Edelweiss Investment Research
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City Union Bank Ltd “This CUB Has Teeth”
Shivaji Thapliyal Research Analyst [email protected] +91 (22) 4272 2159
Date: 3rd July 2017 Edelweiss Investment Research
City Union Bank Ltd CMP INR 177 Target INR 220
This CUB Has Teeth Rating: BUY Upside: 25%
City Union Bank (CUB) is a mid-sized private sector bank with a INR24,112cr loan book and a distribution network comprising 550 branches. It possesses Shivaji Thapliyal unique competitive advantages compared with key peers on the yield, cost of funds and operating expense front, allowing it to deliver sustainably higher Research Analyst risk-adjusted return ratios. Given reasonable valuation for forecast return ratios, we recommend a ‘BUY’ Rating on the stock. [email protected] Loan book re-orientation largely over, CUB can revert to long term risk-managed growth trajectory +91 (22) 4272 2159 Jewel Loan de-focusing is largely behind CUB with exposure having fallen from 22% in FY13 to 9% in FY17 which allows CUB to grow without this drag going forward. Further, over FY1995-2016, CUB has displayed an average growth differential of 5% with the industry while displaying the prescience to pull back prior Bloomberg: CUBK:IN to key crises viz. global tech slowdown, the Great Recession and China slowdown, earmarking CUB as the bank stock to own over the long term cycle.
Under-penetrated home market, market share gains and high operating leverage to further aid growth 52-week range (INR): 170/ 95 CUB’s South/Tamil Nadu focus is adequate for fueling balance sheet growth over the next 4-5 years. (1) Its Q3FY17 branch share in Tamil Nadu is 3.5% compared with 67% for PSU Banks and 28% for Private Sector Banks, indicating significant under-penetration. (2) CUB stands to gain market share from PSU Share in issue (cr): 59.8 Banks due to superior service levels. (3) Competition from large private sector banks is not significant as CUB operates in the INR 25 lacs – 1 cr loan ticket size MSME sub-segment whereas the former focus on much larger ticket sizes (4) CUB remains under-leveraged from a business per branch perspective with their M cap (INR cr): 10,759 FY17 Deposits per branch at INR 55 cr compared with INR 58-145 cr for key peers. Avg. Daily Vol. Well-managed funding profile, prudent asset-liability management lend significant cost of funds comfort 832 BSE/NSE :(‘000): CUB’s FY17 Cost of Funds stood at 5.9% compared with 6.5-7% for key peers. This is driven by (1) lower dependence on Borrowings which were 1.7% of FY17 Deposits and Borrowings compared with 3.1-19% for key peers (2) lower dependence on Bulk Deposits which are 5% of total deposits compared with 15-23% for key peers (4) prudent reluctance to participate in Saving Account interest rate competition with SA rate at 4% compared with key peers at 4-7.1%.
High exposure to MSME loans and higher loan granularity result in yield leadership for CUB CUB’s FY17 Yield on Advances stood at 12.1% compared with 11.3-12% for key peers which, in turn, is driven by (a) higher loan exposure to high-yielding MSME segment at 48% compared with 12-35% for key peers and (b) higher loan granularity with Top 20 borrowers accounting for 5.3% of loan book compared with 8.1-14% for key peers.
Non-IBA bi-partite employee settlement and best-in-class digital franchise drive major opex benefits City Union Bank’s FY17 Cost to Income Ratio stood at 41% compared with 45-60% for key peers. This is led by (1) lower Cost per Employee of INR 6.1 lacs Public, 100.0 compared with INR 6.2-9.1 lacs for key peers which, in turn, is driven by (a) Non-IBA bi-partite employee settlement (b) low average employee age of 27 years (2) 85% of transactions now via non-branch channels compared with c.60% 2 years ago. (3) Further, we looked at ATM, POS, Card and Android platform data and note that City Union Bank is in the top 2 across all parameters, indicating superior digital franchise, a key idiosyncratic advantage.
City Union Bank’s headline asset quality seems middling but underlying credit book indicates no undue risks City Union Bank’s gross total stress (GNPA Ratio + Std. Restructured Assets) stood at 3.4% as of H1FY17 compared with 1.5-6.6% for key peers. We note that (1)
City Union Bank’s exposure to key stressed sectors stood at 20.7% of H1FY17 credit compared with 17-22.9% for key peers whereas (2) Metals and Infra 200 exposure stood at 5.6% compared with 2.6-14.3% for key peers, indicating no incremental underlying credit risk compared with peers. Broad underlying macro risk for lumpy corporate NPA accretion is low with Large Corporate exposure low at 7% of FY17 loan book, avoidance of long-gestation project 180 financing with Working Capital loans 65% of loan book and Consortium lending at c.1% of loan book. 160
Valuation and Rating: Initiate with BUY, PT of Rs 220. CUB undervalued on comprehensive metrics 140 We use Residual Income Model to arrive at a Price Target of Rs 220 for City Union Bank, at which the stock trades at 2.7x FY19E book value. We initiate with 120 BUY Rating with our PT providing 25% upside to CMP. The stock currently trades at a P/B of 2.2x FY19E book value for an FY18E-20E RoE of 16%-17%. (INR cr) FY16 FY17 FY18E FY19E FY20E 100 Net Interest Income 981 1199 1452 1701 2008 80
Total Income 1391 1683 1994 2309 2710 60
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Profit After Tax 445 503 639 748 922 -
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Aug Dec Basic EPS 7.4 8.4 10.7 12.5 15.0 May P/E 23.8 21.0 16.6 14.2 11.8 CUB Sensex Book v alue per share 51 60 69 80 104 P/B 3.5 3.0 2.6 2.2 1.7 Date: 3rd Jul 2017 Return on Average Equity 15.5% 15.2% 16.6% 16.8% 16.3%
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City Union Bank Ltd.
City Union Bank: Well-managed funding profile + Granular high-yielding loan book + Bipartite employee settlement = Higher sustainable RoE
City Union Bank is expected to deliver a best-in-class RoE of 16-17% over FY18E-20E. Healthy sustainable RoE is delivery is expected on the back of high net interest margin and structurally low opex with low reliance on leverage.
City Union Bank’s FY17 City Union Bank’s FY17 Cost City Union Bank’s FY17 Cost Yield on Advances is to Income Ratio is 41% of Funds is 5.9% compared 12.1% compared with compared with 45-60% for with 6.5-7% for key peers 11.3-12% for key peers key peers
FY15 FY16 FY17 FY18E FY19E FY20E FY15 FY16 FY17 FY18E FY19E FY20E PB Multiple FY19E BVPS CMP / Target
NII 807 981 1199 1452 1701 2008 RoAA 1.49% 1.50% 1.51% 1.69% 1.72% 1.82% 2.2x (CMP) 80 177 Other Income 404 410 484 542 608 702 2.7x (Target) 80 220 Opex 519 558 689 795 929 1056 RoAE 16.7% 15.5% 15.2% 16.6% 16.8% 16.3%
PAT 395 445 503 639 748 922
At CMP, FY19E P/B is FY18E-20E RoE of At Target Price, 2.2x 16-17% FY19E P/B is 2.7x
Upside of 25%
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City Union Bank Ltd.
We use the Residual Income Valuation Model to value CUB. We assume a long-term risk-free rate of 7% for India, a Price Target INR 220 Beta of 1.05 for CUB and an India Equity Risk Premium of 6% and arrive at an overall Cost of Equity of 13.3% for CUB. We arrive at a price target of INR220, at which the stock will trade at 2.7x FY19E book value.
Our bull case assumes that CUB will continue to win market share at a fast pace from PSU Banks, have no impact Bull INR 274 from GST and display very good opex control implying an EPS level 5% higher than our base case resulting in an 3.4x 2019E BPS FY17-20E EPS CAGR of 23%.
