Initiating Coverage March 24, 2010

Rating Matrix Rating : Strong Buy South Indian (SOUIN0) Target : Rs 200 Target Period : 12-15 months Rs 156 Potential Upside : 28 %

YoY Growth (%) Good thing in small package… FY09 FY10E FY11E FY12E South (SIB) is shedding its regional tag and growing its NII 39.0 24.5 22.3 21.6 pan- reach. The total business of the bank grew at 22% CAGR over PBT 30.1 31.5 19.8 27.0 FY05-09 to Rs 30237 crore. We expect 22% CAGR over FY09-12E to Rs PAT 28.5 27.2 30.3 27.0 54,845 crore. The deposits and advances grew at 22% CAGR over FY07- 09. We expect a growth of 21% and 24% CAGR, respectively, over FY09- Stock Data 12E. The C/D ratio of the bank improved from 51% in FY04 to 72% for Bloomberg Code SIB.IN Q3FY10. We expect it to stabilise around 70% by FY12E. Reuters Code SIBK.BO Low cost deposits, improving C/D ratio to help maintain NIM Face value (Rs) 10 Above 35% of the total bank’s deposit consists of low cost deposits, Market Cap (Rs Crore) 1763 52 week H/L 171 / 48 (~24% CASA and 11% NRI deposits). The interest rates on these deposits Sensex 17451 are comparatively on the lower side at around 3-3.5%. This helps in Average volumes 69000 controlling the cost of deposits. We expect NIMs at 3% until FY12E. \ Substantial improvement in asset quality: A boon Comparative return matrix (%) SIB has now brought down its net NPA to 0.4% from a high of 6.7% and Company 1m 3m 6m 12m SIB 10 8 32 220 GNPA to 1.5% from over 10% in FY02. The total stressed assets (GNPA City Union bk -9 13 16 178 and restructured) at about 2.6% of total loans, with provision coverage of 3 -5 -16 86 73% looks in good shape for SIB. We expect GNPA at 1.6% and NNPA at Indus ind bank 13 26 61 474 0.8% by FY12E after factoring in slippages from restructured loans.

Price movement (Stock vs. Nifty) Higher HTM proportion to cushion investment book from MTM SIB’s bond portfolio is well cushioned in a rising interest rate scenario 200 6000 since 77% of the total investment is in the HTM category, on the one 150 5000 hand, while the remaining AFS portfolio of 23% carries a short duration of 4000 0.6 years. The total investment book duration stands at 4.5 years. We do 100 3000 not expect a major MTM hit on the AFS book. Hence, there will be no 50 2000 material effect on its profitability. 0 1000 Valuations At the CMP of Rs 156, the bank is trading at 0.9x FY12E ABV, which looks Jul-09 Oct-09 Apr-09 Feb-10 Jan-10 Jun-09 Sep-09 Dec-09 Nov-09 Mar-10 Aug-09 attractive. The bank, with a healthy low cost deposit base of around 35%, May-09 NIM of 3%, strong asset quality (2.5% of stressed assets) and CAR of 17% South Indian bank Nifty (RHS) is poised for above industry growth in the coming period. However, it continues to be regional with 55% of the total business contributed by the

southern region. This is a point of concern to us. Assuming sustainable Analyst’s name RoE of 18%, terminal growth of 3% and CoE of 14.5%, we value the bank Kajal Gandhi at 1.2x FY12E ABV of Rs 167 and assign it a fair value of Rs 200. [email protected]

Chirag Shah Exhibit 1: Key Financials [email protected] FY09 FY10E FY11E FY12E Viraj Gandhi Net Profit (Rs crore) 194.7 247.6 322.6 409.8 [email protected] EPS (Rs) 17.2 21.9 28.5 36.3 Growth (%) 2.8 27.2 30.3 27.0 P/E (x) 9.0 7.1 5.4 4.3

Price / Book (x) 1.4 1.2 1.0 0.8 Price / Adj Book (x) 1.5 1.3 1.1 0.9 GNPA (%) 2.2 1.7 1.7 1.6 NNPA (%) 1.1 0.9 0.8 0.8 RoNA (%) 1.0 1.1 1.2 1.3 RoE (%) 16.0 18.0 20.2 21.6 Source: Company, ICICIdirect.com Research

ICICIdirect.com | Equity Research South Indian Bank (SOUIN0)

