Bank of India (Buy), Union Bank of India (Buy)

Bank of India – BUY

CMP Rs333, Target Price Rs392, Upside 17.7%

Our recent interaction with the management of Bank of India (BoI) has made us believe that the concerns over deterioration in asset quality are set to recede in the coming quarters. High levels of NPLs had been the key worry for the past few quarters. With stringent provisioning norms and strong recovery mechanism in place, the management has guided for limited accretion in NPL. Moreover, with renewed focus on increasing CASA proportion, improving margins, 400+ branch addition and diversification in loan portfolio, we see BoI entering the next league of growth. After a decent run up in valuation across PSU peers - BoB, Corp Bank and PNB, we expect valuations for Bank of India to atch up. BUY

23% CAGR in loans; favorable business mix to boost margins

After a decent 18%yoy growth in loan book during FY10 and a healthy 22% CAGR over FY08-10, we expect BoI to now witness sturdy 23% CAGR in loan book over FY10-12E. Lending towards SME and corporate segment have been the key growth areas. With intention to address its limited exposure towards mid-corporate segment, the bank has now opened 28 branches to cater solely to the needs of this segment. Over 75% of total domestic deposits (excluding CASA deposits) are at interest rate of less than 8%. This is relatively lower as against ~88% of advances at interest rate of over 8%. Increasing proportion of CASA deposits, healthy loan growth and improved loan mix, in our view, would enable the bank to report improvement in margins.

Concerns over asset quality to fade in coming quarters

GNPL for the bank at Rs48.8bn were up 98%yoy and constituted 2.9% of total loans. Net NPLs too, were up 2.5xyoy to Rs22.1bn (1.3% of total loans) largely on account of significant rise in slippages. We expect high level of slippages to recede with improving health of the economy and recovery mechanism in place. With pace of accretion towards restructured loans having slowed down, we expect minimal loans to come up for restructuring.

Valuation gap with peers has widened, BUY

With sturdy 23% CAGR in loans over FY10-12E, we expect the bank to witness 21% CAGR in balance sheet. Returns ratios too are set to improve with average RoE at ~18-19% levels and RoA at 0.8% over the said period. With concerns over deterioration in asset quality to fade in coming quarters, the valuation gap is expected to narrow down. We recommend BUY and assign a multiple of 1.35x FY12 P/Bx (marginally lower than its peers) to arrive at value of Rs392.

Union Bank of India – BUY

CMP Rs310, Target Price Rs360, Upside 16.0%

Loan growth outperformance to continue

In FY11, UBI is targeting 25% loan growth; a material 5% above the system. Improving credit demand, robust branch expansion and various initiatives taken under the 'Nav Nirman' program back bank's confidence to outgrow industry. C/D ratio is expected to remain firm in the year with deposits growth targeted at lower 22%.

NIM to resume a stable trajectory H2 FY11 onwards; to be near 3% for FY11 and FY12

With the nasty impact of significant mobilization of high-cost deposits during Q2-Q4 FY09 behind, UBI's quarterly NIM is expected to exhibit considerably lesser volatility going ahead. Though in the near term NIM could witness a normalizing correction, it is estimated to settle near 3% for FY11 and FY12

GNPL formation to moderate in FY11 and FY12; asset quality to improve gradually  

While additional slippages could happen in H1 FY11, GNPL formation for the year is expected to be lower than FY10. It would further decline in FY12 driven by improvement in credit and economic environment. Moderation in GNPL formation and robust loan book growth would cap GNPL near 2% over the next two years.

Poised for material re-rating over the next 12 months  

We believe that UBI is primed for a valuation re-rating over the next 12 months driven by strong credit growth, stability in NIM, gradual improvement in asset quality and sustenance of above-industry RoA and RoE. The bank is our top pick amongst mid-sized PSBs as it offers the most attractive RoE-P/adj.BV mix. Based on our proprietary valuation model, Bank 20, we assign FY12 P/adj.BV multiple of 1.4x to UBI and arrive at one-year price target of Rs360.