Base Our base case assumes that CUB will continue to win market share at a reasonable pace from PSU Banks, have a INR 220 2.7x 2019E BPS minimal negative impact from GST and display good opex control implying an FY17-20E EPS CAGR of 21%.
Our bear case assumes that CUB will continue to win market share at a moderate pace from PSU Banks, have Bear INR 113 moderate negative impact from GST and display moderate opex control implying an EPS level 5% lower than our 1.4x 2019E BPS base case resulting in an FY17-20E EPS CAGR of 17%.
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City Union Bank Ltd.
Focus Charts Average Daily Turnover (INR cr) Stock Price (CAGR) Relative to Sensex, CAGR (%)
3 months 6 months 1 year 1 year 3 years 5 years 10 years 1 year 3 years 5 years 10 years 1.84 1.05 0.73 59% 33% 32% 28% 39% 26% 19% 11%
Industry loan growth has slowed to 5% in FY17 but there is great divergence among individual banks. While PSU Banks are challenged on the growth and asset quality front, Private Sector Banks are growing faster with superior asset quality. Within Private Sector Banks, banks Nature of Industry with higher loan book exposure to large corporates, especially to stressed sectors like Metals and Infra, are worse off compared with banks with higher exposure to retail and / or retail-like small-ticket MSME loans.
CUB has a Q3FY17 branch share of 3.5% in its home state of Tamil Nadu compared with 65% for PSU Banks, from whom CUB continues to win market share. From an overall perspective, CUB has a market share of only 0.30% of the banking system’s loans as of FY17. Hence, Opportunity Size CUB has significant headroom for growth both within its home state and from an overall perspective. Furthermore, MSME is a major long- term thrust area for the Indian government and MSME / Trade loans are a focus area for CUB with 48% loan book share as of FY17.
CUB has focused on the higher-yielding MSME segment resulting in high Net Interest Margin of 4.2% (FY17). CUB stands very well Capital Allocation
capitalised with a Tier 1 Capital Ratio of 15.4% as of FY17.
Predictability is high since CUB has very low exposure to Large Corporate Loans (7% of FY17 loan book) from where large lumpy NPA Predictability accounts usually emerge. Further, CUB’s exposure to consortium lending is very small at c.1% of loan book providing similar comfort.
In its key home state of Tamil Nadu, CUB is winning market share from PSU Banks, fending off competition effectively against key Tamil- Sustainability Nadu focused listed rivals, Karur Vysya Bank and Lakshmi Vilas Bank, which have significant asset quality issues while larger private sector
rivals operate in significantly higher MSME ticket size range compared with CUB, which has an average MSME ticket size of c. INR 33 lacs.
At present, CUB does not plan to expand rapidly outside its home state of Tamil Nadu, where it has significant headroom. However, Disproportionate Future management is acutely aware of the importance of long-term growth delivery for investors and hence, we think the bank would
Business Value Drivers Value Business ultimately start to focus outside Tamil Nadu, particularly on the loan book side.
CUB will continue to focus on the high-yielding MSME segment, particularly on retail-like small-ticket MSME loans. Cost control to be Business Strategy & maintained on the back of favourable employee settlement and further enhanced with technology initiatives including robust digital Planned Initiatives strategy and robotics.
While there is concern regarding the impact of GST on the overall MSME space, CUB will be impacted minimally since it largely operates Near Term Visibility within an MSME portion that is already tax-compliant. Any slowdown due to onerous compliance requirements will be short-lived.
CUB has high long-term visibility as it is a bank with deep expertise in small-ticket MSME lending, high client retention, improving cost Long Term Visibility control on the back of technology leadership, prudent liability management and best-in-class credit appraisal approach.
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City Union Bank Ltd.
Focus Charts – Story in a nutshell
CUB to grow sans drag as de-focusing of Jewel CUB’s South-focus adequate given high Low dependence on Borrowings and Bulk
Loans largely behind us op. leverage, among other reasons Deposits results in lower CoF
145 22% 7.0% 7.0% 6.7%
18% 6.5%
14% 5.9% 74 76 58 10% 55
9%
FY17 Cost FY17 of Funds
FY17 FY17 Deposits /Branch (INR cr)
Jewel Jewel Loansas % a of Loan book City Union Lakshmi DCB Bank Karur RBL Bank City Union Karur Vysya Lakshmi DCB Bank RBL Bank FY13 FY14 FY15 FY16 FY17 Bank Vilas Bank Vysya Bank Bank Vilas Bank Bank
Small-ticket loan exposure results in high-yielding Non-IBA employee settlement and digital Underlying credit risk for CUB not concerning loan book franchise drive lower opex
12.10% 12.03%
60%
14.3% 53% 51% 10.7%
45% 11.34% 6.6% 11.29% 11.25% 41% 5.6%
2.6%
As a % of H1FY17 a of % H1FY17 As credit
FY17 Yield FY17 on Advances FY 17 17 Cost /FY Income Ratio
City Union Karur Lakshmi RBL Bank DCB Bank DCB Bank City Union RBL Bank Karur Vysya Lakshmi City Union DCB Bank Karur Vysya Lakshmi RBL Bank Bank Bank Vilas Bank Bank Bank Vilas Bank Bank Vysya Vilas Bank Bank Metals Infra
Source: Edelweiss Investment Research
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City Union Bank Ltd.
I. Jewel loan book de-focusing over, CUB poised for growth Jewel Loan exposure has fallen from 22% in FY13 to 9% in FY17 without drag We note that, in FY13, the total Jewel Loan book was 22% of total loan book and this has since fallen to 9% of total loan book, as of FY17. It is clear that CUB Post FY13, City Union Bank de-focused its Jewel Loan book and this had had taken a strategic decision to de-focus its Jewel Loan as it was then not proved to be a material drag on overall loan growth since then. However, willing to keep gold loan risk on its balance sheet. This has no readacross for most of this process seems to be behind CUB and the incremental drag on CUB’s gold loan underwriting standards as this was largely an industry-wide loan book growth due to this reason will be significantly lower going forward. phenomenon wherein several banks have withdrew from gold loans whereas focused gold loan NBFCs such as Manappuram Finance and Muthoot Finance
have grew AUM in this area during the same period. Evolution of loan book proportion for City Union Bank– FY13-FY17
FY13 FY14 FY15 FY16 FY17 Growth rates (yoy) of loan book components for City Union Bank– FY14-FY17 Agri 16% 19% 17% 16% 18% FY13 FY14 FY15 FY16 FY17
MSME 26% 30% 34% 34% 30% Agri 29% -2% 12% 28%
Large Industries 14% 8% 6% 7% 7% MSME 23% 25% 20% -2%
Retail Traders 8% 7% 5% 5% 4% Large Industries -39% -13% 27% 23%
Wholesale Traders 11% 11% 12% 13% 14% Retail Traders -9% -9% 10% -5%
Commercial Real 5% 5% 5% 5% 5% Wholesale Traders 13% 23% 21% 20% Estate Commercial Real JL Non Agri 9% 5% 2% 1% 1% 13% 10% 20% 7% Estate Housing Loans 5% 5% 6% 7% 7% JL Non Agri -41% -49% -40% 15%
Other Personal Loans 2% 2% 3% 3% 3% Housing Loans 24% 32% 27% 15%
Loans coll. by Deposits 2% 2% 2% 2% 2% Other Personal Loans 5% 50% 20% 20%
Infra 1% 1% 1% 1% 1% Loans coll. by Deposits 57% -3% 7% 3%
NBFC 1% 1% 1% 1% 1% Infra -3% -25% -10% 62%
Others 2% 3% 5% 5% 7% NBFC -8% -1% 22% 13%
Jewel Loan* 22% 18% 14% 10% 9% Others 42% 120% 26% 56%
Total Loans 6% 11% 17% 14% Source: Company data; *Including Agri Jewel Loan Jewel Loan* -13% -16% -18% 4%
Loans ex Jewel Loan 11% 18% 23% 14%
Source: Company data; *Including Agri Jewel Loan
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City Union Bank Ltd.