Company Background Shareholding pattern (Q3FY10) Shareholder Holding (%) South Indian Bank (SIB) is one of the oldest in south India, based Promoters - out of , . The bank has a business mix of Rs 35,511 crore. Institutional investors 51.3 SIB has a dominant presence in Kerala and Tamil Nadu, with ~74% of General public 48.7 total branches and 55% of the business from there. The bank has a pan- India presence with a network of over 573 branches and over 230 ATMs across 23 states and two union territories. FII & DII holding trend (%) Exhibit 2: Branch distribution (region wise) Exhibit 3: Shareholding pattern

50 Rural Metro Others 38 40 18% 16% 19% 40 37 36 Public Mutual 30 35% (%) fund 20 8% 14 14 13 12 Urban 10 23% Q3FY10 Q2FY10 Q1FY10 Q4FY09 Semi FII Urban FII DII 38% 43%

Source: Company, ICICIdirect.com Research Source: Company, ICICIdirect.com Research

Exhibit 4: Branch concentration

High concentration

Source: Company, ICICIdirect.com Research

Key management profile VA Joseph, who took charge of SIB as MD and CEO from June 5, 2005, was instrumental in bringing development and revolution at SIB. He has overall 38 years of experience in the banking industry. The business and quality parameters of SIB like C/D ratio, asset quality, NIM, RoA, RoE all improved considerably. We can attribute this to the new management in place.

ICICIdirect.com | Equity Research Page 2 South Indian Bank (SOUIN0)

Investment Rationale

SIB is shifting its focus from a regional bank to a bank with a pan-India presence. The branch concentration in the south zone provided the bank ~35% of low cost deposits. This helped to control the interest cost and maintain NIM of 3%. The total business of the bank grew at 22% CAGR over FY05-09 to Rs 30,237 crore. We expect it to grow at 22% CAGR over SIB is aiming for a pan-India presence FY09-12E to Rs 54,845 crore. The C/D ratio of the bank improved from 51% in FY04 to 72% for Q3FY10. We expect it to stabilise around 70% by FY12E. The GNPA improved from 6.6% in FY05 to 1.5% in Q3FY10. We expect a GNPA of 1.6% and NNPA of 0.8% in FY12E.

Total business to grow at 18% CAGR over FY09-12E SIB’s total business grew at 22% CAGR over FY05-09 to Rs 30,237 crore. Total business growth of 18% CAGR will support Going forward, we expect 24% and 21% CAGR in advances and deposits 21% growth in the balance sheet size over FY09-12E to Rs 22578 crore and Rs 32267 crore, respectively. This will result in a 22% CAGR in business mix over the same period.

The credit growth in the industry was dismal at around 9.9% during October 2009. It has started to pick up from early January. However, the pace of deposit growth was steady at around 20%. According to latest RBI data, bank credit grew at 15.8% showing early signs of a strong pick- up in industry credit. We expect industry loan growth of 21% and 20%, for FY11E and FY12E, respectively, while we expect deposit growth of 20% and 18%, respectively. We feel that SIB should grow ahead of the industry because of the small base and strategic expansion plans laid by the bank along with comfortable capital adequacy ratio (CAR) of 17.4% (Tier I CAR- 14%) for Q3FY10. We expect above industry business growth for SIB Exhibit 5: Industry loan growth Exhibit 6: Industry deposit growth 50000 40 70000 40 60000 40000 30 50000 30 30000 40000 20 20 20000 30000 20000 10000 10 10 10000 0 0 0 0 FY 07 FY 08 FY 09 FY FY 07 FY 08 FY 09 FY FY10E FY11E FY12E FY10E FY11E FY12E YTDFY10 YTDFY10

Amount (Rs. billion) YOY (%) (RHS) Amount (Rs. billion) YOY (%) (RHS)

Source: RBI, ICICIdirect.com Research Source: RBI, ICICIdirect.com Research

Exhibit 7: Total business growth for SIB

60000 54845 50000 45021

40000 37103 35511 30237

30000 25910 20542 (Rs Crore)

20000 16324 13857 10000

0 FY05 FY06 FY07 FY08 FY09 9MFY10 FY10E FY11E FY12E

Source: Company, ICICIdirect.com Research

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Exhibit 8: Market share of SIB likely to improve marginally

0.51 0.51

0.48 0.48 (%) (%)

0.45 0.45

0.42 0.42 FY 06 FY 07 FY 08 FY 09 FY10E FY11E FY12E YTDFY10 Advances Deposits (RHS)

Source: Company, RBI, ICICIdirect.com Research

…low cost deposits facilitate in controlling cost We expect credit growth of 21% and 20% in FY11E Above 35% of the total bank’s deposit consists of low cost deposits, and FY12E, respectively, for the industry (~24% CASA and 11% NRI deposits). The interest rates on these deposits are comparatively on the lower side of around 3-3.5%. This helps in controlling the cost of deposits and maintaining NIM of ~3%. We expect SIB to report 21% CAGR in deposits over FY09-FY12E to Rs 32,267 crore and CASA of 25%.

