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Union Bank of India public issue: Our view - Views on News from Equitymaster
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Union Bank of India public issue: Our view
Feb 14, 2006

Union Bank of India’s (UBI) second public issue (100% book building) for 45 m equity shares will open for bidding between the 15th and 21st of February 2006. The minimum bid size is 50 equity shares and in multiples of 50 shares thereafter. The bank has reserved 4.5 m shares for eligible employees and minimum 14.2 m shares (35% of net issue) for retail investors. Going by the price band of Rs 100 to Rs 110 per share, the bank is expected to mop up approximately Rs 5 bn (at the higher end of the band) through the offer. The issue is slated to bring down government's holding in the bank from 61% to 55%.

About Union Bank of India
Established in 1919 as a public sector bank, UBI is one of the fastest growing banks in India. It has 2,064 branches spread across 25 states serving 15 m customers. The bank had its initial public offering in 2002 during which the government shareholding was diluted to 61%. While the bank has a larger concentration of its credit portfolio in the corporate segment (58% in 1HFY06), advances to retail and agriculture segment (constituting 20% and 15% respectively of the total outstanding loan booking 1HFY06) have shown sizeable growth over the past few quarters.

Objects of the issue
  • To increase the Tier I capital adequacy ratio (at present 5.8%) and overall CAR (at present 10.5%) for meeting the Basel II norms. Also, the bank needs to hike its capital base to meet the growth in the corporate and retail credit segment.

  • Development of infrastructure to support business growth.

Reasons to apply
Outperforming industry: UBI has registered a growth in its advance book at 35% YoY and deposits at 26% YoY during 3QFY06, which are higher than the industry averages (30% and 19% respectively). Its business volumes (deposits and advances) have grown at a CAGR of 20% between FY03 to FY05. The bank has well utilised its diversified franchise (2,064 branches in 1HFY06) to accelerate asset growth over the past couple of years. Also, the fact that the bank’s branches are evenly distributed across different geographies in the country helps it to capture the growth opportunities. The bank’s credit to deposit ratio of 70% (9mFY06) is one of the best in the industry. With additional capital support (post the issue, CAR is expected to go up to 12% even after Basel II provisions), we expect the bank to sustain growth momentum, at least at par with the industry average.

Rationalising for efficiency: The bank has witnessed a steady growth in terms of its efficiency parameters over the past 3 years. Although not very lean in terms of number of branches and employees, the bank has made consistent efforts to improve its productivity parameters, by rationalising its franchise and staff strength. The same, however, may not be sustainable in the long term unless PSU banks get government backing to rationalise their operations (i.e., through approvals for branch closure, VRS and the like).

Low cost funding: The bank has successfully reduced its funding costs through a large base of low-cost deposits, with total deposits representing 89% of its funding at the end of FY05. At the end of 9mFY06, low cost deposits constituted 32% of the bank’s total deposits. This has helped the bank considerably improve its net interest margins (NIMs 3.1% in 9mFY06) over the last couple of years. Further, the bank believes that it can enlarge its low-cost funding base by leveraging on its extensive branch network and large customer base, particularly in the rural areas where majority of the deposits are in low-cost category. Having said this, with the interest rates keeping an upward bias, we expect some pressure at the NIM levels for the banking sector as a whole in the medium term.

Assets to get re-priced: Union Bank has some short-term loans in its books at lower yields. With the loans expected to get re-priced at higher yields from 4QFY06 onwards, the bank’s overall yield on assets will also improve.

Hedging treasury risks: Union Bank has garnered approximately 33% of its revenues through treasury operations at the end of 1HFY06. Also, 65% of its investments were in the form of G-Secs at the end of FY05, the market value of which are subject to interest rate risks being witnessed in the money market currently. Nevertheless, the bank has been reasonably proactive in terms of provisioning and has increased the proportion of investments in the HTM basket to 72% in 9mFY06. The same, therefore, reasonably hedges the bank against further spikes in interest rates in the medium term.

Reasons not to apply
Margin pressures evident: While Union Bank has been to an extent successful in paring its borrowing costs by increasing the contribution of low cost deposits, the yields on its investments and advances have marginalized at a faster rate than the costs on the funding side. This has pressurised the bank’s net interest margins (3.1% in 9mFY06) over the past couple of quarters. With interest rates now heading upwards, we expect the pressure on margins to continue unless the bank can profitably deploy the incremental offtake in higher yielding assets.

High cost to income ratio: Although Union Bank made some efforts to bring down its cost to income ratio until FY04, the ratio has been steadily rising since then (45% in 9mFY06). This can be attributed to additional expansion overseas and technological upgradation. Once the benefit of these starts filtering into the bank’s bottomline, we expect the ratio to improve in the long-term.

Quality below par: Despite being proactive in terms of provisioning, the bank seems to be unsuccessful in aggressively arresting the incremental delinquencies. The gross NPA to advance ratio stood at 5% in FY05 and 4.2% in 1HFY06. At the same time, the net NPA to advance ratios stood at 2.6% and 1.4% respectively. Thus, although the bank’s coverage ratio of 70% compares quite favourably against its PSU banking peers, given the higher provisioning that the bank needs to make for the same, we believe that impaired asset quality will continue to dampen the return ratios for the bank.

Financials

(Rs m) FY03 FY04 FY05 1HFY06
Interest earned 43,062 45,163 49,698 27,780
Interest expended 28,085 27,801 29,052 16,409
Net Interest Income 14,977 17,362 20,646 11,371
Other income 8,246 8,315 7,661 2,740
Total income 23,223 25,677 28,307 14,111
Other Expenses 10,183 10,846 12,575 7,008
Operating profit 4,794 6,516 8,071 4,363
OPM (%) 11.1% 14.4% 16.2% 15.7%
Provisions 7,512 7,710 8,541 4,087
Net profit 5,528 7,121 7,191 3,016
NPM (%) 12.8% 15.8% 14.5% 10.9%
No. of shares (m) 460.0 460.0 460.0 460.0
EPS (Rs) 12.0 15.5 15.6 13.1
1HFY06 EPS is annualised

Comparative valuation and comments
At the higher end of the valuation band of Rs 100 to Rs 110 per share, the stock will trade at 1.8 times its post issue adjusted book value.

Comparitive valuations
1HFY06 ROE (%) NIM (%) NPM (%) CAR (%) Net NPA (%) P/ABV (x)
Union Bank of India* 18.5% 3.1% 10.9% 10.5% 1.4% 1.8
OBC 8.2% 3.0% 11.6% 12.0% 0.8% 1.3
SBI 18.4% 3.2% 14.6% 12.4% 2.3% 2.2
ICICI Bank 12.9% 2.4% 17.9% 12.0% 1.0% 2.4
HDFC Bank 14.7% 3.9% 21.0% 12.2% 0.3% 4.7
* P/ABV has been calculated post issue by considering the higher end of the price band

While we do acknowledge the fact that Union Bank is well placed to capitalise on growth opportunities in the sector in the longer term, it needs to consolidate its position and derive better efficiency parameters to compete against its counterparts in the private banking space Though the bank compares favorably against its PSU banking peers across several valuation parameters, the pricing of the follow-on issue has already factored in most possible upsides to the stock. While margin sustainability is a concern for the sector as a whole, slippages in asset quality and treasury risks may also retard growth for the bank. We would thus advise investors to avoid the issue.

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