Jewel Loans de-growth from smaller base and slower place has already translated to lower drag We note that CUB overall loan book growth was 6%, 11% and 17% in FY14, FY15 and FY16, respectively, whereas loan book excluding Jewel Loans grew 11%, 18% and 23% in FY14, FY15 and FY16, respectively. This differential has narrowed significantly in FY17 with total loan book growing 13.5% whereas loan book ex Jewel Loans grew 14.5%. This is because the Jewel Loan book is now (a) a small portion of overall loan book and therefore does not move the needle as much as it used to and (b) de-growth of -13%, -16% and -18% yoy for the Jewel Loan book in FY14, FY15 and FY16 has given way to modest growth of 4% in FY17.
RBI Notification capping cash disbursal of Gold Loans at INR 20,000 an incremental positive The relatively recent RBI Notification capping cash disbursal of Gold Loans at INR 20,000 (i.e. loans with ticket size exceeding INR 20,000 will have to be disbursed through non-cash means e.g. cheque, etc) has, on balance, improved the regulatory setup somewhat in favour banks making loans against gold compared with specialised gold loan NBFCs.
While Gold Loans of ticket size exceeding INR 1 lacs were already being disbursed through non-cash means (primarily cheque), now Gold Loans of ticket size between INR 20,000 and INR 1 lac would have to be disbursed through non-cash means. What this means for specialised Gold Loan NBFCs is that they would have to encourage borrowers falling in this bracket to develop a banking habit, which exposes these customers to being poached by banks.
It may be noted that, for Manappuram Finance, c.50% of loan book is to borrowers of loan ticket size exceeding INR 1 lac wheras, for borrowers below INR 1 lac ticket size, the average ticket size is c.INR 15,000 indicating that most of such borrowers fall below the INR 20,000 threshold. Hence, for Manappuram, a relatively lower c.10-15% of disbursals are potentially exposed to the poaching threat. For other specialised Gold Loan NBFCs, however, this sort of loan book skew (of very large and very small ticket size loans) is not quite witnessed and hence, the vulnerability is higher. It may noted that the addressable NBFC universe (for poaching) for banks engaged in Gold Loan business goes beyond just the well known players in this segment such as listed specalised Gold Loan NBFCs (Muthoot Finance, Manappuram Finance), unlisted specialist Muthoot Fincorp and listed diversified NBFCs (IIFL, SCUF) as the number of players engaged in the Gold Loan business is very large.
Furthermore, it may be noted that a bounce-back in the Gold Loan book, which has just taken root on a moderate scale in FY17, will also be yield-accretive for CUB.
Slowdown in loan growth in FY17 is mainly on account of the transient impact of Demonetisation De-monetisation has impacted certain components of the loan book viz. MSME, Retail Traders and Commercial Real Estate (comprising 39% of total loan book as of FY17). We do not think the impact of De-monetisation would sustain as the economic activity linked to the aforementioned portion of the loan book is driven by cash availability, which we believe would normalise soon given cash withdrawal limits have been completely removed.
It is worth noting that, if the growth rate of the affected portion of the loan book would have been the same as that in FY16, then the overall FY17 loan growth (yoy) would have been significantly higher at 22% as opposed to the observed 13.5%. It may be noted that CUB did sell some PSLC backed by their MSME loans and bought PSLC in the Agri segment. However, suffice to say that Re-monetisation is going to have a salutary impact on CUB loan growth going forward.
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City Union Bank Ltd.
II. Ultra-long term advances trend underlines CUB as growth CUB has displayed the prescience to pull back prior to key financial crises engine with prudent risk management Further, we note that the growth rate differential steadily contracted from FY1996 to FY2000, turned significantly negative in FY2006 and then, again in
FY2014. We note that these prudent relative growth pullbacks on the part of We go as far back as FY96 and examine CUB and banking system advances’ CUB happened prior to key financial crises. It may be noted that the FY2000 growth trend since then. There are some interesting insights to glean from this crisis was led by the global tech slowdown, the FY2007-2008 crisis was the most and overall, it establishes CUB as possessing judicious risk management debilitating global financial crisis since the Great Depresssion and FY2015-2016 expertise while delivering higher growth than the system. was a phase in which a China slowdown caused great stress to the Indian Banking sector. In each of these cases, CUB has displayed great prescience and slowed down lending to levels even lower than the system. This sense of Advances growth (yoy) and Growth Differential – City Union Bank – FY96-FY16 counter-cyclicality and general risk management prudence displayed by CUB 50% earmarks it as a prime bank name to be owned over the long-term cycle. 42%
40% 36% 35% 30% 31% 31% 27% 30% 27% 26% 24% 24% 21% 20% 21% 17% 20% 16% 15% 14% 15% 12% 10% 6%
0%
FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 -10%
-20% City Union Bank Differential with System
Source: RBI, Ace Equity
We note that CUB delivered an Advances CAGR of 23% over FY1995-2016 compared with banking system Advances CAGR of 18.6% over the same period. The average differential of growth rate of CUB compared with the system is 5% and the average multiple of growth rate of CUB compared with the system is 1.3x.
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City Union Bank Ltd.
III. South/Tamil Nadu focus adequate for growth over medium term We evaluated the branch presence breakdown data for Tamil Nadu from the State Level Banking Committee and note that PSU banks CUB currently does not have the intention to rapidly become a significantly pan- account for 65% of branches, indicating their significant penetration in Indian bank and its South/Tamil Nadu focus is adequate for fueling growth over the the state. Private sector banks account for 30% of branches in the state. next 4-5 years. We do not possess, strictly speaking, market share data for Tamil Nadu and business per branch would alter the market share for a given branch Market share gains expected at the expense of PSU Banks share. However, our understanding is that PSU banks have a somewhat The market share of PSU banks in the key Southern state of Tamil Nadu is significantly lower market share than their branch share, while the opposite holds true high and eating into their share remains one of CUB’s key growth drivers. Loss of for private sector banks. Moreover, brach share is a reasonable indicator share for PSU banks is an overarching mega trend on account of their comparably of the penetration of the respective banks. inadequate service levels. Branch share in Tamil Nadu—CUB versus peers (9mFY17-end) Competition from large private sector banks not intense for CUB 3.63% 3.51% Competition from large private sector banks is also not a pressing concern since these banks’ focus is on higher MSME ticket sizes (c. INR5cr), whereas CUB focuses more on the INR25lacs –1cr segment. The average ticket size for the bank in the 2.49% MSME segment is c. INR33lac. Consequently, large private sector banks are unable to match CUB’s service levels for smaller-ticket MSME clientele.
Home state of Tamil Nadu as yet under-penetrated from CUB’s perspective
Branch share breakdown—Tamil Nadu (9m17-end) Semi 0.16% 0.08% Rural Urban Metro Total Urban Karur Vysya Bank City Union Bank Lakshmi Vilas RBL Bank DCB Bank State Bank Group 12% 12% 15% 17% 13% Bank
Other Public Sector Banks 54% 49% 55% 50% 52% Source: Company data, SLBC TN; LVB, DCB numerators are as at H1FY17-end, FY16-end Private Sector Banks 25% 33% 29% 32% 30% CUB’s branch share in Tamil Nadu stands at 3.51%, Karur Vysya Bank’s at Regional Rural Banks 10% 6% 1% 0% 5% 3.63% and Lakshmi Vilas Bank’s at 2.49%. From these numbers, we get a Foreign Banks 0.0% 0.0% 0.2% 1.1% 0.2% sense of the under-penetration of these smaller-sized TN-focused banks.
The differentiation among the 3 banks lies in the extent to which each Source: SLBC Tamil Nadu has sweated its branch network, which we discuss in the next section.
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City Union Bank Ltd.
