DCB Sector: Bank/Small cap

Initiating Coverage 29 January 2014

Sensex Nifty 17 February 2014 Price: INR 52 Target Price: INR 68 BUY 20,648 6,121

Background : DCB Bank Limited (formerly Development Credit Bank Limited) is the smallest listed private sector lender with a total asset base of INR

~120bn as of 3QFY14. DCB has a deposit base of INR 95.91bn and advances of INR 73.61bn at the end 3QFY14, making it the smallest bank in the listed private sector space, including both new and old generation private sector . Promoter group the Aga Khan Fund for Economic Development (AKFED) & Platinum Jubilee Investments Ltd holds ~19% stake. DCB services entails, corporate banking - 24%, SME -19%, Agriculture – 12%, – 40%. As on 3QFY14, the bank had a network of 115 branches, with ~58% of branches in the western region.

52 Week High/Low 60.55/38.05 Focus on SME, Mortgage to lead to sustainable loan growth Bloomberg code DEVB IN Core strategy to drive growth Reuters code DCBA BO Issued Equity DCB’s core strategy to focus on SME, as well as Mortgage, would help it build a well balanced loan 250.0 book, given mortgage loans relatively longer tenure and higher yields in SME segment, whereas branch (shares in mn) Mkt. Cap in mn INR 13,120 expansion into tier II to tier VI and unbanked areas should shore up retail deposits, thereby helping Mkt. Cap in mn USD $ 212.987 DCB sustain healthy NIM at 3.3% (by FY16E). Further, a) Asset-Liability management, by lending to Avg. Daily Vol. (‘000) 1127.33 SMEs, through retail term deposits (b) receding asset quality worries (GNPA at 2.77% at the end Avg. Daily Vol. (mn) INR 58.6/$0.94 3QFY14), c) lower provisioning requirement in conjunction with improving asset quality d) adequate capital (CAR at 12.86% end 3QFY14) are the positive aspects for DCB. Core income, effective cost control to aid profitability Shareholding Dec 13 Sep13 Dec 12 Sep12 DCB’s earnings is estimated to grow at ~22%CAGR over FY13-FY16E, on the back of stable growth in Promoters(%) 18.46 18.46 18.48 19.20 core income (~25%CAGR FY13-FY16E); driven by healthy business growth of ~22%CAGR over FY13- FII (%) 11.91 11.37 11.09 167.64E. Other income is estimated to improve as DCB’s increased focus on SME segment /cross-selling of DII (%) 15.04 14.06 12.99 products,14.46 should aid fee income growth, thus giving a fillip to operating income. Moreover, improvement Others (%) 54.59 56.11 57.44 in 58.7 cost efficiency (cost/income at 57% by FY16E), given, DCB’s branch expansion in tier II to tier VI Pledge (% of areas, where operating expenses are relatively lower, should help reduce costs and improve operating promoter 0.00 0.00 0.00 leverage.0.00 holding) Return ratios to improve steadily

DCB’s RoA is estimated to improve to 1.1% by FY15E, led by steady growth in earnings. With Performance% 1M 3M 6M improvement in ROA and adequate capital, the RoE is estimated to inch higher to ~13.2% by FY15E, DCB - 6.92 5.50 6.69 as the bank leverages its capital. However, with tax benefit likely to expire by 3QFY15, the ROE should Sensex - 2.41 0.55 2.89 moderate at ~13% by FY16E and thereafter, improve steadily. Valuation The stock trades at 0.9X FY16E P/BV and 7.0X P/E FY16E. Healthy business growth, stable NIM, 70 140 improving asset quality and steady earnings growth should complement return ratios. We arrive at a target price of INR 68/share, using two stage gordon growth model, implying a FY16E P/BV of 1.2X and 60 120 FY16 P/E of 9.1X. We rate the stock a BUY. Risks 50 100 Weakness on the asset quality from the SME division and slower than expected increase in loan book

40 80 growth, on the back of economic slowdown could put pressure on its RoA, leading to slower improvement in the ROE. 30 60 Valuation Summary 20 40 Y/E March ( INR mn) FY13 FY14E FY15E FY16E Net Interest Income 2,844 3,301 4,234 5,534 10 20 Other Income 1,170 1,406 1,420 1,750 Pre Provisioning Profit 1,261 1,741 2,318 3,132 0 0

PAT 1,021 1,425 1,655 1,863

13 13 14

13

13 13

13 EPS

- - -

-

- - - 4.1 5.7 6.6 7.5

Jul EPS growth (%)

Jan Jan

Mar Sep

Nov 81.0 39.6 16.1 12.5 May DCB Relative Sensex (RHS) PE 12.7 9.1 7.9 7.0 P /BV * 1.3 1.2 1.0 0.9

Dividend Yield (%) 0.0 0.0 0.0 0.0

GNPA (%) 3.2 3.2 2.9 2.8 NNPA (%) 0.8 0.7 0.6 0.5

Karthikeyan P +91-44-30007344 PCR (calc) 76.0 77.0 81.0 80.0 [email protected] ROA (%) 0.8 0.9 1.1 1.0 ROE (%) 10.2 12.7 13.2 12.9 CAR – Tier I 12.6 12.1 11.6 11.1 ROE/PBV 7.9 11.0 12.7 14.3 * adjusted for uncovered loan losses and intangible assets

Company Overview

DCB Bank is a small private sector bank promoted by Aga Khan Fund for Economic Development (AKFED). Promoter group is represented by Aga Khan Fund for Economic Development (AKFED) & Platinum Jubilee Investments Ltd holds ~19% stake. AKFED is an international development enterprise and operates as a network of affiliates with more than 90 separate project companies employing over 30,000 people. In FY09, DCB saw a sharp spike in its GNPA, primarily due to asset quality problems. The asset quality shock during FY09 and the subsequent restructuring of the balance sheet with increased focus on secured loans helped DCB to comfortably grow its loan book.

