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Union Bank: Quality control disappoints - Views on News from Equitymaster

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Union Bank: Quality control disappoints

May 10, 2010

Union Bank of India declared its FY10 results. The bank has reported a 12% YoY and 20% YoY growth in interest income and net profits respectively. Here is our analysis of the results.

Performance summary
  • Interest income grows by 12% YoY in FY10 on the back of 23% YoY growth in advances.
  • Other income grows by 33% YoY on the back of 47% YoY growth in fees.
  • Net interest margin drops from 3.2% in FY09 to 2.7% in FY10 due to pricing pressure
  • Capital adequacy ratio at 12.5% as per Basel II at the end of FY10.
  • Net NPA ratio higher at 0.8% in FY10 from 0.3% in FY09.

Rs (m) 4QFY09 4QFY10 Change FY09 FY10 Change
Interest income 32,897 35,616 8.3% 118,894 133,027 11.9%
Interest Expense 23,633 21,655 -8.4% 80,758 91,103 12.8%
Net Interest Income 9,264 13,961 50.7% 38,136 41,924 9.9%
NIM (%)       3.2% 2.7%  
Other Income 5,590 4,925 -11.9% 14,825       19,747 33.2%
Other Expense 5,740 7,411 29.1% 22,141 25,078 13.3%
Provisions and contingencies 2,834 3,400 20.0% 7,375 8,264 12.1%
Profit before tax 6,280 8,075 28.6% 23,445 28,329 20.8%
Tax 1,630 2,140 31.3% 6,180 7,580 22.7%
Profit after tax / (loss) 4,650 5,935 27.6% 17,265 20,749 20.2%
Net profit margin (%) 14.1% 16.7%   14.5% 15.6%  
No. of shares (m)         505.1  
Book value per share (Rs)*         174.4  
P/BV (x)              1.7  
* (Book value as on 31st March 2010)

What has driven performance in FY10?
  • While managing to improve its share of the banking sector's deposits to 3.5%, Union Bank of India (UBI) showed some instability in its asset growth. UBI managed to grow its advance book by 23% YoY in FY10, while partially sacrificing margins and asset quality. In order to hedge the slowdown in the growth of retail and agriculture segments, the bank tapped SME clients. However, the pricing pressure on advances hurt UBI's net interest margins (NIMs). While the bank had to pass on lower interest rates to loan customers, the high cost bulk deposits in its books kept its interest costs relatively high during FY10. Thus despite sustenance of CASA proportion, UBI's NIMs were significantly lower in FY10 as compared to that in FY09.

    Leveraging SME support
    FY09 % of total FY10 % of total Change
    Advances 982,650       1,212,490   23.4%
    Corporate 585,050 59.5% 669,890 55.2% 14.5%
    Agriculture 135,190 13.8% 180,690 14.9% 33.7%
    Retail 100,920 10.3% 135,060 11.1% 33.8%
    SME 161,490 16.4% 226,850 18.7% 40.5%
    Deposits    1,387,030       1,700,400   22.6%
    CASA 417,080 30.1% 539,027 31.7% 29.2%
    Term deposits 969,950 69.9% 1,161,373 68.3% 19.7%

  • The bank's cost to income ratio dropped marginally from 42% in FY09 to 41% in FY10 due to the base effect of provision for wage arrears and brand building expenses in the corresponding quarter of FY09. We expect this cost advantage to further improve the bank's efficiency ratios. The bank expects its cost to income ratio to stabilise at 41% in FY11.

  • Although UBI does have a lot of catching up to do with its peers in fee income, the same have shown signs of improvement over the past few quarters. The bank's fee income has grown by 47% YoY in FY10. Nevertheless, it formed merely 5% of the bank's total income in FY10. The growth in other income has been aided by gains on the treasury portfolio and recovery of non-performing loans.

  • While UBI has witnessed a 38% YoY increase in the absolute value of its gross NPAs over the last 12 months; primarily from the bank's restructured assets. The net NPAs have also moved up from 0.3% of total advances in FY09 to 0.8% in 9mFY10. Having said that, the NPA coverage ratio stood at 74% at the end of FY10, above the RBI's mandate of 70% coverage. The same was 87% at the end of FY09.

What to expect?
At the current price of Rs 295, the stock is valued at 1.2 times our estimated FY12 adjusted book value. Despite sustenance of a healthy current and savings account mix, the deterioration in margins and asset quality, albeit temporary, are our prime concerns about the bank. Going forward, with technological upgradation although the growth prospects of the bank appear enthusing, excessive reliance on treasury income may prove to be risky. Having said that, the bank has outperformed our conservative margin estimates for FY10. Also, most of the near term risks already seem to be priced in and we continue to retain our positive view on the stock.

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