IV. CUB’s branch network as yet under-leveraged from a business Deposits per branch (INR cr / branch) – FY17 - City Union Bank vs Key peers per branch perspective 160 145
Advances per branch (INR cr / branch) – FY17 - City Union Bank vs Key peers 140
140 120
123
120 100 76 80 74 100 55 58 60 80 40 57 58
60 FY17 Deposits /Branch (INR cr)
44 44 20 40 0
City Union Bank Lakshmi Vilas DCB Bank Karur Vysya RBL Bank FY17 FY17 Advances /Branch (INR cr) 20 Bank Bank
Source: Company data; LVB data is for H1FY17 0 Lakshmi Vilas City Union Bank DCB Bank Karur Vysya Bank RBL Bank Bank CUB’s deposit per branch stands at INR55cr compared to peers’ INR58-145cr.
Source: Company data; LVB data is for H1FY17 Thus, CUB remains significantly under-leveraged compared to key peers from a business per branch perspective. Hence, we believe there is significant We note CUB’s advances per branch is INR44cr compared with peers’ INR44- upside for the bank from an operating leverage perspective. 124cr.
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City Union Bank Ltd.
V. City Union Bank possesses Cost of Funds advantage over key Lower dependence on high-cost bulk deposits compared to peers peers Another key aspect of CUB’s funding mix is low dependence on high-cost bulk deposits. There is no exposure to corporate bulk deposits and
certificates of deposit. Moreover, dependence on other bulk deposits at CUB has a lower cost of funds compared to key small private sector banks. This c.5% of deposit book is also low feeds directly into higher net interest income for a given balance sheet size,
implying higher net interest margin, ceteris paribus. Bulk Deposits as % of Total Deposits – CUB versus peers (FY17)
Cost of funds—CUB versus peers (FY17) 22.5%
7.0% 7.0% 18.0% 6.7% 6.5% 15.0% 5.9%
5.0% FY17 Cost FY17 of Funds
City Union Bank Karur Vysya Bank Lakshmi Vilas Bank DCB Bank RBL Bank
Source: Company data; DCB, RBL figures are simple averages of 4 FY17 quarters City Union Bank Karur Vysya Bank Lakshmi Vilas Bank DCB Bank
Source: Company data; KVB figure is Bulk Term Deposits to Total Term Deposits Lower dependance on borrowings compared to peers
The bank has employed prudent approach and superior asset liability The dependence of key private sector peers on bulk deposits at 15-22.5% of management to keep its cost of funds on the lower side. One of the aspects of total deposits is materially higher than CUB’s. Bulk deposits are typically this approach is low dependence on borrowings in comparison with deposits, the higher cost deposits that banks lean on to fulfil their asset-liability former being generally higher cost than the latter. management requirements.
Borrowings as % of Deposits and Borrowings—CUB versus peers (FY17) 18.7%
5.5% 6.2% 3.1% 1.7%
City Union Bank Karur Vysya Bank Lakshmi Vilas Bank DCB Bank RBL Bank
Source: Company data; *Figure for LVB is calculated
CUB’s proportion of borrowings as a percentage of total deposits and borrowings as of FY17 is 1.7% compared with key peers at 3.1-18.7%.
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City Union Bank Ltd.
CASA ratio for CUB is broadly comparable with peers City Union Bank not participating in Savings Account interest rate competition CUB’s FY17 CASA ratio of 23.4% is broadly comparable with key peers whose We note that City Union Bank offers a Savings Account (SA) interest rate of 4% CASA ratio ranges between 19.1% and 27.7%. Hence, even from a headline across accounts and hence, the headline CASA ratio needs to be viewed in CASA ratio perspective, this is neither a material negative or positive for the the context of SA interest rate competition, which City Union Bank is not bank from a cost of funds perspective for CUB. participating in. Consequently, CUB’s cost of SA deposits will be concomitantly lower compared with banks that are participating in this rate competition. CASA ratio—CUB versus peers (FY16, H1FY17, FY17) Highest SA interest rate—CUB versus peers 30.0% 27.7%
24.0% 25.0% 23.4% 7.1% 22.0% 6.5% 19.1% 20.0%
15.0%
4.0% 4.0% 4.0% 10.0%
5.0%
0.0% Karur Vysya Bank DCB Bank City Union Bank RBL Bank Lakshmi Vilas Bank
FY16 H1FY17 FY17 City Union Bank DCB Bank Karur Vysya Bank Lakshmi Vilas Bank RBL Bank Source: Company data Source: Company data
We note that Lakshmi Vilas Bank and RBL Bank offer higher SA interest rates of 6.5% and 7.1% p.a., respectively, on certain savings account offerings.
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City Union Bank Ltd.
VI. City Union Bank has higher Yield on Advances compared We note that CUB’s MSME exposure is 48% of FY17 loan book compared to key peers at 12-35%. Total small-ticket loans (SME + Retail) are 68% of loan book with key peers compared with 30-64% for key peers. To arrive at the advances breakdown, we have made certain reasonable assumptions / approximations to enable an CUB has a higher Yield on Advances compared with key small private sector apple-to-apple comparison across these companies. We are well into the MCLR bank peers. This feeds directly into higher net interest income for a given regime and CUB has sustained its yield and maintained its margin leadership. balance sheet size, implying higher net interest margin, ceteris paribus. CUB’s Loan book granularity positive for Yield on Advances Yield on advances—CUB versus peers Granularity of CUB’s loan book is significantly higher compared to peers. This 12.10% results in higher loan yield for the bank since higher granularity implies that it
12.03% operates in a higher yield bracket from a target client and ticket size perspective.
Top 20 borrowers as a % of loan book—CUB versus Peers (FY16) 11.34% 11.29% 11.25% 14.0% 11.4% 9.8% 8.1%
5.3% FY17 Yield FY17 on Advances
City Union Bank DCB Bank Karur Vysya Bank Lakshmi Vilas RBL Bank Bank City Union Bank DCB Bank Karur Vysya Bank Lakshmi Vilas Bank RBL Bank
Source: Company data Source: Company data
Small-ticket MSME expertise of CUB feeding into higher Yield on Advances We note that the share of Top 20 Borrowers as a proportion of FY16 loan book We note that CUB is an small-ticket MSME specialist on the lending front. stood at 5.3% for City Union Bank compared with 8.1%-14% for key peers, Small-ticket MSME loans are higher-yielding assets leading to superior yield indicating higher granularity for City Union Bank and concomitantly higher yield on advances for the bank compared to peers. bracket (lower ticket size). Higher granularity also implies lower loan book risk, ceteris paribus, due to lower concentration risk. Advances breakdown—CUB versus peers (FY17) City Union Bank’s Net Interest Margin higher compared with peers 100% Consequent to its Yield and Cost of Funds leadership, CUB delivers higher NIM 80% compared with key peers, implying higher RoE, ceteris paribus. 60% 20% Net interest margin—CUB versus peers (FY17) 40% 52% 15% 20% 48% 20% 10% 35% 4.17% 4.04% 12% 12% 20% 3.70% 0% 3.50% CUB DCB KVB RBL LVB 2.85%
MSME Retail Agri Corporate
Source: Company data, Edelweiss Investment Research City Union Bank DCB Bank Karur Vysya Bank RBL Bank Lakshmi Vilas Bank
Source: Company data; LVB figure is avg. of quarterly figures
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City Union Bank Ltd.
