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Edelweiss Investment Research

Insightful. Independent. Decisive.

City Union Bank Ltd


“This CUB Has Teeth”
Shivaji Thapliyal
Research Analyst
shivaji.thapliyal@edelweissfin.com
+91 (22) 4272 2159

Date: 3rd July 2017


Edelweiss Investment Research

City Union Bank Ltd CMP INR 177 Target INR 220

This CUB Has Teeth Rating: BUY Upside: 25%

City Union Bank (CUB) is a mid-sized private sector bank with a INR24,112cr loan book and a distribution network comprising 550 branches. It possesses
Shivaji Thapliyal
unique competitive advantages compared with key peers on the yield, cost of funds and operating expense front, allowing it to deliver sustainably higher
Research Analyst
risk-adjusted return ratios. Given reasonable valuation for forecast return ratios, we recommend a ‘BUY’ Rating on the stock.
shivaji.thapliyal@edelweissfin.com
Loan book re-orientation largely over, CUB can revert to long term risk-managed growth trajectory +91 (22) 4272 2159
Jewel Loan de-focusing is largely behind CUB with exposure having fallen from 22% in FY13 to 9% in FY17 which allows CUB to grow without this drag going
forward. Further, over FY1995-2016, CUB has displayed an average growth differential of 5% with the industry while displaying the prescience to pull back prior Bloomberg: CUBK:IN
to key crises viz. global tech slowdown, the Great Recession and China slowdown, earmarking CUB as the bank stock to own over the long term cycle.
Under-penetrated home market, market share gains and high operating leverage to further aid growth 52-week range (INR): 170/ 95
CUB’s South/Tamil Nadu focus is adequate for fueling balance sheet growth over the next 4-5 years. (1) Its Q3FY17 branch share in Tamil Nadu is 3.5%
compared with 67% for PSU Banks and 28% for Private Sector Banks, indicating significant under-penetration. (2) CUB stands to gain market share from PSU Share in issue (cr): 59.8
Banks due to superior service levels. (3) Competition from large private sector banks is not significant as CUB operates in the INR 25 lacs – 1 cr loan ticket size
MSME sub-segment whereas the former focus on much larger ticket sizes (4) CUB remains under-leveraged from a business per branch perspective with their M cap (INR cr): 10,759
FY17 Deposits per branch at INR 55 cr compared with INR 58-145 cr for key peers.
Avg. Daily Vol.
Well-managed funding profile, prudent asset-liability management lend significant cost of funds comfort 832
BSE/NSE :(‘000):
CUB’s FY17 Cost of Funds stood at 5.9% compared with 6.5-7% for key peers. This is driven by (1) lower dependence on Borrowings which were 1.7% of FY17
Deposits and Borrowings compared with 3.1-19% for key peers (2) lower dependence on Bulk Deposits which are 5% of total deposits compared with 15-23%
for key peers (4) prudent reluctance to participate in Saving Account interest rate competition with SA rate at 4% compared with key peers at 4-7.1%.
High exposure to MSME loans and higher loan granularity result in yield leadership for CUB
CUB’s FY17 Yield on Advances stood at 12.1% compared with 11.3-12% for key peers which, in turn, is driven by (a) higher loan exposure to high-yielding
MSME segment at 48% compared with 12-35% for key peers and (b) higher loan granularity with Top 20 borrowers accounting for 5.3% of loan book
compared with 8.1-14% for key peers.
Non-IBA bi-partite employee settlement and best-in-class digital franchise drive major opex benefits
City Union Bank’s FY17 Cost to Income Ratio stood at 41% compared with 45-60% for key peers. This is led by (1) lower Cost per Employee of INR 6.1 lacs Public, 100.0
compared with INR 6.2-9.1 lacs for key peers which, in turn, is driven by (a) Non-IBA bi-partite employee settlement (b) low average employee age of 27
years (2) 85% of transactions now via non-branch channels compared with c.60% 2 years ago. (3) Further, we looked at ATM, POS, Card and Android
platform data and note that City Union Bank is in the top 2 across all parameters, indicating superior digital franchise, a key idiosyncratic advantage.
City Union Bank’s headline asset quality seems middling but underlying credit book indicates no undue risks
City Union Bank’s gross total stress (GNPA Ratio + Std. Restructured Assets) stood at 3.4% as of H1FY17 compared with 1.5-6.6% for key peers. We note that (1)
City Union Bank’s exposure to key stressed sectors stood at 20.7% of H1FY17 credit compared with 17-22.9% for key peers whereas (2) Metals and Infra 200
exposure stood at 5.6% compared with 2.6-14.3% for key peers, indicating no incremental underlying credit risk compared with peers. Broad underlying
macro risk for lumpy corporate NPA accretion is low with Large Corporate exposure low at 7% of FY17 loan book, avoidance of long-gestation project 180