Chronology of events

• Incorporation of Masalawala Co-operative Bank Limited and Ismailia Co-operative Bank Limited 1930

• Amalgamation of Masalawala Co-operative Bank and Ismailia Co-operative Bank into Development 1981 credit Bank.

• Acquired scheduled status from RBI. 1988

• Private equity investment by AFKED(Principal promoter) of INR 1.38bn. 2005

• IPO, raised INR 1.86bn through, issue oversubcribed 35 times. 2006

• Raised INR 940 mn through QIP and INR 988mn through Preferential Allotment at INR 47.94/share in 2012 March 2012. DCB raised INR 402mn via PreferentialAllotment at INR 43.68/share in December 2012.

Source Company, CSEC Research

Major non-promoter Shareholders as on Dec, 2013 % Shareholding

Tano Mauritius FVCI II 4.76 WCP Holding III 4.69 Ambit Corporate Finance Pvt. LTd.: 4.21 The South 3.42 Tata Capital 2.63 TVS Shriram Growth Fund India 2.51 Sundaram Mutual Fund –Select Midcap 2.20 HDFC Ltd 1.62 College Retirement Equities Fund 1.61 Satpal Khattar & Shareen Khattar 1.30 ICICI Prudential Life 1.24 Bajaj Allianz Life Insurance 1.12 Dimensional Emerging Market Value Fund 1.15 Source Company, CSEC Research

Key Management Personnel

Murali M. Natrajan – Managing Director & Chief Executive Officer (CEO)

• A Fellow Member of the Institute of Chartered Accountants of India, Mr Natrajan started career with American Express TRS in India where he worked for 5 years in Business Planning, Finance and Operations. In 1989, he joined where he spent 14 years in various disciplines such as Operations, Credit, Finance, Product Management and Business Management of Consumer Banking. Prior to joining Bank in October 2002, he had successful stints as Cards Business Director in , Hong Kong and Indonesia.

Bharat Sampat – Chief Financial Officer (CFO)

• Chartered Accountant and Cost Accountant alongwith a Post Graduate Degree in Law, has over 25 years of experience in senior positions with reputed organizations such as ABN Amro Bank, ANZ , Standard Chartered Bank, Hoechst India and Larsen & Toubro.

Abhijit Bose – Head – Retail Assets & Strategic Alliances

• Over 23 years of experience in retail and SME banking, housing finance and the real estate sector. He has managed sales and distribution, credit risk management and audit in markets such as India, Asia Pacific, Middle East and Africa. Previously, he was with Standard Chartered Bank as Risk Head Consumer Banking for Southern African markets. Prior to which he has worked in Citibank, the Eldeco Group and GIC Housing Finance Ltd.

J. K. Vishwanath – Chief Credit Officer

• Over 19 years of rich experience in all aspects of Credit and Risk Management. Prior to joining DCB Bank, he has worked with with Fullerton India Credit Company Ltd. and , he began his professional career with Eicher Ltd.

Praveen Kutty – Head – Retail & SME Banking

• Over 19 years of banking experience. He has worked with Citibank’s Indian and international operations where he successfully managed multiple consumer banking businesses including Credit Cards, Personal Loans, Home Loans, Branch Banking and .

Narendranath Mishra - Head – Agri & Inclusive Banking

• Joined DCB in August 2007. He has previously worked with ICICI Bank and Ral lis India. He has approximately 13 years of experience

Rajesh Verma – Head – Treasury, Corporate Banking, FIG & Trade Finance

• Over 31 years of experience within Banking & in State . His rich experience spans across the various functions of Treasury, Credit, Loan Syndications, Project Finance, Investment Banking, General Administrations and IT Project Management in India and UK. In his last role, he was working as a Deputy General Manager, Global Market Department for SBI in .

Ravi Kumar – Chief Internal Auditor

• Over 15 years of rich experience in a career that spans national as well as international roles. Prior to DCB, he spent seven years with the Samba Financial Group (previously Citibank) and four year with Ernst & Young at Riyadh.. Ravi is a Chartered accountant and a Certified Information Systems Auditor .

Source Company, CSEC Research

Investment Rationale On the comeback trail DCB, focused on high-yield unsecured lending in FY08 to grow its loan book, funded by wholesale deposits. Exposure to unsecured personal loans stood at ~32% in FY08. Although, this strategy helped DCB to grow its loan book by ~53% in FY08, the economic downturn resulted in delinquencies in the loan portfolio (GNPA of 8.4% at the end FY09), predominantly in personal loans and corporate loan segment. Consequently, DCB’s management team was replaced by a new team led by Mr. Murali Natrajan. DCB’s new management restructured its balance sheet, improved underwriting standards with more focus on secured loans and other stringent criteria for loan approvals. Under the revamped strategy, DCB started focusing more on secured loans (mortgage, SME, Agri & Inclusive Banking, corporate banking), thereby making it more diversified. Simultaneously, DCB stopped disbursement to personal loans (PL), commercial vehicle (CV) and construction equipment (CE), which formed a large chunk of the portfolio. Unsecured personal loan portfolio, which stood at ~32% in FY 08, has been clamped down to 5% (at the end FY13) from 24% in FY10. The share of PL/CV/CE reduced sharply to ~2% of total loan in FY13. Advances grew from ~INR 32.74bn in FY10 to ~INR 65.86bn in FY13 (15% CAGR FY09-FY13), due to effective implementation of its diversification strategy.