VII. City Union Bank has lower Cost to Income Ratio compared with CUB’s cost per empoyee at INR 6.1lacs is significantly lower than peers’ INR 6.2- key peers 9.1lacs. There are 2 key reasons for this:
City Union Bank has a lower Cost to Income Ratio compared with key small CUB has successfully negotiated the bi-partite settlement between private sector banks. This feeds into higher Profit after Tax for a given Total management and staff union officers’ association. This is not related to the Income, implying higher Return on Equity, ceteris paribus. settlement negoatiated by Indian Banking Association (IBA) on behalf of banks that agree to IBA negotiating on their behalf. Cost to income ratio—CUB versus peers
It is to be noted that CUB employees were granted a significant wage revision in
60% FY17, which is expected to stand for the medium term. This implies that the INR 53% 6.2 lac cost per employee for FY17 is now at an increased level (INR 4.7 lac for 51% FY16) which would rise only at a moderate pace in the coming years, keeping 45% employee cost under control. 41% The second reason is that CUB has a prudent human resource strategy and has worked to maintain a young workforce, implying lower employee cost, ceteris
FY 17 17 Cost /FY Income Ratio paribus. The average age of its employees is 27 years, indicating a young City Union Bank Karur Vysya Bank Lakshmi Vilas RBL Bank DCB Bank employee base. Bank
Source: Company data Moreover, the bank’s business acquisition cost is on the lower side. It has a focused approach for MSME clients due to which client retention is higher and We note that CUB’s cost-to-income ratio stands at 41% compared to 45-60% business acquisition costs are concomitantly lower. for key peers. High proportion of transactions through non-branch channels also lowers opex Lower cost per employee one of the key drivers of lower cost-to-income materially ratio CUB has been able to successfully transfer its branch transactions to non-branch One of the key drivers of lower cost-to-income ratio compared to peers is channels. 2 years ago, c.50-60% of transactions happened via non-branch the bank’s lower cost per employee channels but this has now moved up to c.85% thereby reducing cost. Furthermore, this also releases branch personnel to focus on business promotion Cost per employee (INR lacs) —CUB versus peers (FY17) activities. City Union Bank’s thrust on technology is typified by its investment in robotics as its was able to introduce India’s first banking robot ‘Lakhsmi’ in 9.1 8.2 November 2016. (We expand further on the efficacy of City Union Bank’s digital 7.8 strategy in the next section).
6.1 6.2 (INR lakh)(INR
City Union Bank DCB Bank Lakshmi Vilas Karur Vysya Bank RBL Bank Bank
Source: Company data; CUB excl. one-off ex-gratia provision; LVB is FY16 figure
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City Union Bank Ltd.
City Union Bank’s best-in-class digital strategy a key factor driving lower opex Monthly ATM transaction value (Oct-16; INR) per card—CUB versus peers We compare the digital strategy outcomes of City Union Bank and note that it
is the only bank in our set of key peers that is in the top 2 on all parameters. 5752 5682 5628
Monthly ATM transaction value (Oct 2016) as a % of deposits—CUB versus 2988 2919 peers (INR)
4.5%
CUB KVB DCB RBL LVB 3.2% Source: RBI
We also compare the monthly ATM transaction value per card for October 1.2% 1.2% 2016 and note that this is INR5,752 for CUB compared with INR2,919-5,682 for 0.6% key peers.
Monthly POS transaction value (Oct-16; INR) per card—CUB versus peers KVB CUB LVB DCB RBL
Source: RBI, Company data 779
We compare the monthly ATM transaction value for October 2016 as a percentage of deposits (H1FY17-end) and note that this is 3.2% for CUB with 398 380 only Karur Vysya Bank higher at 4.5%; balance 3 peers are at 0.6-1.2%. (INR) 313 170 Monthly POS transaction value (Oct-16) as a % of deposits—CUB versus peers
DCB CUB RBL KVB LVB 0.25% 0.22% Source: RBI
0.16% We also compare monthly POS transaction value per card for October 2016 and note that this is INR398 for CUB with only DCB Bank higher at INR779; 0.07% 0.07% balance 3 key peers are at INR170-380.
KVB CUB DCB LVB RBL
Source: RBI, Company data
We also compare the monthly POS transaction value for October 2016 as a percentage of deposits (H1FY17-end) and note that this is 0.22% for CUB with only Karur Vysya Bank higher at 0.25%; balance 3 peers are at 0.07-0.16%.
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City Union Bank Ltd.
Debit cards as a multiple of deposits (Oct-16; per INR cr)—CUB versus peers Android downloads as a multiple of deposits (Oct-16; per INR cr)—CUB versus peers 79 3.7 3.5
2.8
55
42 1.9 1.8
(INR cr)(INR (INR cr)(INR
21 18
LVB CUB DCB KVB RBL KVB CUB LVB DCB RBL Source: Google Play Store, Company Data Source: RBI, Company data We also compare the number of downloads on the Android platform cards as We also compare the number of Debit Cards at the end of October 2016 as a of October 2016 as a multiple of deposits at H1FY17 end. It stands at 3.5 multiple of Deposits at H1FY17-end and note that this is 55 cards / INR cr for downloads / INR cr for CUB with only Lakshmi Vilas Bank higher at 3.7 City Union Bank with only Karur Vysya Bank higher at 79 cards / INR cr with the downloads / INR cr; balance 3 peers are at 1.8-2.8 downloads / INR cr. remaining 3 key peers at 18-42 cards / INR cr. Thus, we note that CUB is in the top 2 among key peers across all parameters considered, implying greater traction for its digital strategy compared to key peers. This implies lower opex cost for CUB, ceteris paribus, compared to peers.
N.B. We looked at October 2016 as the period for this analysis as we wanted to exclude the partly transient impact of Demonetisation.
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City Union Bank Ltd.
VIII. City Union Bank has middling asset quality and is not a Exposure to stressed sectors within peer range We compare CUB’s exposure to key stressed sectors of the Indian economy major concern and note that it is well within the peer range, indicating no significant concern from an underlying asset quality perspective on this metric. CUB’s asset quality is of middling nature and is not a major concern in absolute terms. Credit exposure* to stressed sectors – H1FY17 - City Union Bank vs Key peers Gross total stress—CUB versus peers (FY17)
25.0% 22.6% 22.9% 20.7%
20.0% 17.8% 2.0% 3.8% 17.0%
0.6% 15.0% 0.3% 0.3% 3.6% 2.8% 2.8% 10.0% 1.2% 1.6%
RBL Bank DCB Bank City Union Bank Karur Vysya Bank Lakshmi Vilas Bank 5.0%
GNPA Ratio Std. Restr. Ratio 0.0% Source: Company Data; LVB data as of Q3FY17 DCB Bank RBL Bank City Union Bank Lakshmi Vilas Bank Karur Vysya Bank
While CUB’s headline GNPA ratio (as of FY17) is 2.8% compared to 1.2-3.6% for Metals Construction Gems & Jewellery Infra Mining Textiles Engineering key peers, its gross stock of total stress (the sum of GNPA ratio and Standard
Restructured Assets Ratio) stands at 3.4% compared to peers’ 1.5-6.6%. Source: Company Data; *Loan book + Credit substitutes Notably, Standard Restructured Assets Ratios for Karur Vysya Bank and Lakshmi Vilas Bank at 2.0% and 3.8, respectively, are significantly higher than CUB’s I 0.6%.
Management commentary in the Q4FY17 results conference call with regard to asset quality has been significantly positive, particularly on the recovery front. Recovery in Q4FY17 was INR 56cr, which is the highest and 3 years and this momentum, if it continues, could result in the bank making up for the lower trading profit on high FY17 base. Recovery rate, at the portfolio level, has been c.80% and this is expected to continue going forward.
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City Union Bank Ltd.
