37.2 6.5 6.0 5.4 1.7 1.7 1.8 12.5 12.8 14.4
Yes Bank (YESBAN) 185 190 UR 42,736 18.3 22.1 26.3 10.1 8.4 7.0 1.7 1.5 1.2 1.6 1.4 1.4 17.6 18.0 18.2
Bandhan Bank (BANBAN) 518 650 Buy 61,775 11.3 16.9 21.9 16.4 10.9 8.4 2.4 2.0 1.7 3.6 4.0 4.0 19.5 19.6 21.1
Source: Company, ICICI Direct Research

ICICI Securities Ltd | Retail Equity Research Page 11

RATING RATIONALE
ICICI Direct Research endeavours to provide objective opinions and recommendations. ICICI Direct Research
assigns ratings to its stocks according to their notional target price vs. current market price and then
categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and
the notional target price is defined as the analysts' valuation for a stock.

Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction;
Buy: >10%/15% for large caps/midcaps, respectively;
Hold: Up to +/-10%;
Sell: -10% or more;

Pankaj Pandey Head – Research pankaj.pandey@icicisecurities.com

ICICI Direct Research Desk,

ICICI Securities Limited,
1st Floor, Akruti Trade Centre,
Road No 7, MIDC,
Andheri (East)
Mumbai – 400 093
research@icicidirect.com

ICICI Securities Ltd | Retail Equity Research Page 12

ANALYST CERTIFICATION
We /I, Kajal Gandhi, CA, Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the
subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.

Terms & conditions and other disclosures:

ICICI Securities Limited (ICICI Securities) is a full-service, integrated investment banking and is, inter alia, engaged in the business of stock brokering and distribution of financial products. ICICI Securities
Limited is a Sebi registered Research Analyst with Sebi Registration Number – INH000000990. ICICI Securities Limited Sebi Registration is INZ000183631 for stock broker. ICICI Securities is a wholly-owned
subsidiary of ICICI Bank which is India’s largest private sector bank and has its various subsidiaries engaged in businesses of housing finance, asset management, life insurance, general insurance, venture
capital fund management, etc. (“associates”), the details in respect of which are available on www.icicibank.com.

ICICI Securities is one of the leading merchant bankers/ underwriters of securities and participate in virtually all securities trading markets in India. We and our associates might have investment banking
and other business relationship with a significant percentage of companies covered by our Investment Research Department. ICICI Securities generally prohibits its analysts, persons reporting to analysts
and their relatives from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover.

The information and opinions in this report have been prepared by ICICI Securities and are subject to change without any notice. The report and information contained herein is strictly confidential and
meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without
prior written consent of ICICI Securities. While we would endeavour to update the information herein on a reasonable basis, ICICI Securities is under no obligation to update or keep the information current.
Also, there may be regulatory, compliance or other reasons that may prevent ICICI Securities from doing so. Non-rated securities indicate that rating on a particular security has been suspended
temporarily and such suspension is in compliance with applicable regulations and/or ICICI Securities policies, in circumstances where ICICI Securities might be acting in an advisory capacity to this
company, or in certain other circumstances.

This report is based on information obtained from public sources and sources believed to be reliable, but no independent verification has been made nor is its accuracy or completeness guaranteed. This
report and information herein is solely for informational purpose and shall not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial
instruments. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. ICICI Securities will not treat recipients as customers by virtue of their
receiving this report. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific
circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment
objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. The recipient should independently evaluate
the investment risks. The value and return on investment may vary because of changes in interest rates, foreign exchange rates or any other reason. ICICI Securities accepts no liabilities whatsoever for any
loss or damage of any kind arising out of the use of this report. Past performance is not necessarily a guide to future performance. Investors are advised to see Risk Disclosure Document to understand the
risks associated before investing in the securities markets. Actual results may differ materially from those set forth in projections. Forward-looking statements are not predictions and may be subject to
change without notice.

ICICI Securities or its associates might have managed or co-managed public offering of securities for the subject company or might have been mandated by the subject company for any other assignment
in the past twelve months.

ICICI Securities or its associates might have received any compensation from the companies mentioned in the report during the period preceding twelve months from the date of this report for services in
respect of managing or co-managing public offerings, corporate finance, investment banking or merchant banking, brokerage services or other advisory service in a merger or specific transaction.

ICICI Securities or its associates might have received any compensation for products or services other than investment banking or merchant banking or brokerage services from the companies mentioned
in the report in the past twelve months.

ICICI Securities encourages independence in research report preparation and strives to minimize conflict in preparation of research report. ICICI Securities or its associates or its analysts did not receive any
compensation or other benefits from the companies mentioned in the report or third party in connection with preparation of the research report. Accordingly, neither ICICI Securities nor Research Analysts
and their relatives have any material conflict of interest at the time of publication of this report.

It is confirmed that Kajal Gandhi, CA, Research Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months.

Compensation of our Research Analysts is not based on any specific merchant banking, investment banking or brokerage service transactions.

ICICI Securities or its subsidiaries collectively or Research Analysts or their relatives do not own 1% or more of the equity securities of the Company mentioned in the report as of the last day of the month
preceding the publication of the research report.

Since associates of ICICI Securities are engaged in various financial service businesses, they might have financial interests or beneficial ownership in various companies including the subject
company/companies mentioned in this report.

It is confirmed that Kajal Gandhi, CA, Research Analysts do not serve as an officer, director or employee of the companies mentioned in the report.

ICICI Securities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report.

Neither the Research Analysts nor ICICI Securities have been engaged in market making activity for the companies mentioned in the report.

We submit that no material disciplinary action has been taken on ICICI Securities by any Regulatory Authority impacting Equity Research Analysis activities.

This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution,
publication, availability or use would be contrary to law, regulation or which would subject ICICI Securities and affiliates to any registration or licensing requirement within such jurisdiction. The securities
described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and
to observe such restriction.

ICICI Securities Ltd | Retail Equity Research Page 13