Figure 1: De-risked loan book Figure 2: Run down of risky assets helped reduce

slippages

120% 10% 8.40% 8.69% 9% 5% 100% 15% 8% 24% 5.85% 80% 32% 29% 91% 95% 85% 6% 4.40% 76% 3.18% 60% 68% 71% 4% 1.50% 40% 2% 20% 0%

0% FY 08 FY 09 FY 10 FY 11 FY12 FY13 Gross slippages FY 08 FY 09 FY 10 FY 11 FY12 FY13 Secured Unsecured

Source: Company, CSEC Research Source Company, CSEC Research

Figure 3: Diversification strategy helped grow loan book Figure 4: Changing loan mix

120 113 100% 5% 6% 5% 14% 100 87 84 80% 36% 33% 24% 27% 23% 74 80 25% 63 66 59 61 4% 56 53 60% 14% 26% 24% 60 48 12% 23% 46 43 INR bn INR 33 35 40 40% 28% 17% 12% 46% 20% 15%

20 20% 17% 32% 36% 25% 29% 0 10% 8% 0% 4% FY 09 FY 10 FY 11 FY12 FY13 Advances Deposits Total Assets FY 08 FY 09 FY 10 FY 11 FY12 FY13 Others SME + MSME AIB Mortgages

Source: Company, CSEC Research Source: Company, CSEC Research

SME- a sizeable opportunity Focus on lending to SME is likely to help DCB ramp up its loan book without substantial incremental slippages. MSME financing is lending to manufacturing/services firms with investment in fixed assets of less than INR100mn and INR 50mn, respectively. As per data from the 4th, all India Census of MSME, only 22% of the ~ 35mn MSMEs in India had financed themselves through Banks & Institutional services. This segment therefore represents a good opportunity in terms of growth due to under-penetration. DCB provides term loans and working capital loans to SMEs, whose annual turnover is between INR 100-1,000mn and predominantly in A or BBB category. Under SME & MSME category, DCB’s loans are fully collateralized with LTV of 70-80%. In addition, attachment of promoter property, which empowers DCB to recover the bad loans under SARFAESI act, corroborates DCB’s better risk management practices. The average ticket size of DCB’S MSME segment stood at ~ INR 4.1mn (at the end 3QFY14).

Figure 5: ~78% of SMEs are dependent on informal Figure 6: DCB’s average ticket size one of the lowest sources amongst comparable peers

12 10 78% 10.2 8

34.61 6 1.56 4 4.6 4.1 2 3.5 22% 2.2 0

CUB KVB DCB SIB FB SME Organized Enterprises (mn) Unorganized Enterprises (mn) Average Ticket Size (mn) Informal sources + Promoter Banks & Financial Institutions

Source: Fourth all India MSME Census, CSEC Research Source: Bloomberg, CSEC Research

Mortgage segment to lead to sustainable growth In FY13, DCB mortgage book comprised of loan against property (60%) and home loans (40%). Under mortgages, DCB does not extend loans for a property that is under construction (~80% needs to be completed), while the Loan- to-value (LTV) for these loans, are in the range of 60-75%. To achieve faster growth in mortgages, DCB explored inorganic route and acquired a significant portion of mortgage assets from a NBFC, after stringent risk assessment. DCB’s mortgage share (acquired + sourced) increased to 36% of overall portfolio in FY13, from ~4% in FY08. Under mortgage, DCB strategically targets, self-employed segment, given its huge potential (51% of total workforce) and relatively high yields. Figure 7: Acquired mortgage contributed a Figure 8: Mortgages grew sharply post FY08

significant portion

30 200% 163.0% 100% 19.10% 25 28.60% 80% 36.60% 38.00% 35.40% 150% 20 60% 15 100% 40% 56.9% 54.6%

10 43.5%

80.90%

62% 71.40%

64.60% 50% 20% 63.40% 5 2.62 4.11 10.81 15.51 23.98 0% 0 0% FY 09 FY 10 FY 11 FY12 FY13 FY 09 FY 10 FY 11 FY12 FY13 Sourced Mortgages Acquired Mortgages Mortgages (INR bn) Mortage Loan growth rate

Source: Company, CSEC Research Source: Company, CSEC Research

Corporate, AIB loans stabilizing DCB witnessed slippages in few large corporate accounts, due to the economic slowdown. Apart from slippages in its unsecured retail book, DCB faced asset quality troubles due to large ticket slippages, which led to losses for the bank. Also, small size restricts large corporate funding for DCB. Moreover, loans to large corporate leads to concentration of loan book, which increases the credit risk. Therefore, as a prudent approach DCB targets mainly the mid-corporate segment, while disbursing term loans and working capital loans. This apart, Agri & Inclusive Banking (AIB), through which DCB primarily aims to meet its priority sector lending (PSL) targets, should help drive loan book growth.

Figure 9: Corporate loans to enhance loan book growth Figure 10: AIB loans to help meet PSL mandate

31% 18 40% 10 67.9% 80% 16 19% 30% 9 50.3% 70% 20% 14 7% 8 60% 1% 10% 7 12 50% 0% 10 6 -10% 40% 8 5 -20% 30% 6 4 -30% 8.0 20% 3 8.5 7.7 4 -50% -40% 5.7 8.6 2 10% 2 9.3 11.1 11.2 11.9 15.7 -50% -0.9% -4.5% 1 -5.7% 0% 0 -60% 0 -10% FY 09 FY 10 FY 11 FY12 FY13

Corporate Loans (INR bn) % Growth YoY FY 09 FY 10 FY 11 FY12 FY13 AIB % Growth YoY

Source: Company, CSEC Research Source: Company, CSEC Research

Figure 11: DCB exposure to risky sectors Figure 12: DCB risky sector exposure one of the lowest amongst peers

Infra CRE Gems & Jewellery Metals & Mining SME

KMB 20% YES 49% 2.0% IIB 19% ICICI 50% 6.8% HDFC 24%

AXIS 43%

DCB 38% 1.0% FB 57% CUB 71% 22.6% 3.2% SIB 41% KVB 59%

ING VYSYA 59%

0% 20% 40% 60% 80%

Source: Company, CSEC Research Source: Bloomberg, CSEC Research

Branch locations- focus shifts to unbanked areas

In the wake of economic downturn, the RBI did not issue any new branch licence to DCB as it was incurring losses and its promoter’s shareholding being above RBI guidelines. However, as DCB turned profitable (2QFY11); it started expanding its branch network from FY12. The management has guided to increase the number of branches to 150 by FY15E from 115 branches currently, with much of the new additions in states such as MP, Gujarat, Orissa, , and AP. Further, DCB is focusing on a cluster approach for branch expansion and it plans to set up branches in Tier II to Tier VI cities and unbanked areas, where it will be the first or second private sector bank. This strategy is likely to enable DCB to have presence in top 40 cities and address 80-85% of SME loan market within the locality.