We drew up a list of key stressed sectors of the Indian economy as follows: Credit exposure* to Metals and Infra—CUB versus peers (H1FY17) Metals, Construction, Gems & Jewellery, Infra, Mining and Textiles. We note that 20.0% CUB’s credit exposure to these stressed sectors stands at 20.7% of credit (loan book + credit substitutes) compared with 17-22.9% for key peers, indicating that 18.0% CUB is not undertaking any meaningful incremental risk from an underlying 16.0% 14.3% sector perspective. 14.0% 12.0% 10.7% We do note that the relative stress of each sector is not identical. Furthermore, 10.0% we also acknowledge there would be differences across individual banks in 8.0% 6.6% credit appraisal standards to the same sector. Additionally, credit risk across 5.6% projects within the same sector would also vary. Nevertheless, a sum of 6.0% respective exposures to these stressed secors gives us some sense of the 4.0% 2.6% potential gross underlying stress for a given bank. 2.0% 0.0% We further note that among the selected sectors, in terms of concentration risk, DCB Bank City Union Bank RBL Bank Karur Vysya Bank Lakshmi Vilas City Union Bank’s exposure is the highest to Textiles at 10.3% of credit, which is Bank expected given its main area of operation is Tamil Nadu. Metals Infra Source: Company Data; *Loan book + Credit substitutes
Most importantly, we also note that City Union Bank’s credit exposure to the We note that City Union Bank’s credit exposure to Metals and Infra is 5.6% of two most stressed sectors of the Indian economy viz. Metals and Infra is lower credit with DCB Bank at 2.6% and the remaining 3 key peers higher at 6.6- than peers, barring DCB Bank. (Power and Telecom are subsumed in Infra 14.3%. The nature of Infra exposure, particularly expsoure to Power exposure.) Generation and Distribution, across peer banks considered may vary but this exposure data was not available across banks and we have made the apple-to-apple comparison based on data available.
From a 30,000 feet view, it is important to appreciate that CUB carries very little of the loan book risk that has arisen in the wider banking sector from exposure to large corporates (7% of FY17 loan book) in riskier sectors, project financing of long-gestation projects (Working Capital Loans are 65% of loan book) and concomitant consortium lending (c.1% of loan book). We shall discuss these aspects and more in detail in the subsequent section. Hence, to that extent, the possibility of the accretion of large lumpy corporate NPA is low for CUB.
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City Union Bank Ltd.
IX. CUB’s water-tight credit appraisal and lending approach also (5) Additional document – Any additional document that provides useful and indicates sound underlying asset quality incremental knowledge about the business is also considered for credit appraisal. For example, stock (inventory) report for the business.
We looked deeply into CUB’s credital appraisal process and overall approach (6) Existing bank account – If a potential borrower already has an existing to lending and note that they follow a fairly conservative process which bank account (savings / OD) with CUB, it is considered as an additional precludes an outsized accretion of bad loans. input for the credit appraisal team. Such a bank account can provide valuable information about the businessman’s cash flow profile in the past. CUB requirements for making an MSME loan point to a water-tight credit appraisal method Other factors in CUB’s overall lending approach provide underlying asset quality comfort (1) Income Tax Return filing of the last 3 years – While this may not be stressed upon by lenders and NBFCs operating in the MSME space, IT Return filings (1) Focus on secured lending - It may be noted that as much as 99% of CUB’s for last 3 years are viewed as critical by CUB. This enables CUB to make a lending is collateralised. more informed decision about a businessman’s earning capacity and analyse better the plausibility of cash flow projections of his business. The (2) Use of Personal Guarantee – CUB also often obtains personal guarantee proportion of SME borrowers who submit IT Return filings are as much as along with collateral. This also acts as a deterrent reducing a borrower’s c.80%. probabiliy of defaulting, ceteris paribus. (2) Immovable propety as collateral – CUB has a strong preference for (3) Single banker relationships – CUB generally avoids consortium lending and immovable property as collateral as opposed to movable property and opts for single-banker relationships instead. This helps them arrive at a shares. Hence, the quality of collateral is superior for CUB loan assets. better understanding of their clients’ cash flows and liquidity position and Usually, the immovable property in question is residential property. Not thereby, take more informed lending decisions. Consortium lending cases only does immovable property provide sound value as collateral, its value amount to only about c.1% of total loan book. to the borrower also acts as a deterrent and reduces the latter’s (4) Higher granularity in loan assets – The average ticket size of MSME loans is probability of defaulting. Nearly all of the secured loan book is c.INR 33 lacs as opposed to c. INR 5 cr for larger private sector bank peers. collateralised by immovable property. The average recovery rate for CUB This means their MSME exposure is ‘retail-like’ in nature and possesses a is c.85% which compares very favourably with the national average of different risk profile compared to larger ticket MSME exposure, which India at 26% (as per World Bank statistics). carries greater macro risk (3) Project report (business plan) – This includes a description of the business (5) Focus on Working Capital lending – 63% of loan book is Working Capital and estimation of cash flows for the business going forward. While, as a loans. This means that the macro risk present in term loans made during standalone document, this would be of lesser value, when analysed in long-term project lending is low for CUB. conjunction with the last 3 years’ Income Tax Return filings, it enables the credit appraisal team to take a more informed decision about the business proposal. (4) CIBIL score – This is invariably downloaded from the relevant third-party source on the basis of identity proof (PAN) submitted to CUB. A poor or non-existant credit history translates into a low CIBIL score, which is not viewed positively by the bank’s credit appraisal team
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City Union Bank Ltd.
(6) Streamlined, centalised loan approval structure f. We note that, in the Indian credit market, the macro risk in Large Corporate loan exposure is comparably higher than in other segments. a. All loan proposals are placed at the branch level. Such exposure is lower for CUB compared with key peers. b. The loan proposals are then analysed by 10 loan processing centers. If g. We also note differences in classification where, in contrast, for the proposal is rejected, then no further action is taken. If approved, example, RBL Bank classifies companies with turnover exceeding INR the proposal is forwarded to the respective regional DGM, which is a 1500 cr under C&IB (Corporate and Investment Banking) and very senior level functionary in CUB hierarchial nomenclature. companies with turnover between INR 250 and INR 1500 cr under c. Importantly, the regional DGM (each of whom may handle upto 50-75 Commercial Banking. The MSME piece falls under Branch and Business branches) is located at the Head Office. This, in effect, means the loan Banking (which also contains loans to individual consumers) and this approval is highly centralised in nature. consists of MSME players with turnover lower than INR 250 cr. This implies that even the small headline exposure of 7% to Large Industries of CUB d. An intranet software is in place that enables seamless exchange of is of a different (lower risk) nature than alternate classifications of the information across the organisation. nature discussed above. e. All loans others than Loans collateralised by Deposits (2% of Q3FY17 loan book) and Jewel Loans (9% of loan book) required centralised CUB’s credit appraisal process gives us comfort that it will tackle the GST approval meaning 89% of loan book has undergone centralised situation admirably approval. We think that CUB will remain largely unscathed from the impact of GST implemention on the MSME sector given that it largely operates in that portion (7) Low exposure to Large Corporate Loans of MSME that is already tax-compliant. A small portion of the bank’s MSME borrowers may, as per a certain hypothesis, see a moderate margin shrinkage a. The only loan exposure truly in the nature of Large Coporate Loans is but this is not likely to lead to significant incremental NPA accruals. There can, the 7% exposure (as of Q3FY17) to Large Industries. The ‘Large however, be a significant impact on disbursement to the MSME sector since Industries’ classification followed by CUB is as per the MSMED Act 2006 the borrowers may become preoccupied with onerous compliance and classifies loans to companies with investment in plant and requirements but we believe that this is likely to be transient and not persist machinery in excess of INR 5 cr as under Large Industries. with materiality beyond H1FY18. b. Furthermore, consortium lending cases amount to only about c.1% of total loan book.
c. The 5% Commerical Real Estate exposure is mostly to contractors with ticket size usually ranging between INR 20-50 lacs. Builders are usually not the category being lent to though there is some exposure to builders with ticket sizes usually not exceeding c.INR 5 cr and going up to INR 10 cr at the most. d. The Infra exposure of 1% of loan book is mostly legacy exposure to SEB. e. The NBFC expsoure of 1% of loan book consists of exposure to Mutual Benefit Fund and other NBFC exposure.
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City Union Bank Ltd.