We expect stable CASA of around 25% for SIB until Exhibit 9: Deposit base growing well FY12E 35000 @21 % CAGR 32267

30000

@21 % CAGR 26517 25000 22015 20643 20000 18092 (Rs Crore) 15000 15156 12239 9579

10000 8492

5000 FY05 FY06 FY07 FY08 FY09 9MFY10 FY10E FY11E FY12E

Source: Company, ICICIdirect.com Research

SIB is likely to add another 82 branches by FY12E to Branch expansion plan to support deposit growth

take its tally to 655 The deposit base of SIB grew at 21% CAGR over FY05-09 to Rs 18,092 crore. SIB expanded its branch distribution from 430 in FY05 to 573 by Q3FY10. The bank is planning to add another 150 branches by FY13E. We expect the bank to add 82 branches until FY12E from the current 573 levels. These recent additions in branches will enable SIB to grow its deposits at 21% CAGR over FY09-12E to Rs 32267 crore.

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Exhibit 10: Branch expansion plan

800 100 655 615 80 573 575 600 530 475 500 60 430 450 40

49 (Rs Crore) 400 43 36 38 30 34 20 26 20 21 200 0 FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10 Branches Deposit/branch (RHS)

Source: Company, ICICIdirect.com Research

Higher concentration in the southern zone poses The bank is predominantly a south-based player, with major concentration risk to SIB concentration in Kerala and Tamil Nadu. Of the total branches currently, 55% is concentrated in Kerala and 19% in Tamil Nadu. We have seen that CASA accumulation for south-based banks is lower compared to other banks where it ranges between 32% and 33%. Exhibit 11: CASA proportion for south based banks (Q3FY10)

35 30 25 20

(%) 33 15 24 25 22 10 20 19 5 0 SIB Karnatak bank City Union Dhanlaxmi Industry* bank bank

Source: Company, RBI, ICICIdirect.com Research *Industry CASA is for FY09

South zone’s contribution is equal to the northern Exhibit 12: Region wise distribution of CASA in India (Industry) zone in total CASA accumulation in the industry North-East East 2% 14% West 28%

Central 14%

South North 21% 21%

Source: RBI, ICICIdirect.com Research

ICICIdirect.com | Equity Research Page 5 South Indian Bank (SOUIN0)

Exhibit 13: CASA per branch lowest in Kerala South zone is a highly banked region of India resulting in lower CASA per branch especially for 35 Kerala 29 30 Focus area of operation 25 20 20

15 12 12 13 13 (Rs Crore) 10 10

5

0 West North South Central East North-East Kerala

Source: RBI, ICICIdirect.com Research

Exhibit 14: Contribution from Kerala and Tamil Nadu in total business of SIB

60 54 53 51 50 40 The share of Kerala and Tamil Nadu combined in 33 33 33 33 32 32 total business is likely to drift from current levels of 30 (%) 45% owing to branch expansion plans of SIB outside 20 12 the south zone 11 12 10 0 Deposits Advance Deposits Advance Deposits Advance

Mar-08 Mar-09 Dec-09

Kerala Tamil Nadu

Source: Company, ICICIdirect.com Research

The share of Kerala in the total business of the bank is declining from 45% in FY08 to 42% by 9MFY10. The management is aiming to curtail it to 35% by FY13E. With branch expansion outside southern states, we expect the share of these states to moderate from current levels.

NRE deposits: Hidden CASA

SIB has benefited by operating in Kerala in the form of access to low cost NRE deposits, in addition to CASA deposits, enabling to contain its cost of deposits and, thus, supporting NIM. The cost of these deposits ranges around 3-3.5%. The proportion of NRE deposits in total deposits for SIB has reduced in the past two years from over 20% in FY08 to 17% by Q3FY10 on account of higher growth in bulk deposits to support loan growth. We expect the share of low cost deposits (CASA + NRE deposits) to remain stable around 35% until FY12E. The recent addition of new branches is likely to contribute significantly to CASA accumulation after FY12E.