Figure 13: Significant presence of MSMEs in the Figure 14: Western region contribute ~58% of Western region DCB branches

18% 16% 4% 7% 14% 15% 12% 10% 11% 8% 15% 39% 6% 12% 10% 16% 4% 9% 6% 7% 2% 4% 3% 3% 0% 18%

Maharastra Gujarat Andhra Pradesh Delhi Karnataka Major statewise distribution of MSMEs

Source: Company, CSEC Research Source: Fourth All India MSME Census, CSEC Research

Figure 15: Tier-wise distribution of DCB branches Figure 16: DCB only bank amongst peers with western region focus

120% % Distribution of Branches in Core-States 96% 100% 87% 83% 83% 78% 75% 80% 70% 58% 82% 62% 57% 60% 100% 41%

17% 40% 18%

18% 7% 20%

0% KVB CUB FB SIB ING KTK LVB J&K Yes DCB North South Based Based Rural S-urban Urban Metro Tier1&2 Tier 3&6

Source: RBI definition of centers, Company, CSEC Research Source: Company, CSEC Research

Focus on retail deposits provides stability Prior to FY09, DCB funded the loan book by high-cost wholesale deposits, resulting in higher cost of deposits (7.5% in FY09). Under the renewed strategy, DCB shifted its focus on retail term deposits and CASA deposits to fund its loan book, while simultaneously reducing its dependence on bulk deposits. DCB’s deposits grew at ~13% CAGR over FY08-13, despite its relatively small number of branches. DCB’s strategic presence in CASA rich states and urban presence helped enhance its retail deposits to 78 % (at the end FY13) from ~52% in FY08, while CASA stood at ~27% (at the end 3QFY14). However, off late growth rate of new account opening has been tapering in urban and metro regions; while the pace of account opening growth has remained steady at ~12% in rural and semi-urban regions. Against, this backdrop, DCBs focus to expand its branch network in tier II to tier VI cities and unbanked areas should augur well for deposit mobilization and help maintain a stable CASA ratio.

Figure 17: Account opening growth has been tapering in Figure 18: Expansion in Tier II to VI geographies’ urban/metro centers to shore up deposits 32.0% 90.0 40% 30% 17% 12% 80.0 30% 25% 12% 12% 70.0 17.2% 20% 20% 60.0 8% 10% 15% -2% 50.0 12.9% 3.0% 83.6 40.0 0% 10% 3% 1% 2% 3% 12% 30.0 63.4 2% 2% 12% 56.1 -10% 10% 10% 46.5 47.9 5% 8% 20.0 5% 6% -20%

0% 4% 3% 10.0 -23.5%

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY02 0.0 -30%

FY09 FY10 FY11 FY12 FY13 Urban + Metro - Account opening growth Total Deposits (INR bn) % Growth in deposits YoY Rural+Semi-Urban -Account opening growth

Source: RBI, CSEC Research Source Company, CSEC Research

Figure 19: Deposit Profile (as a % of portfolio) Figure 20: DCB CASA Ratio one of the highest amongst comparable peers

100% 90% CUB 16%

80% Dhanl… 19% KVB 19% 70% 20% 60% SIB 21% 50% KTK 24%

40% 84% DCB 82%

81% 27%

77%

69%

68% 64%

30% 64% KMB 29%

61% 60%

60%

35%

35%

52%

32% 31% 20% 48% FB 31%

27% 24% 32% IIB 32% 10%

23%

19%

18%

7% 9% 3% 5% 3% 9% 16% 32% 0% J&K 39% FY08 FY09 FY10 FY11 FY12 FY13 CASA Term Deposits Other Deposits Retail Deposits Wholesale Deposits 0% 5% 10% 15% 20% 25% 30% 35% 40%

CASA Ratio

Source: Company, CSEC Research Source: Bloomberg, CSEC Research

NIMs to remain steady

DCB’s NIMs have been steadily improving, from ~2.8%( at the end FY10) to ~3,5%(end 3QFY14) led by increasing share of low-cost CASA deposits and retail term deposits, which mitigated the impact of run-down in high-yielding personal unsecured loan book to a certain extent. Moreover, shedding of bulk deposits, capital raising, and with the loan book having moved from fixed to floating interest rates with low duration giving re-pricing flexibility, has augured well for improvement in NIM. The management expects to maintain NIM’s at ~3.3%, on the backdrop of increasing share of high yielding MSME segment, while stable CASA ratio and recent rating up gradation ( CRISIL upgraded DCB’s long-term rating to A-/stable during 2QFY14) should help keep cost of funds stable.

Figure 21: Improvement in credit rating to augur well Figure 22: Increasing share of SMEs to provide for cost of funds stability to NIM

3.4% 16% 13.58% 12.60% 12.75% 14% 12.33% 12.10% 12.00% 12.00% 11.12% 3.2% 12% 10% 7.51% 7.12% 7.78% 7.50% 7.40% 7.40% 6.44% 3.0% 8% 5.83% 6% 3.34%

2.8% 3.30%

3.25% 3.20% 4% 3.20%

6.07% 3.13% 5.89% 5.29% 5.49% 4.97% 4.60% 4.60% 4.60%

2% 2.6% 2.86% 0% 2.79% FY 09 FY 10 FY 11 FY 12 FY13 FY14E FY15E FY16E 2.4% Yield on advances Cost of Funds Spread FY 09 FY 10 FY 11 FY 12 FY13 FY14E FY15E FY16E Net Interest Margin (%) Source: CSEC Research Source: CSEC Research

Improvement in branch productivity to aid operational efficiency

DCB’s operating cost has historically remained elevated vis-à-vis peers, on account of low branch productivity and high employee cost (wage cost/operating income at 35% end FY13). Moreover, consolidation of balance sheet, led to subdued asset growth, translating into lower core income (8% CAGR FY08-FY13), However, Cost/income ratio is likely to trend lower given, DCB’s branch expansion in tier II to tier VI areas, where operating expenses are relatively lower, should help reduce costs. Further, increasing branch network, should improve productivity, thereby giving a fillip to operating income.