Key financial indicators X. Higher capital levels implies lower dilution compared with peers FY16 FY17 FY18E FY19E FY20E
CUB raised its Tier-1 capital to 16.03% in FY15 and has since maintained higher Net Interest Income 981 1199 1452 1701 2008 capital levels than peers. Other Income 410 484 542 608 702 Total Income 1391 1683 1994 2309 2710 Tier 1 Capital ratio—CUB versus peers (FY15-FY17) Operating Expenses 558 689 795 929 1056 18.0% Pre-Provisioning Operating Profit 833 994 1200 1380 1654 15.36% 16.0% Provisions excl for Tax 231 301 336 370 408 14.0% 12.54% Profit Before Tax 603 693 863 1010 1246 11.87% 11.40% 12.0% Profit After Tax 445 503 639 748 922 10.0% 8.75% Basic EPS 7.4 8.4 10.7 12.5 15.0 8.0% P/E 24 21.0 16.6 14.2 11.8 6.0% Book value per share 51 60 69 80 104 4.0% P/B 3.5 3.0 2.6 2.2 1.7 2.0% Provisions on Average Advances 1.2% 1.3% 1.3% 1.2% 1.1% 0.0% City Union Bank Karur Vysya Bank DCB Bank RBL Bank Lakshmi Vilas Bank GNPA Ratio 2.41% 3.10% 2.70% 2.40% 2.30%
FY15 FY16 H1FY17 FY17 NNPA Ratio 1.53% 1.97% 1.71% 1.52% 1.46% C/I Ratio 40% 41% 40% 40% 39% Source: Company data Yield on Avg Advances and Investments 11.4% 10.7% 10.7% 10.8% 10.9% We evaluate Tier 1 Capital Ratio for comparison instead of Total Capital Ratio Cost of Average Deposits and Borrowings 7.6% 6.8% 6.5% 6.7% 7.0% (CRAR) since the regulator emphasises on the former and there is a separate minimum level for the same. Net Interest Margin 3.8% 4.1% 4.4% 4.4% 4.4% Return on Average Assets 1.50% 1.51% 1.69% 1.72% 1.82% Higher Tier 1 Capital Ratio of 15.4% for CUB compared with 8.7-12.5% for key Return on Average Equity 15.5% 15.2% 16.6% 16.8% 16.3% peers implies lower dilution of existing shareholders going forward, ceteris paribus, Source: Company data, Edelweiss Investment Research compared with those for key peers.
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City Union Bank Ltd.
P/B vs RoE—CUB versus expanded set of private sector peers Valuation 3.6 3.5 4.0 3.4 3.2 27% 2.3 2.2 2.2 We use the Residual Income Valuation Model to value CUB. We assume a 1.8 1.7 1.6 1.5 1.4 18% 2.0 1.1 1.0 long-term risk-free rate of 7% for India, a Beta of 1.05 for CUB and an India 9%
Equity Risk Premium of 6% and arrive at an overall Cost of Equity of 13.3% for 0.0 0%
CUB. We arrive at a price target of INR220, at which the stock will trade at 2.7x
FY19E book value.
Bank
Bank
Yes Bank Yes
RBL Bank RBL Bank
Bank Axis
DCB Bank DCB
IDFC Bank IDFC
ICICIBank
Bank
HDFC Bank HDFC Karur VysyaKarur
Valuation metrics Indian South
Lakshmi Lakshmi Vilas
Federal Bank Federal
IndusindBank City Union Union City Bank
FY16 FY17 FY18E FY19E FY20E Kotak Mahindra Basic EPS 7.4 8.4 10.7 12.5 15.0 P/B (FY19E) Avg RoE (FY17-19E) EPS growth 9% 13% 27% 17% 20% Source: Edelweiss Investment Research, Bloomberg P/E 23.8 21.0 16.6 14.2 11.8
Book value per share 51 60 69 80 104 We note that that all banks in our expanded universe which have an RoE of 14% P/B 3.5 3.0 2.6 2.2 1.7 or higher, trade at a P/B of 3.2-3.6x except for City Union Bank, Yes Bank and Return on Average Equity 15.5% 15.2% 16.6% 16.8% 16.3% Lakshmi Vilas Bank, which trade at 2.2x, 2.3x and 1.6x, respectively. We examine Source: Company data, Edelweiss Investment Research RoA and implied Financial Leverage to get a clearer picture.
At CMP, CUB trades at P/B of 2.2x FY19E book, which we believe is attractive The (P/B, RoA) pair also indicates undervaluation for CUB given FY18E-20E RoE of 16-17%. Consequently, we believe the multiple of 2.7x implied by our price target of INR 220 is reasonable. Since the average FY17-19E RoE is a period average, its value as a proxy for sustainable long-term RoE is not necessarily all-encompassing. Hence, it is The stock trades at P/E of 11.8x FY18E EPS for FY17-20E EPS CAGR of 21%. necessary to look at RoA, which indicates a bank’s underlying ability to sweat its Hence, we conclude that CUB is attractive from P/E basis as well. assets to generate bottomline. When RoE is viewed in conjunction with RoA, we get a better sense of the sustainability of the former, since an RoE achieved with Is CUB a multiple re-rating candidate? We believe so high financial leverage indicates higher generic balance sheet risk and concomitantly lower sustainability of RoE. We carry out a multi-layered analysis to understand whether CUB deserves a re-rating and find that a valuation gap exists between CUB’s FY19E P/B multiple and what it should logically trade at. P/B vs RoA—CUB versus expanded set of private sector peers 3.6 3.5 4.0 3.4 3.2 2.7% 2.3 2.2 2.2 The (P/B, RoE) pair indicates undervaluation for CUB 1.8 1.7 1.6 1.5 1.4 1.8% 2.0 1.1 1.0 The (P/B, RoE) pair encapsulates all aspects of a bank’s internals and, 0.9%
theoretically, is sufficient to judge the bank’s valuation as long as the P/B is 0.0 0.0%
…
calculated accurately and the RoE represents the accurate structural and
sustainable long-term RoE (the long-term growth rate of the “book” in the P/B
Kotak Kotak
Bank
Bank
Bank
Yes Bank Yes
RBL Bank RBL Bank
ratio). Bank Axis
Mahindra
DCB Bank DCB
City Union Union City
IDFC Bank IDFC
ICICIBank
HDFC Bank HDFC
Karur VysyaKarur South Indian South
Lakshmi Vilas Federal Bank Federal We use the average FY17-19E RoE as a proxy for the sustainable long-term IndusindBank P/B (FY19E) Avg RoA (FY17-19E) RoE for a bank and then compare the P/B multiples for a relevant private Source: Edelweiss Investment Research, Bloomberg sector banks’ universe.
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City Union Bank Ltd.
We note that all banks in our universe which have an RoA of 1.6% of higher, P/AB+ (with incremental adjustment for unrecognized loan book stress) trade at a P/B of 3.2-3.6x except for City Union Bank and Yes Bank. Lakshmi indicates undervaluation for CUB Vilas falls significantly short of this RoA threshold with an RoA of 0.9% implying a high Financial Leverage of 16.2x calling into question the sustainability of its RoE While the total stress recognized, measured as the sum of NNPA and Standard of 15%. As for Yes Bank, it is unique in the banking universe as far as trading at Restructured Assets, is a reasonable measure of the quality of underwriting its valuation for its return metrics. This has mostly to do with, among private standards, we must also provide for unrecognized stress. We do this by looking largecaps, (a) the highest exposure to large corporate loans as a percentage at the credit exposures to two key stressed sector viz. Metals and Infra. of loan book (68%) (b) high exposure to Infra and Metals sectors (c.12% of H1FY17 credit) (c) the widest divergence with RBI with regard to NPA P/AB+ vs RoE—CUB versus expanded set of private sector peers recognition. 5.0 28% 3.9 3.7 3.5 3.4 4.0 21% While Financial Leverage captures the overall potential generic balance sheet 2.5 2.5 2.4 3.0 2.3 2.3 2.0 risk but to provide further colour on balance sheet risk, one needs to adjust for 2.0 2.0 14% 2.0 1.5 1.4 the quality of underwriting standards of banks. 1.0 7%
0.0 0%
…
P/AB vs RoE—CUB versus expanded set of private sector peers
3.8 3.6
4.0 3.4 3.3 28%
Kotak Kotak
Bank
Bank
Bank
Yes Bank Yes RBL Bank RBL 2.4 2.4 Bank
3.0 2.3 21% Bank Axis Mahindra
2.1 2.1 Bank DCB
City Union Union City IDFC Bank IDFC
1.9 1.9 1.8 ICICIBank
HDFC Bank HDFC Karur VysyaKarur
2.0 1.3 1.2 14% Indian South
Lakshmi Lakshmi Vilas Federal Bank Federal 1.0 7% IndusindBank
0.0 0% P/AB+ (FY19E) Avg RoE (FY17-19E)
Source: Edelweiss Investment Research, Bloomberg
Yes Bank Yes
RBL Bank RBL
Axis Bank Axis
DCB Bank DCB
IDFC Bank IDFC
ICICIBank Bank
HDFC Bank HDFC We adjust the book value further by 10% of Metals credit exposure and 5% of Federal Bank Federal
IndusindBank Infra credit exposure and designate the same Adjusted Book Value+ (or AB+).