financing with Working Capital loans 65% of loan book and Consortium lending at c.1% of loan book. 160

Valuation and Rating: Initiate with BUY, PT of Rs 220. CUB undervalued on comprehensive metrics 140
We use Residual Income Model to arrive at a Price Target of Rs 220 for City Union Bank, at which the stock trades at 2.7x FY19E book value. We initiate with
120
BUY Rating with our PT providing 25% upside to CMP. The stock currently trades at a P/B of 2.2x FY19E book value for an FY18E-20E RoE of 16%-17%.
(INR cr) FY16 FY17 FY18E FY19E FY20E 100

Net Interest Income 981 1199 1452 1701 2008 80

Total Income 1391 1683 1994 2309 2710 60

Jun-16
Jul-16
Apr-16

Apr-17
Nov-16
Jan-16

Jan-17
Aug-16
Feb-16

Feb-17
Sep-16

Dec-16
Oct-16

Mar-17
Mar-16

May-16
Profit After Tax 445 503 639 748 922
Basic EPS 7.4 8.4 10.7 12.5 15.0
P/E 23.8 21.0 16.6 14.2 11.8 CUB Sensex

Book v alue per share 51 60 69 80 104


P/B 3.5 3.0 2.6 2.2 1.7
Date: 3rd Jul 2017
Return on Av erage Equity 15.5% 15.2% 16.6% 16.8% 16.3%

1 GWM
City Union Bank Ltd.

City Union Bank: Well-managed funding profile + Granular high-yielding loan book + Bipartite employee settlement = Higher sustainable RoE

City Union Bank is expected to deliver a best-in-class RoE of 16-17% over FY18E-20E. Healthy sustainable RoE is delivery is expected on the back
of high net interest margin and structurally low opex with low reliance on leverage.

City Union Bank’s FY17 City Union Bank’s FY17 Cost


City Union Bank’s FY17 Cost to Income Ratio is 41%
Yield on Advances is
of Funds is 5.9% compared compared with 45-60% for
12.1% compared with
with 6.5-7% for key peers key peers
11.3-12% for key peers

FY15 FY16 FY17 FY18E FY19E FY20E FY15 FY16 FY17 FY18E FY19E FY20E PB Multiple FY19E BVPS CMP / Target

NII 807 981 1199 1452 1701 2008 RoAA 1.49% 1.50% 1.51% 1.69% 1.72% 1.82% 2.2x (CMP) 80 177
Other Income 404 410 484 542 608 702
2.7x (Target) 80 220
Opex 519 558 689 795 929 1056 RoAE 16.7% 15.5% 15.2% 16.6% 16.8% 16.3%

PAT 395 445 503 639 748 922

At CMP, FY19E P/B is FY18E-20E RoE of At Target Price,


2.2x 16-17% FY19E P/B is 2.7x

Upside of
25%

2 GWM
City Union Bank Ltd.

We use the Residual Income Valuation Model to value CUB. We assume a long-term risk-free rate of 7% for India, a
Price Target INR 220 Beta of 1.05 for CUB and an India Equity Risk Premium of 6% and arrive at an overall Cost of Equity of 13.3% for CUB.
We arrive at a price target of INR220, at which the stock will trade at 2.7x FY19E book value.