Figure 23: Cost/Income remains elevated Figure 24: DCB Total Assets/Employee lowest amongst the peers 4.5 82% 80.6% 4.0 80% DCB 50 78% 3.5 76.3% IIB 67 76% 3.0 68.6% KMB 61 74.5% 74% 145 2.5 71.4% 72% Dh… 53

INR bn INR 2.0

4.0 70% LVB 59 3.3

1.5 3.2 CUB 64 3.0

2.8 68%

2.5 2.4 2.4 KTK 70

1.0 2.2 2.0 66% SIB 78 0.5 64% KVB 74 0.0 62% ING 57 FY 09 FY 10 FY 11 FY12 FY13 J&K … 121 Operating Cost Operating Income FB 71 Cost/Income Ratio (%) 0 50 100 150 200 Total Assets / Employee(INR mn) Source: Company, CSEC Research Source: Bloomberg, CSEC Research

Focus on SME /Corporate segment to give a thrust to fee income

DCB’s fee income growth remained muted, by virtue of its high share of retail portfolio and lower processing fees and charges relative to its peers. However, with increasing focus on SME and mid-corporate segments, where DCB provides cash management services, letters of credit, etc should help improve its fee income to a certain extent. Additionally, DCBs focus to distribute products on bancassurance (cross-selling insurance) and wealth management services should bode well for Commission, exchange and brokerage (CEB).

Figure 25: SME/Corporate segment to support fee Figure 26: Fee income a key enabler to other income growth income growth

1.0 20% 90% 1.29% 1.4% 0.9 15% 80% 1.11% 0.8 1.2% 70% 0.92% 0.91% 0.7 10% 1.0% 60% 0.79% 0.6 5% 50% 0.8% 0.5

0.4 0.9 0% 40% 0.6%

0.8

78.3%

0.8

76.3%

71.4% 0.7 0.3 0.7 30%

-5% 63.4% 60.9% 0.4% 0.2 20% -10% 0.2% 0.1 10% 0.0 -15% 0% 0.0% FY 09 FY 10 FY 11 FY 12 FY13 FY 09 FY 10 FY 11 FY 12 FY13 CEB (INR bn) % Growth YoY CEB/non-interest income CEB/Total assets

Source: Company, CSEC Research Source: Company, CSEC Research

Forex, treasury income to moderate

DCB’s forex & treasury income/total assets at 0.2% (at the end FY13), remains one of the lowest amongst peers; on account of DCB’s relatively low share of NRE deposits (7.7% at the end 3QFY14). Given, increasing NRE flows DCB’s forex exposure is estimated to increase, which should augur well for forex income. This apart, as DCB accelerates its loan book growth; the Available for Sale (AFS) and Held for Trading (HFT) investment portfolio growth is likely to remain lower, thereby reducing the treasury income. Against this backdrop, DCB’s forex and treasury income growth is estimated to remain flat over the period FY13-FY16E.

Figure 27: Forex & Treasury income growth Figure 28: Forex & Treasury income one of the estimated to remain flat lowest amongst peers

0.5% 25% 0.4% 20% 0.4% 0.3% 15% 0.3%

10% 22.6% 0.2% 0.4%

16.6% 0.2%

5% 0.3% 11.9%

11.8% 0.1%

8.0%

0.2% 0.2%

6.9%

6.3%

6.2% 1.9% 6.0%

0% 0.1% 0.1% FY09 FY 10 FY 11 FY 12 FY13 0.0% Forex income/Non-interest income KVB DCB SIB CUB FB Treasury income/Non-interest income Forex & treasury income as % of Total assets

Source: Company, CSEC Research Source: Company, CSEC Research

Asset Quality in better position Historically, asset quality has been a key concern for DCB. GNPA increased from 1.5% in FY08 to 8.7% in FY10, with slippages increasing ~5X over FY08-10. However, GNPA peaked out at 11.24% in 2QFY10, and showed steady improvement over FY10-14E, with GNPA falling to 2.77% in 3QFY14. Provision Coverage Ratio (PCR) also improved significantly from 48.4% in FY08 to 84.25% in 3QFY14. Despite, increasing share of the SME segment, DCB’s asset quality is likely to improve steadily on the back of increased recovery efforts (Recoveries /opening GNPA at 11% in FY13). Further, stringent risk management, low unsecured portfolio, modest risky sector exposure and smaller ticket size, provides comfort on asset quality.

Figure 29: Asset Quality improving 10% 91.2% 100% 87.6% 9% 81.00% 80.0% 90% 70.0% 76.0% 78.0% 8% 80% 7% 53.3% 70% 6% 60% 5% 50%

8.8% 4% 8.7% 40%

3% 30%

5.9% 2% 20%

4.4%

3.9%

3.2%

3.2%

3.1% 2.9%

1% 2.8% 10%

1.0% 0.6% 0.8% 0.7% 0.6% 0.5% 0% 0% FY 09 FY 10 FY 11 FY 12 FY13 FY14E FY15E FY16E GNPA NNPA PCR

Source: Company, CSEC Research Lower provisioning requirement DCB sub-standard assets in GNPL remained substantially higher at 87% in FY09, owing to sharp increase in slippages. However, with the subsequent restructuring of balance sheet, DCB has been able to control its sub- standard loans (18% sub-standard loans in GNPL book in FY13). Further, reduced fresh slippage rate, relatively well secured loan book, and 100% provision coverage on loans pertaining to PL/CV/CE, the probability of higher future provisioning spikes is low for DCB. Against this backdrop, the management expects PCR to sustain at 80%, over the period FY13-FY16E.