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Exhibit 15: Low cost deposits boosting NIM

10000 50

8000 40 8555 8306 8047

6000 7727 7196 7048 6951 30 (%) 4000 (Rs Crore) 20 2000

0 10 Jun-09 Jun-08 Sep-09 Sep-08 Dec-09 Dec-08 Mar-09

CASA + NRI deposits % of Total deposits(RHS)

Source: Company, ICICIdirect.com Research

We do not expect a sharp drop in NRE deposits for Of the total deposit of Rs 20,643 crore in 9MFY10, CASA constitutes SIB from current levels ~24% and 11% of NRE deposits as low interest bearing deposits. The NRE deposit base stands at Rs 3,556 crore. Of this, the FCNR account constitutes Rs 1,600 crore where RBI pegs interest rates. Lately, the growth in NRE deposits has moderated because of slowdown in Middle East countries. However, we expect the CASA growth to stem sliding NRE deposit growth. We, thus, expect low cost deposits to stay at current levels of 35% until FY12E.

Trend in remittance inflow into India Remittances form a major share of the current account in the balance of payments owing to a large number of Indians who are working abroad and repatriating income mainly for family maintenance. India today is the highest receiver of remittances according to the World Bank's Migration and Development Brief. Remittances to India increased from US$28 billion in 2006 to US$52 billion in 2008. However, it declined to US$47 billion in 2009 owing to the economic recession. With the global economic scenario improving, remittances would rise continuing the trend. South Indian Bank would benefit from such an increase due to its stronghold in southern India. It is the largest recipient of remittance income in India.

SIB to benefit from remittance income owing to high Exhibit 16: SIB to benefit from growing remittances in India southern concentration 60 52 50 47

40 37

28 30 22 USD (bn)

20 14

10

0 2001 2005 2006 2007 2008 2009(est.)

Source: RBI, ICICIdirect.com Research

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Loan book growth strong, retail portfolio constitutes ~50% The loan book of SIB grew at 23% CAGR over FY05-09 from Rs 5,365 crore to Rs 12,145 crore. We believe the industry is set for an uptrend in credit growth. The credit growth was dismal @9.9% in Q3FY10. This accelerated to 15.8% in the fortnight ended February 26. We expect credit growth in the industry at 21% and 20% in FY11E and FY12E, respectively. With comfortable CAR of 17.4% and a relatively small loan base, SIB should grow ahead of the industry during our investment horizon. Therefore, we expect 24% CAGR over FY09-FY12E to Rs 22578 crore.

SIB is adequately capitalised for near term growth Exhibit 17: Loan book grows at 23% CAGR

25000 40

20000 30 22578 15000 18505 20 (%) 15088

10000 14868 (Rs Crore)

12145 10 5000 10754 8303 6745 0 5365 0 FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10 Advance YoY Growth (RHS)

Source: Company, ICICIdirect.com Research

Gold loan forms 32% of total retail loans i.e. 16% of The loan book of SIB is tilted towards retail loans, which constitutes total loan book as of Q3FY10 nearly 50% of total loans by 9MFY10. Despite such higher retail portfolio, the bank managed to improve its asset quality over the years, reflecting better credit assessment of the bank. We expect the share of retail portfolio to stay at 49-50% until FY12E. Of the retail portfolio, nearly 32% comes from gold loans (~16% of total loan book) where yields are comparatively higher allowing SIB to maintain higher yield on advances of ~11%.

Exhibit 18: Components of loan book

52 50 48 50 51 51 50

(%) 10 12 12 14 10 11 10 15 15 15 14 15 16 14 10 11 9 10 10 10 9 13 14 14 14 15 16 16

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10

Agri SME Corporate Housing Others including retail

Source: Company, ICICIdirect.com Research

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C/D ratio shifting gears and improving NIM The C/D ratio of the bank was around 51% during FY04 and started to gain momentum from FY05. In the past five years, the C/D ratio stabilised around 65-66% and improved to 72% in 9MFY10. We expect credit growth to pick up with growth in loan demand in the industry. However, recent branch additions will result in a growth in the deposit base. Thus, the C/D ratio is likely to stabilise around 70%. The C/D ratio of SIB was dismal at 51% in FY04. It Exhibit 19: C/D ratio to stabilise around 68% improved to 72% in 9MFY10 and we expect it to stabilise at 70% until FY12E 75 72 70 69 69 70 70 67 65 66 65 63 60 55 (%) 55 53 51 50 45 40 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10

Source: Company, ICICIdirect.com Research

We expect industry C/D ratio of 72% in the next Exhibit 20: Industry C/D ratio likely to stay stable couple of years 75 74 74 74 73 72 72 72 72 72 72 71 (%) 71 70 69 68 FY 06 FY 07 FY 08 FY 09 FY10E FY11E FY12E YTDFY10

Source: RBI, ICICIdirect.com Research

The new management in place from FY05 started to focus on growing the core business operations. On account of this, the C/D ratio of the bank improved. The reliance on treasury gains reduced drastically and NII growth started to pick up. The net interest income accelerated at 21% CAGR during 2004-2009. We expect 23% CAGR over FY09-12E to Rs 968 crore.