City Union Union City Bank
Kotak Kotak Mahindra Karur VysyaKarur Bank
South Indian South Bank We understand the limitation of this exercise as headline Metals exposure Lakshmi Lakshmi VilasBank P/AB (FY19E) Avg RoE (FY17-19E) across banks may not be similar but this is done as best approximation. We treat this as possible incremental recognition that is not currently part of recognized Source: Edelweiss Investment Research, Bloomberg stress and, to that extent, there is no overlap. The adjustment for the quality of underwriting standards is achieved by adjusting the book balue for Net NPA and Standard Restructured Assets book. The P/AB+ is the valuation mutiple of the respective bank having adjusted for We adjust for 100% of Net NPA (since Net NPA has not been provided for) and recognized and certain unrecognized stress. We note that that all banks in our 25% of Standard Restructured Assets. expanded universe which have an RoE of 14% or higher, trade at a P/AB+ of 3.4-3.9x except for City Union Bank, Yes Bank and Lakshmi Vilas Bank, which We note that that all banks in our expanded universe which have an RoE of trade at 2.5x, 2.5x and 2.4x, respectively. Given that Lakshmi Vilas Bank’s 14% or higher, trade at a P/AB of 2.4-3.8x except for City Union Bank, Yes Bank implied financial leverage of 16.2x is prohibitively high and Yes Bank has and Lakshmi Vilas Bank, which trade at 2.4x, 2.4x and 2.1x, respectively. We idiosyncratic issues, we find that CUB is the most undervalued bank in our note again that the analysis here does not account for the risk of high financial choice set on the basis of the our comprehensive set of valuation metrics as leverage whereas an RoA-only analysis would have ignored the greater laid out in our extended analysis above. significance of RoE, the direct driver of shareholder value.
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City Union Bank Ltd.
Financials Income Statement (INR cr) Balance Sheet (INR cr) Year to March FY16 FY17 FY18E FY19E FY20E As on 31st March FY16 FY17 FY18E FY19E FY20E Interest income 2,944 3,174 3,604 4,232 5,067 CAPITAL AND LIABILITIES Interest charges 1,963 1,975 2,151 2,531 3,058 Share Capital 60 60 60 60 63 Net interest income 981 1,199 1,452 1,701 2,008 Reserves and Surplus 2,992 3,510 4,068 4,735 6,479 Other income 410 484 542 608 702 Deposits 27,158 30,116 34,550 40,212 46,567 Net revenues 1,391 1,683 1,994 2,309 2,710 Borrowings 113 531 531 531 531 Operating expense 558 689 795 929 1,056 Other Liabilities & Provisions 929 1,054 1,054 1,054 1,054 - Em ployee exp 214 299 359 430 495 Total 31,252 35,271 40,263 46,592 54,694 - Depreciation / am ortisation 52 54 54 62 71 ASSETS - Other opex 291 336 382 436 490 Cash and Balances with RBI 1,363 1,484 1,633 1,796 1,975 Preprovision op. profit 833 994 1,200 1,380 1,654 Balances with Banks & Call Money 1,238 1,395 1,534 1,688 1,856 Provisions 231 301 336 370 408 Investments 6,324 7,031 7,693 8,420 9,220 PBT 603 693 863 1,010 1,246 Advances 21,057 23,833 27,884 33,740 40,488 Taxes 158 190 224 263 324 Fixed Assets 218 215 247 284 327 PAT 445 503 639 748 922 Other Assets 1,053 1,313 1,272 664 827 Extraordinaries 0 0 0 0 0 Total 31,252 35,271 40,263 46,592 54,694 Reported PAT 445 503 639 748 922 Basic number of shares (cr.) 59.8 59.8 59.8 59.8 61.3 RoAE Decomposition Basic EPS (INR) 7.43 8.40 10.68 12.50 15.03 Year to March FY16 FY17 FY18E FY19E FY20E Diluted number of shares (cr.) 61.2 61.2 61.2 61.2 62.7 Net Interest Income / Assets 3.3% 3.6% 3.8% 3.9% 4.0% Diluted EPS (INR) 7.27 8.22 10.44 12.22 14.70 Other Income / Assets 1.4% 1.5% 1.4% 1.4% 1.4% Net Revenues / Assets 4.7% 5.1% 5.3% 5.3% 5.4% Growth Ratios Operating Expense / Assets 1.9% 2.1% 2.1% 2.1% 2.1% Year to March FY16 FY17 FY18E FY19E FY20E Provisions / Assets 0.8% 0.9% 0.9% 0.9% 0.8% NII growth 22% 22% 21% 17% 18% Taxes / Assets 0.5% 0.6% 0.6% 0.6% 0.6% Net Revenues growth 15% 21% 19% 16% 17% Total Costs / Assets 3.2% 3.5% 3.6% 3.6% 3.5% Opex growth 7% 24% 15% 17% 14% Return on Assets 1.5% 1.5% 1.7% 1.7% 1.8% PPOP growth 20% 19% 21% 15% 20% Assets / Equity 10.3 10.0 9.8 9.7 8.9 Provisions growth 26% 31% 12% 10% 10% Return on Average Equity 15.5% 15.2% 16.6% 16.8% 16.3% PAT growth 13% 13% 27% 17% 23% Valuation Metrics Operating Ratios Year to March FY16 FY17 FY18E FY19E FY20E Year to March FY16 FY17 FY18E FY19E FY20E Basic EPS 7.4 8.4 10.7 12.5 15.0 Yield on Average Advances and Investments 11.4% 10.7% 10.7% 10.8% 10.9% EPS growth 9% 13% 27% 17% 20% Cost of Average Deposits and Borrowings 7.6% 6.8% 6.5% 6.7% 7.0% Book value per share 51 60 69 80 104 Spread 3.7% 3.9% 4.2% 4.1% 4.0% Basic P/E 23.8 21.0 16.6 14.2 11.8 Net Interest Margin 3.8% 4.1% 4.4% 4.4% 4.4% Price - to - Book 3.5 3.0 2.6 2.2 1.7 Cost to Income Ratio 40% 41% 40% 40% 39% Tax Rate 26% 27% 26% 26% 26%
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City Union Bank Ltd.
Edelweiss Broking Limited, 1st Floor, Tower 3, Wing B, Kohinoor City Mall, Kohinoor City, Kirol Road, Kurla(W) Board: (91-22) 4272 2200
Vinay Khattar
Head Research
Rating Expected to
Buy appreciate more than 15% over a 12-month period
Hold appreciate between 5-15% over a 12-month period
Reduce Return below 5% over a 12-month period
City Union Bank 5 years price chart
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Disclaimer
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