Figure 30: Ageing of GNPA’s

as a % of GNPA 100% 9%

56% 80% 35% 47% 33%

60% 21% 87% 40% 21% 17% 26%

7% 12% 20% 41% 19% 24% 18% 10% 0% FY 09 FY 10 FY 11 FY12 FY13 Sub-standard assets Doubtful assets-1 Doubtful assets-2 Doubtful assets-3 Loss assets Source: Company, CSEC Research

Modest restructured assets pipeline DCB restructured assets reduced sharply from 2.72% of advances in FY09 to 0.42% in FY13. DCB restructured accounts, also steadily declined from ~325 in FY10 to 12 (under standard asset classification) in FY13, with negligible restructured assets turning into NPAs. At the end FY13, DCB’s restructured pipeline stood at ~ INR 28bn, while amount outstanding under CDR mechanism remained at ~INR 0.21bn.

Figure 31: Marginal restructured pipeline Figure 32: Stressed assets in-line with industry

average

1.0 2.72% 3.0% 5.0 12.05% 14% 2.5% 0.8 10.11% 12% 4.0 2.0% 10% 0.6 1.5% 3.0 6.44% 8% 0.88% 0.4 0.42% 3.68% 1.0% 2.0 6% 0.28% 0.2 0.5% 4% 0.89 0.31 0.12 0.27 1.0 2% 0.0 0.0% 3.95 3.50 2.76 2.42 FY 09 FY 10 FY 11 FY12 FY13 0.0 0% Restructured Assets (INR bn) Restructured Assets/Advances FY 09 FY 10 FY 11 FY12 FY13 Stressed Assets (INR bn) Stress Assets/Advances Source: Company, CSEC Research Source: Company, CSEC Research

ALM match to help maintain healthy spread DCB has relatively high ALM mismatch compared to its peers, with ~98% of deposits and ~66% of advances having maturity period of one to three years in FY13. DCB’s advances mix is skewed towards long- term loans, as against short-term deposits, which reduces a higher churn for the bank. However, with increasing share of SME loans and retail term deposits, DCB should be able to balance its asset-liability by lending to small businesses, through retail term deposits; this should help maintain a healthy spread. Asset-Liability match would also aid DCB maintain stable NIM across interest rate cycles as a similar maturity pattern helps to pass on deposit rate hikes to re-pricing of loans.

Figure 33: Deposits & Advances maturity profile (as a % of Figure 34: ALM mismatch in different time bucket overall portfolio FY13)

30 80% 25 70% 20 60% 15 50% 10 40%

5 12.6

8.9

8.0

2.4 0.7 5.9 30% bn INR 0 20%

-5 4.1 -

10% 16.6

-10 - 0% Over -15 Over 29 3 Over Over 6 -20 1 to 15 to days mont 1 3 Abov mont 14 28 to 3 hs to year years e 5 hs to days days mont 6 to 3 to 5 years 1 hs mont years years year hs

Deposits 9.91% 4.65% 19.46 13.45 17.85 32.39 2.11% 0.18% Loans & 3.56% 2.29% 5.55% 3.55% 10.57 40.09 8.89% 25.49 Advances Loans & Advances FY13 Deposits FY 13 ALM Mismatch

Source: Company, CSEC Research Source: Company, CSEC Research

Investment book growth to moderate As, DCB was conservative on the lending front during FY09-10, its Investment/Deposit (I/D) ratio scaled up from 34.9% in FY09 to 42.2% in FY10. Since then, I/D ratio has hovered ~40% between FY10-FY13. DCB’s investment book is slightly vulnerable to mark to market (MTM) losses caused by elevated G-Sec yields, as DCB’s (AFS + HFT) book constitutes ~ 25% of the investment portfolio. However, as DCB accelerates its loan book growth; it’s I/D ratio should moderate at ~38-40% over FY13-16E, which is likely to minimize the share of (AFS+HFT) to a more acceptable level in overall investment portfolio.

Figure 35: Investment/Deposit ratio to stabilize ~35-38% Figure 36: AFT+HFT portfolio to moderate as loan growth accelerates

42.2% 40.0 40.9% 45% 39.7% 40.0% 100% 37.9% 37.7% 35.0 34.9% 40%

30.0 35% 80% 30% 25.0 25% 60% 20.0

bn INR 20%

33.6 33.1

15.0 31.5 40% 83.7%

15% 82.1%

74.2%

25.2

70.3%

69.9%

66.6% 23.0

10.0 64.5%

20.2 10%

16.2 20% 5.0 5%

0.0 0% 0%

FY 09 FY 10 FY 11 FY12 FY13 1QFY14 2QFY14 FY 09 FY 10 FY 11 FY12 FY13 1QFY14 2QFY14 SLR Non-SLR Total Investment Inv/Deposit HTM AFS HFT Source: Company, CSEC Research Source: Company, CSEC Research

Priority sector Lending (PSL) mandate DCB fell short of its aggregate priority-sector lending mandate in FY13; priority sector loans comprised 33% of the overall loan book in FY13. Nevertheless, DCB has consistently achieved the overall PSL target (direct & indirect- via investment made in securitized assets) as required by the RBI mandate between FY09-FY13. This apart, given, DCB’s increasing focus on SME segment and AIB segment, DCB should be able to meet its priority sector loan mandate solely through its loan book, over the years FY13-FY16E.

Figure 37: Trend in priority sector lending Figure 38: Agri-GNPA remains relatively low

45% 40%

35% 0.66% 30% 25%

20% 42.1%

41.9% 38.0% 15% 36.3% 0.41% 32.2% 10% 2.10% 5% 0% FY 09 FY 10 FY 11 FY12 FY13 Priority sector as a % of overall advances FY 09 FY 10 FY 11 FY12 FY13 Source: Company, CSEC Research Source: Company, CSEC Research

Adequately capitalized to fund business growth DCB has a strong Tier-I ratio at 11.89% and comparatively low Tier-II ratio of 0.88% at the end 3QFY14 totalling a capital adequacy ratio (CAR) of 12.86% (at the end 3QFY14).DCB is adequately funded to achieve the estimated growth (22% CAGR FY13-FY16E) with the current CAR. Moreover, with comfortable tier-I capital and moderate increase in risk weighted assets (RWA), DCB would not need to raise Tier-II capital in the near term. The management guided to maintain minimum Tier-I ratio at 10.5%.