SIB was heavily dependent on treasury gains, which contributed over 40% to the net total income in FY04. The C/D ratio in FY04 was dismal at 51%. It gathered momentum and stabilised around 68% after that. We expect the quality of earnings to improve further and estimate the share of interest on advances in total interest income to rise to 80% by FY12E from 71% in FY07.

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Exhibit 21: Income from advances to improve Exhibit 22: Treasury gains to net total income 90 50 79 80 77 40 80 74 75 71 30 (%)

70 (%) 20

60 10

FY07 FY08 FY09 0 FY10E FY11E FY12E

-10 FY02 FY03 FY04 FY07 FY08 FY09 Interest on advances to total int income FY10E FY11E FY12E

Source: Company, ICICIdirect.com Research Source: Company, ICICIdirect.com Research

Core interest income contribution to total interest Interest rates are likely to move northwards again. This will result in income is gradually rising. This looks quite healthy higher yield on advances. However, rising deposit cost will result in NIM for SIB being maintained at current levels. We, therefore, expect the NIM to stay stable at 3% levels until FY12E.

Exhibit 23: Stable NIM

16.0 3.5 3.2 3.1 3.1 3.0 3.0 3.0 3.0 12.0 2.8 2.9 2.5 2.5 8.0 (%) 2.0 (%) 4.0 1.5

0.0 1.0 FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10

YoA CoD NIM

Source: Company, ICICIdirect.com Research

Lately we have seen steady growth in industrial production. The latest reported figure shows 16.7% YoY growth for January. This suggests that demand for credit (both working capital and term loans) will pick up coupled with a revival in industrial capex. Improving credit demand and rising interest rates should help SIB to protect its NIM at 3% until FY12E.

Strong IIP number and economic recovery expected Exhibit 24: IIP trend positive Exhibit 25: Credit growth picking up to push credit growth in the coming fiscal 20 17.6 50000 40 16.7 40000 15 (%) 30 11 11.7 30000 9.6 10.3 8.3 20 10 7.2 20000 (%) 10 5 10000 0 0 0 FY 07 FY 08 FY 09 FY FY10E FY11E FY12E YTDFY10 Jul-09 Oct-09 Jan-10 Jun-09 Sep-09 Dec-09 Nov-09 Aug-09 Amount (Rs. billion) YOY (%)

Source: Industry, ICICIdirect.com Research Source: RBI, ICICIdirect.com Research

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Improving asset quality: A boon SIB has been able to improve its asset quality over the past few years through cautious loan book growth, better recoveries and lower delinquencies. SIB brought down its net NPA to 0.4% from a high of 6.7% and GNPA to 1.5% from over 10% in FY02.

The total stressed assets (GNPA and restructured) at about 2.6% of total loans, with provision coverage of over 73% looks in good shape for SIB. We estimate GNPA at 1.6% and NNPA at 0.8% by FY12E. Strong asset quality and low stressed assets to Exhibit 26: NPAs to rise marginally from current level bode well for SIB 400 366 363 328 321 307 300 261 261 204 214 188 175 200 153 118 134 137

(Rs Crore) 78 57 100 34 0 FY05 FY06 FY07 FY08 FY09 9MFY10 FY10E FY11E FY12E

GNPA NNPA

Source: Company, ICICIdirect.com Research

Exhibit 27: Improvement in asset quality 12

10

8 3.8

6 1.9 (%) 1.0 4 6.6 1.1 5.0 0.9 0.8 0.8 2 3.9 0.3 0.4 1.8 2.2 1.5 1.7 1.7 1.6 0 FY05 FY06 FY07 FY08 FY09 9MFY10 FY10E FY11E FY12E

GNPA NNPA

Source: Company, ICICIdirect.com Research

SIB has lowest stressed assets among Exhibit 28: Stressed asset: Comparative matrix (Q3FY10) comparatives 8 7.2 7.3 5.7 6.1 5.2 5.5 6 4.7 4.4 4.5 4 3.0

(%) 2.6 2.7 1.5 1.7 1.8 2 1.1 1.3 0.9

0 SIB Federal bank Corporation Allhabad bank bank

GNPA Restructured assets Total stressed

Source: Company, ICICIdirect.com Research

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Higher HTM proportion to cushion investment book from MTM hit G-sec yields are expected to harden in a rising interest rate scenario. SIB is well placed in such an environment since 77% of the total investment portfolio of Rs 5,838 crore is held in the HTM category, 23% in the AFS category (Rs 1335 crore), with a duration of 0.58 years, and very little in the HFT category. The total investment book duration stands at 4.5 years. Exhibit 29: Distribution of investment book