Our bull case assumes that CUB will continue to win market share at a fast pace from PSU Banks, have no impact
Bull
INR 274 from GST and display very good opex control implying an EPS level 5% higher than our base case resulting in an
3.4x 2019E BPS
FY17-20E EPS CAGR of 23%.

Base Our base case assumes that CUB will continue to win market share at a reasonable pace from PSU Banks, have a
INR 220
2.7x 2019E BPS minimal negative impact from GST and display good opex control implying an FY17-20E EPS CAGR of 21%.

Our bear case assumes that CUB will continue to win market share at a moderate pace from PSU Banks, have
Bear
INR 113 moderate negative impact from GST and display moderate opex control implying an EPS level 5% lower than our
1.4x 2019E BPS
base case resulting in an FY17-20E EPS CAGR of 17%.

3 GWM
City Union Bank Ltd.

Focus Charts
Average Daily Turnover (INR cr) Stock Price (CAGR) Relative to Sensex, CAGR (%)
3 months 6 months 1 year 1 year 3 years 5 years 10 years 1 year 3 years 5 years 10 years
1.84 1.05 0.73 59% 33% 32% 28% 39% 26% 19% 11%

Industry loan growth has slowed to 5% in FY17 but there is great divergence among individual banks. While PSU Banks are challenged on
the growth and asset quality front, Private Sector Banks are growing faster with superior asset quality. Within Private Sector Banks, banks
Nature of Industry
with higher loan book exposure to large corporates, especially to stressed sectors like Metals and Infra, are worse off compared with
banks with higher exposure to retail and / or retail-like small-ticket MSME loans.

CUB has a Q3FY17 branch share of 3.5% in its home state of Tamil Nadu compared with 65% for PSU Banks, from whom CUB continues to
win market share. From an overall perspective, CUB has a market share of only 0.30% of the banking system’s loans as of FY17. Hence,
Opportunity Size
CUB has significant headroom for growth both within its home state and from an overall perspective. Furthermore, MSME is a major long-
term thrust area for the Indian government and MSME / Trade loans are a focus area for CUB with 48% loan book share as of FY17.

CUB has focused on the higher-yielding MSME segment resulting in high Net Interest Margin of 4.2% (FY17). CUB stands very well
Capital Allocation
capitalised with a Tier 1 Capital Ratio of 15.4% as of FY17.
Business Value Drivers

Predictability is high since CUB has very low exposure to Large Corporate Loans (7% of FY17 loan book) from where large lumpy NPA
Predictability
accounts usually emerge. Further, CUB’s exposure to consortium lending is very small at c.1% of loan book providing similar comfort.

In its key home state of Tamil Nadu, CUB is winning market share from PSU Banks, fending off competition effectively against key Tamil-
Sustainability Nadu focused listed rivals, Karur Vysya Bank and Lakshmi Vilas Bank, which have significant asset quality issues while larger private sector
rivals operate in significantly higher MSME ticket size range compared with CUB, which has an average MSME ticket size of c. INR 33 lacs.

At present, CUB does not plan to expand rapidly outside its home state of Tamil Nadu, where it has significant headroom. However,
Disproportionate Future management is acutely aware of the importance of long-term growth delivery for investors and hence, we think the bank would
ultimately start to focus outside Tamil Nadu, particularly on the loan book side.

CUB will continue to focus on the high-yielding MSME segment, particularly on retail-like small-ticket MSME loans. Cost control to be
Business Strategy &
maintained on the back of favourable employee settlement and further enhanced with technology initiatives including robust digital
Planned Initiatives
strategy and robotics.

While there is concern regarding the impact of GST on the overall MSME space, CUB will be impacted minimally since it largely operates
Near Term Visibility
within an MSME portion that is already tax-compliant. Any slowdown due to onerous compliance requirements will be short-lived.