Figure 39: Strong core capital Figure 40: Tier I capital one of the highest in the industry 18% KMB 16% 14.70% FB 14.20% 14% DCB 13.81% 12% IIB 13.80% CUB 13.30% 10% KVB 13.10%

8% ICICI 12.80% 15.4%

14.9% SIB 12.50% 13.8%

6% 13.6%

13.3%

13.3%

12.9%

12.6%

12.3% 12.1%

11.9% AXIS

11.8% 12.20%

11.6%

11.5%

11.1% 11.1%

4% 2.9% HDF… 11.10%

2.2% 1.8% 1.6% INDBK

1.0% 10.90%

0.8% 0.7% 2% 0.7% INGVY 10.50% 0% YES 9.50% FY 09 FY 10 FY 11 FY12 FY13 FY14E FY15E FY16E 1% 3% 5% 7% 9% 11% 13% 15% Tier I Tier II CAR Tier I

Source: Company, CSEC Research Source: Company, CSEC Research Earnings stability to drive ROE DCB’s initiatives on cost rationalization and improvement in fee income growth are likely to provide more stability to earnings profile. This apart, stable cost of funds and increasing share of high yielding SME segment should help sustain NIMs at 3.3% by FY16E. Against this backdrop, the RoA is estimated to improve by 1.1% by FY15E. With improvement in ROA and adequate capital (12.86%), the RoE is estimated to inch higher, from ~12.7% in FY13 to ~13.2% by FY15E, as the bank leverages its capital. However, with tax benefit likely to expire by 3QFY15, the ROE should moderate at ~13% by FY16E and thereafter, improve steadily.

Figure 41: Business growth to help improve ROA Figure 42: Stable earnings profile should drive ROE

1.2% 14.0%

1.0% 12.0%

0.8% 10.0%

8.0% 0.6%

1.1% 13.2%

6.0% 13.0%

1.0% 12.7%

0.4% 0.9% 0.8% 4.0% 10.2% 0.6%

0.2% 6.4% 0.4%

2.0% 4.9%

0.0% 0.0% FY 11 FY12 FY13 FY14E FY15E FY16E FY 11 FY12 FY13 FY14E FY15E FY16E Return on Asset (ROA) Return on Equity (ROE) Source: Company, CSEC Research Source: Company, CSEC Research

Financial Outlook

Strong advances growth to drive core income DCB registered a modest loan book growth of ~15%CAGR during FY09-FY13; the outstanding loan book stood at INR 73.61bn at the end 3QFY14. Going forward, DCB’s strategy to strengthen its focus in the tier II to tier VI cities along with increasing focus on SME, mortgage should augur well for loan book growth (Mortgage + SME share at ~50% by FY15E). DCB’s core income; is estimated to grow at ~ 25% CAGR FY13-16E, driven by strong business growth of ~22%CAGRFY13-16E. Loan book growth, is likely to be led by a diversified mix of Mortgage, SME, AIB and Mid-Corporate.

Branch expansion to strengthen deposit profile Under the renewed strategy, DCB shifted its focus on CASA and retail deposits during FY09-13. This led to proportion of retail deposits increasing to 78% in FY13 from 52% in FY08. Given, DCB’s focus to expand its branch network in tier II to tier VI cities and strong presence in urban areas, DCB’s deposits are estimated to grow at ~22% CAGR (FY13-FY16E), driven by retail deposits (~80% by FY16E), while CASA ratio is likely to remain stable at ~28% by FY16E.

NIM likely to moderate ~3.3% by FY16E Despite, yield on advances consistently declining over the years FY09-FY12, DCB’s NIM has been steadily improving led by shedding of high cost bulk deposits, while simultaneously increasing its retail share of deposits. This strategy helped DCB improve its cost of funds from 7.5% in FY09 to 7.1% in FY13. Going forward, with increasing share of high yielding SME segment in loan book, DCB’s yield on advances is likely to remain steady at ~12.0% by FY16E, while cost of funds is estimated to moderate ~7.4% by FY16E, thereby helping to sustain NIM’s at 3.3% by FY16E

Cost rationalization and lower provisioning requirement to boost earnings DCB’s PAT is estimated to grow at ~22%CAGR (FY13-FY16E), as the increasing share high yielding SME, mid- corporate loans translates into strong core income, thereby improving profitability. Moreover, efficient cost control (Cost/ income at ~57% by FY16E), stable fee income, and lower provisioning requirement in conjunction with improving asset quality, should act as key enablers in boosting earnings. However, with tax benefits likely to expire by 3QFY15, DCB’s earnings growth should moderate ~12% in FY16E.

Receding asset quality worries Since FY10, DCB has not only run down unsecured loans, but also improved its risk management, and hence asset quality, since then, has been largely improving (from 8.7% in FY10 to 3.2% in FY13). GNPA and NNPA are estimated to improve steadily at 2.8% and 0.5% respectively by FY16E, given DCB has de-risked its balance sheet completely, while simultaneously expanding its loan book with a focus on quality led by mortgage lending. This apart, minimum re-structured asset pipeline, modest exposure to risky sectors and smaller ticket size provides comfort on asset quality.

Valuation Since January 2011, DCB has traded between 0.9X to 1.25X its 1-year fwd adjusted book value and between 8.1X to 10.2X P/E of its 1-year fwd earnings. DCB stock trades at 0.9X FY16E P/BV and 7.0X P/E FY16E. Healthy business growth, stable NIM, improving asset quality and steady earnings growth should complement return ratios. We arrive at a target price of INR 68/share, using two stage Gordon growth model, implying a FY16E P/BV of 1.2X and FY16 P/E of 9.1X. We rate the stock a BUY.