HFT, 25, 0% AFS, 1335, 23%

(Rs Crore)

HTM, 4478, 77%

Source: Company, ICICIdirect.com Research HTM- Held till maturity, AFS- Available for sale, HFT- Held for trading

Because of a rise in G sec yields from current levels to 8.5%, we estimate SIB will have to provide Rs 7.8 crore of MTM hit on its AFS portfolio. This will affect the bottom-line to that effect. Bond portfolio is well placed in a rising interest rate Exhibit 30: Sensitivity analysis of rising G sec yields scenario Estimated MTM hit for rise in G sec yields by Rs Crore HTM AFS AFS duration (yrs) 50 bps 75 bps 100 bps 9MFY10 4495 1343 0.6 3.9 5.8 7.8 Pre tax impact on PAT FY10E 248 1.6% 2.4% 3.1% PAT FY11E 323 1.2% 1.8% 2.4% FY12E 410 1.0% 1.4% 1.9% Source: Company, ICICIdirect.com Research

Driven by rising food prices India's annual rate of inflation, based on the WPI, rose 9.89% in February YoY against 8.56% in the previous month. We saw inflation rising, resulting in a spike in yields mostly in the long duration (10 years) bond portfolio. The average duration of the SIB investment portfolio is 4.5 years. The movement in five-year yields is not expected to move so drastically as the 10-year bond. Exhibit 31: Movement in G sec yields 9 8.0 8 7.3 7.3 7 7.0 (%) 6

5 5.2 5.1 4 5-Feb 6-Jan 1-Dec 7-Dec 1-Mar 7-Mar 11-Feb 17-Feb 23-Feb 12-Jan 18-Jan 24-Jan 30-Jan 13-Dec 19-Dec 25-Dec 31-Dec 13-Mar 1 Year 5 Year 10 Year

Source: Reuters, ICICIdirect.com Research

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Financials

Net interest income to grow at 24% CAGR The new management, which took charge of SIB in FY06, focused on higher business growth and aimed to reduce dependency on treasury gains. The higher business growth led to strong NII growth of 19% CAGR over FY07-09 to Rs 523 crore. We expect above industry business growth for SIB. This will result in 23% CAGR over FY09-12E to Rs 968 crore.

Healthy NII growth to support NIM at 3% Exhibit 32: Higher than industry business growth to support NII growth

1200

968 1000 796 800 651 600 523 (Rs Crore) 489 368 376 400

200 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10

Source: Company, ICICIdirect.com Research

Core fee-based income to drive non-interest income We expect the growth in non-interest income to moderate from 26% CAGR over FY07-09 at Rs 164 crore to 17% CAGR over FY09-12E to Rs 266 crore owing to lower treasury gains and comparatively higher growth in fee based income.

Exhibit 33: Non-interest income growth to be in line with business growth

300 266 250 224 194 200 164 165 143 150 103 (Rs Crore) 100

50

0 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10

Source: Company, ICICIdirect.com Research

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Exhibit 34: Break-up of non interest income

80

60 18 17 5 40 18 18 6

(Rs Crore) 21 22 17 7 6 37 20 26 5 4 13 7 15 10 5 2 7 8 9 8 6 8 0 4 Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10

CEB Treasury Forex Others

Source: Company, ICICIdirect.com Research

We expect SIB to add over 600 employees by FY12E Employee cost and efficiency The cost ratio of SIB improved from 57% in FY06 to 45% in 9MFY10. However, it is still higher than peers are currently. We do not expect it to fall drastically from current levels owing to the recent branch expansion put into operation by the bank. We expect the cost to income ratio to stabilise around 44% by FY12E.

Exhibit 35: Cost to income ratio likely to stabilise around 44% by FY12E

48 48 46 6000 45 44 44 50 5500 5000

5502 40

4500 5197 4900 4000 4893 4523

3500 4223 30 (%) Nos. 3000 2500 20 2000 1500 1000 10 FY08 FY09 9MFY10 FY10E FY11E FY12E

Employee Cost to income ratio (RHS)

Source: Company, ICICIdirect.com Research

The investment made by the bank in human capital and technology (CBS implementation) is yielding dividends. The business per employee and branch is on the rise. We expect a further improvement on both fronts.