Figure 43: 1-year forward P/BV Figure 44: 1-year forward P/E DCB DCB 80 100 15x 70 1.5x 90 80 60 12x 1.25x 70 50 60 1.0x 9x

40 50 DCB DCB 7x 30 0.75x 40 20 30 20 10 10 0

0

11 12 13

11 12 13

11 12 13 14

11 11 11 12 12 12 13 13 13

- - -

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- - - -

------

11 12 13

11 12 13

11 12 13 14

11 12 13

11 11 12 12 13 13

- - -

- - -

- - - -

- - -

- - - - -

-

Jul Jul Jul

Jan Jan Jan Jan

Mar Mar Mar

Jul Jul Jul

Sep Sep Sep

Nov Nov Nov

May May May

Jan Jan Jan Jan

Mar Mar Mar

Sep Sep Sep

Nov Nov Nov

May May May

Source: Bloomberg, CSEC Research Source: Bloomberg, CSEC Research

Peers – Valuation- Standalone

CMP NIM C/I ROA 2015E 2016E 2015E 2016E 2015E 2016E 50.0 3.2 3.2 41.8 40.8 1.5 1.5 332.8 2.8 2.8 50.2 46.8 1.0 1.1 20.0 3.1 3.2 47.3 47.5 1.0 1.0 79.9 3.1 3.2 46.3 45.4 1.1 1.2 INDUSIND BANK 389.9 3.7 3.8 47.1 46.6 1.8 1.8 ING VYSYA BANK 537.2 3.3 3.4 51.6 48.5 1.3 1.3 ROE P/E P/BV

2015E 2016E 2015E 2016E 2015E 2016E CITY UNION BANK 19.4 20.9 6.0 4.9 1.1 1.0 KARUR VYSYA BANK 17.5 19.1 5.7 4.4 1.0 0.9 SOUTH INDIAN BANK 16.7 17.1 4.5 3.8 0.7 0.6 FEDERAL BANK 13.1 14.3 7.0 5.8 0.9 0.8 INDUSIND BANK 17.9 19.1 12.1 9.8 2.0 1.7 ING VYSYA BANK 12.4 13.3 11.0 9.4 1.3 1.2

Source Bloomberg, CSEC Research Risks  Weakness on the asset quality from the SME division could put pressure on its RoA, leading to slower improvement in the RoE.  Vulnerable to large ticket corporate slippages, owing to its small size.  Slower than expected loan book growth, due to economic slowdown, would lower the ROE  Possible acquisition target, given its small size.

Financials

Income Statement (Abstract) Per Share Ratios INR(million) Particulars FY 13 FY14E FY15E FY16E Particulars FY 13 FY14E FY15E FY16E EPS (Rs) 4.1 5.7 6.6 7.5 Interest income 9,161 10,939 13,293 16,493 Earnings growth (%) 81.0 39.6 16.1 12.5 Interest expense 6,317 7,638 9,060 10,959 PPP* / Share (Rs) 5.0 7.0 9.3 12.5 Net interest income 2,844 3,301 4,234 5,534 BV / share (Rs) 40.0 45.0 50.1 57.6 Growth (%) 24.9 16.0 28.3 30.7 Adj BV / Share (Rs) 38.7 44.5 48.8 55.9 Other income 1170.2 1406.1 1419.7 1750.4 Div / Share (Rs) 0.0 0.0 0.0 0.0

Total Income 4,014 4,707 5,653 7,284

Staff Costs 1383 1577 1845 2121

Others 1,370 1,389 1,491 2,031

Op. Expenses 2,753 2,965 3,335 4,152 Key Ratios Pre-provision Profit 1,261 1,741 2,318 3,132 Growth (%) 50.5 38.1 33.1 35.1 %

Provisions 240 316 383 471 Particulars FY 13 FY14E FY15E FY16E PBT 1,021 1,425 1,935 2,661 Gross NPLs 3.2 3.2 2.9 2.8 Provision for Tax 0 0 280 798 Net NPLs 0.8 0.7 0.6 0.5 PAT 1,021 1,425 1,655 1,863 Growth (%) 85.2 39.6 16.1 12.5 Capital Adequacy 13.6 12.9 12.3 11.8 Tier I CAR 12.6 12.1 11.6 11.1 Yield on Advances 12.2 12.1 12.0 12.0

Yield on IEA 9.8 9.7 9.5 9.5

Balance Sheet (Abstract) Cost of Funds 7.6 7.5 7.4 7.4 INR(million) Net Interest Margin 3.4 3.2 3.2 3.3 Particulars FY 13 FY14E FY15E FY16E Cost / Income 68.6 63.0 59.0 57.0 Net worth 9997 11260 12530 14393 PCR 76.0 77.0 81.0 80.0 Borrowings 15256 18573 22951 28276 Tax rates 0.0 0.0 14.5 30.0 Growth (%) 35.8 21.7 23.6 23.2 ROA 0.8 0.9 1.1 1.0 Deposits 83638 100366 121945 150602 ROE 10.2 12.7 13.2 12.9 Growth (%) 32 20 22 24

Other liabilities 3863 3161 3825 4713 Total Liabilities 112,755 133,360 161,251 197,983 Valuation Ratios Deferred Tax Asset Particulars FY 13 FY14E FY15E FY16E (Net) - - - - Cash Balances with P / E 12.7 9.1 7.9 7.0 RBI 8833 10288 12316 14458 P / PPP* 10.3 7.5 5.6 4.2 Advances 65861 79033 95630 117816 P / BV 1.3 1.2 1.0 0.9 Growth (%) 24.6 20.0 21.0 23.2 P/ABV$ 1.3 1.2 1.1 0.9 Investments 33587 38139 46339 57229 Dividend Yield 0.0 0.0 0.0 0.0 Fixed assets 2361 2573 3250 4159 Other Current assets 2114 3327 3716 4322 * PPP – Pre Provisioning Profit $ Book value adjusted for uncovered loan losses Total Assets 112,755 133,360 161,251 197,983 *IEA- Interest Earning Assets Growth (%) 30.8 18.3 20.9 22.8