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Exhibit 36: Efficiency parameters to improve further in tandem with growth in business activity

12 120 10 90 8 6 60

(Rs crore) 4 (Rs crore) 30 2 0 0 FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10

Business/Employee Business/ branch (RHS)

Source: Company, ICICIdirect.com Research

CAGR of 28% in PAT over FY09-12E to improve the PAT estimated at 28% CAGR over FY09-12E return ratio for SIB The pick-up in business activity coupled with stable NIM and cost ratio will boost PAT growth in the coming period. The PAT, which grew at 37% CAGR over FY07-09, is estimated at 28% CAGR over FY09-12E to Rs 410 crore. The pick-up in PAT will drive return ratios. RoE, which improved from 1.9% in FY05 to 17.4% by Q3FY10, is expected to be around 22% by FY12E. Similarly, RoA is expected at ~1.3% for FY12E.

Exhibit 37: Return ratios to improve further

1.4 21.4 22 25 20 1.2 17 18 1.3 20 1.0 14 15 1.2 13 1.2 1.1 15 0.8 1.0 0.9 0.9 (%) 8 (%) 0.6 0.8 10 0.4 1.9 0.5 5 0.2 0.0 0 0.1 FY04 FY05 FY06 FY07 FY08 FY09 FY10E FY11E FY12E 9MFY10

RoA RoE (RHS)

Source: Company, ICICIdirect.com Research

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Risks & concerns

Concentration risk The share of Kerala in the total business of the bank was 42% by 9MFY10. The management is aiming to curtail it to 35% by FY13E. Hence, it is vulnerable to region specific risk.

Delay in expansion plan The management is confident of growing its pan-India reach. We have assigned a valuation multiple on its growing pan India reach. Any delay in plan will affect our future growth projections and bottomline to that effect.

Sluggish loan growth in industry We have estimated a revival in growth of credit demand in the industry from FY11E. Any disappointment in credit growth for the industry will affect SIB to that extent.

Deterioration of asset quality SIB currently has one of the lowest stressed assets among peers with 2.6% (GNPA 1.5% and 1.1% of restructured assets). The bank has high contribution of the retail portfolio that could lead to higher slippage and rise in NPA in case of prolonged slowdown in economy.

ICICIdirect.com | Equity Research Page 16 South Indian Bank (SOUIN0)

Valuations At the CMP of Rs 156, the bank is trading at 0.9x FY12E ABV, which looks attractive. The bank, with a healthy low cost deposit base of around 35%, NIM of 3%, strong asset quality (2.5% of stressed assets) and CAR of 17% is poised for above industry growth in the coming period.

South Indian Bank has always traded at a discount to most of its peers historically because of regional concentration, poor asset quality and higher dependency on treasury gains. The new management has concentrated on higher business growth. This has improved the C/D ratio of SIB from a dismal 50% in FY04 to 72% by 9MFY10. A stable C/D ratio and rich low cost deposit enabled it to maintain its NIM of 3%.

Going forward, we expect the bank to grow its balance sheet at 21% CAGR over FY09-12E to Rs 35,832 crore. We have modelled in 24% and 21% CAGR in advances and deposits to Rs 22578 crore and Rs 32267 crore, respectively. We anticipate [email protected]%and [email protected]% for FY12E. With an RoE of above 20% and RoA>1% the stock is trading at a compelling valuation.

The parameters that traditionally warranted discount Whereas the bank has already improved on most parameters like NPA, in valuation multiple for SIB have improved NIM and management, it continues to be regional with 55-60% of the total drastically and warrant higher P/ABV multiple, which business contributed by the southern region. This is a point of concern for we are assigning us. Assuming sustainable RoE of 18%, terminal growth of 3% and CoE of 14.5%, we value the bank at 1.2x FY12E ABV of Rs 167 and assign it a fair value of Rs 200.

Exhibit 38: P/ABV band 200

150

100 Bouncing from 50 trough valuation

0 Jun-09 Jun-08 Jun-07 Jun-06 Sep-09 Sep-08 Sep-07 Sep-06 Dec-09 Dec-08 Dec-07 Dec-06 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06

Price 1.5x 1.3x 1.1x 0.9x 0.7x

Source: Company, ICICIdirect.com Research

SIB has always traded at a discount to most peers Exhibit 39: Peer P/ABV : A comparative matrix 3.0 2.5 2.0

(x) 1.5 1.0 0.5 0.0 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 May-05 May-06 May-07 May-08 May-09

Federal bank Karur Vyasa bank SIB

Source: Company, ICICIdirect.com Research

ICICIdirect.com | Equity Research Page 17 South Indian Bank (SOUIN0)

Exhibit 40: Ratios FY09 FY10E FY11E FY12E Valuation No. of Equity Shares 11.3 11.3 11.3 11.3 EPS (Rs.) 17.2 21.9 28.5 36.3 BV (Rs.) 113.8 129.8 152.5 182.9 BV-ADJ (Rs.) 101.9 117.7 139.0 167.5 P/E 9.1 7.1 5.5 4.3 P/BV 1.4 1.2 1.0 0.9 P/ABV 1.5 1.3 1.1 0.9 DPS (Rs.) 3.0 5.0 5.0 5.0

Yields & Margins (%) Yield on avg int earning assets 9.2 8.8 9.1 9.3 Avg. cost on funds 6.9 6.2 6.4 6.7 Net Interest Margins 2.9 3.0 3.0 3.0 Avg. Cost of Deposits 6.3 6.1 6.4 6.6 Yield on average advances 10.7 11.0 11.3 11.5

Profitabilty (%) Interest income/ total avg. assets 9.0 8.5 8.8 9.1 Net interest income/ total income 28.2 30.9 30.6 30.0 Non-interest income/ total income 8.9 9.2 8.6 8.2 Non-interest income/ avg. assets 0.9 0.9 0.8 0.8 Trading gains/ total income 5.2 4.5 3.9 4.7 Non-interest income/ total net income 23.9 23.0 21.9 21.5

Quality and Efficiency (%) Credit/Deposit ratio 65.5 68.5 69.8 70.0 GNPA 2.2 1.7 1.7 1.6 NNPA 1.1 0.9 0.8 0.8 RONW 16.0 18.0 20.2 21.6 ROA 1.0 1.1 1.2 1.3 Source: Company, ICICIdirect.com Research

Exhibit 41: RoE decomposition FY09 FY10E FY11E FY12E Net interest income/ avg. total assets 2.8 2.9 2.9 3.0 Non-interest income/ avg. total assets 0.9 0.9 0.8 0.8 Non-operating profit/ avg. total assets 3.7 3.8 3.8 3.8 Operating expenses/ avg. total assets 1.8 1.7 1.7 1.7 Operating profit/ avg. total assets 1.9 2.0 2.1 2.1 Provisions/ Avg. total assets 0.3 0.3 0.3 0.3 Return on Avg. assets 1.0 1.1 1.2 1.3 Leverage (Avg assets/ Avg equity) (x) 15.4 16.4 17.0 17.2 Return on equity 16.0 18.0 20.2 21.6 Source: Company, ICICIdirect.com Research

ICICIdirect.com | Equity Research Page 18 South Indian Bank (SOUIN0)

Exhibit 42: Profit and loss account Rs Crore FY09 FY10E FY11E FY12E Interest Earned 1686.9 1911.5 2381.0 2963.5 Interest Expended 1164.0 1260.8 1585.3 1995.8 Net Interest Income 522.9 650.7 795.7 967.7 growth (%) 39.0 24.5 22.3 21.6 Non Interest Income 164.3 194.3 223.6 265.6 Net Income 687.2 845.0 1019.2 1233.2 Operating expense 328.5 387.3 451.4 547.0 Gross profit 358.6 457.7 567.8 686.2 Provisions 57.3 61.5 93.4 83.5 Taxes 106.6 148.6 151.8 192.9 Net Profit 194.7 247.6 322.6 409.8 growth (%) 28.5 27.2 30.3 27.0 Source: Company, ICICIdirect.com Research

Exhibit 43: Balance sheet Rs Crore FY09 FY10E FY11E FY12E Liabilities Capital 113 113 113 113 Reserves and Surplus 1191 1373 1629 1973 Networth 1304 1486 1742 2086 Deposits 18092 22015 26517 32267 Borrowings 257 291 338 455 Other Liabilities & Provisions 730 851 951 1024 Total 20384 24643 29548 35832

Assets Fixed Assets 136 166 197 230 Investments 6075 6393 7924 9819 Advances 11852 15088 18505 22578 Other Assets 284 805 515 507 Cash with RBI & call money 1038 1049 1098 1199 Total 20384 24643 29548 35832 Source: Company, ICICIdirect.com Research

ICICIdirect.com | Equity Research Page 19 South Indian Bank (SOUIN0)

RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Add, Reduce, 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: 20% or more; Buy: Between 10% and 20%; Add: Up to 10%; Reduce: Up to -10% Sell: -10% or more;

Pankaj Pandey Head – Research [email protected]

ICICIdirect.com Research Desk, ICICI Securities Limited, 7th Floor, Akruti Centre Point, MIDC Main Road, Marol Naka, Andheri (East) Mumbai – 400 093

[email protected]

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