CUB has high long-term visibility as it is a bank with deep expertise in small-ticket MSME lending, high client retention, improving cost
Long Term Visibility
control on the back of technology leadership, prudent liability management and best-in-class credit appraisal approach.

4 GWM
City Union Bank Ltd.

Focus Charts – Story in a nutshell

CUB to grow sans drag as de-focusing of Jewel CUB’s South-focus adequate given high Low dependence on Borrowings and Bulk
Loans largely behind us op. leverage, among other reasons Deposits results in lower CoF

22% 145
7.0% 7.0%

FY17 Deposits / Branch (INR cr)


Jewel Loans as a % of Loan book

6.7%
18% 6.5%

FY17 Cost of Funds


14% 5.9%
74 76

55 58
10%
9%

City Union Lakshmi DCB Bank Karur RBL Bank City Union Karur Vysya Lakshmi DCB Bank RBL Bank
FY13 FY14 FY15 FY16 FY17 Bank Vilas Bank Vysya Bank Bank Vilas Bank
Bank

Small-ticket loan exposure results in high-yielding Non-IBA employee settlement and digital Underlying credit risk for CUB not concerning
loan book franchise drive lower opex
12.10%
12.03% 60%

As a % of H1FY17 credit
FY 17 Cost / Income Ratio
FY17 Yield on Advances

14.3%
53%
51%
10.7%

45%
11.34% 6.6%
11.29% 11.25% 41% 5.6%

2.6%

City Union Karur Lakshmi RBL Bank DCB Bank DCB Bank City Union RBL Bank Karur Vysya Lakshmi
City Union DCB Bank Karur Vysya Lakshmi RBL Bank Bank Bank Vilas Bank
Bank Bank Vilas Bank Bank Vysya Vilas Bank
Bank
Metals Infra

Source: Edelweiss Investment Research

5 GWM
City Union Bank Ltd.

I. Jewel loan book de-focusing over, CUB poised for growth Jewel Loan exposure has fallen from 22% in FY13 to 9% in FY17
without drag We note that, in FY13, the total Jewel Loan book was 22% of total loan book
and this has since fallen to 9% of total loan book, as of FY17. It is clear that CUB
Post FY13, City Union Bank de-focused its Jewel Loan book and this had had taken a strategic decision to de-focus its Jewel Loan as it was then not
proved to be a material drag on overall loan growth since then. However, willing to keep gold loan risk on its balance sheet. This has no readacross for
most of this process seems to be behind CUB and the incremental drag on CUB’s gold loan underwriting standards as this was largely an industry-wide
loan book growth due to this reason will be significantly lower going forward. phenomenon wherein several banks have withdrew from gold loans whereas
focused gold loan NBFCs such as Manappuram Finance and Muthoot Finance
have grew AUM in this area during the same period.
Evolution of loan book proportion for City Union Bank– FY13-FY17
FY13 FY14 FY15 FY16 FY17 Growth rates (yoy) of loan book components for City Union Bank– FY14-FY17
Agri 16% 19% 17% 16% 18% FY13 FY14 FY15 FY16 FY17
MSME 26% 30% 34% 34% 30% Agri 29% -2% 12% 28%
Large Industries 14% 8% 6% 7% 7% MSME 23% 25% 20% -2%
Retail Traders 8% 7% 5% 5% 4% Large Industries -39% -13% 27% 23%
Wholesale Traders 11% 11% 12% 13% 14% Retail Traders -9% -9% 10% -5%
Commercial Real
5% 5% 5% 5% 5% Wholesale Traders 13% 23% 21% 20%
Estate
Commercial Real
JL Non Agri 9% 5% 2% 1% 1% 13% 10% 20% 7%
Estate
Housing Loans 5% 5% 6% 7% 7% JL Non Agri -41% -49% -40% 15%
Other Personal Loans 2% 2% 3% 3% 3% Housing Loans 24% 32% 27% 15%
Loans coll. by Deposits 2% 2% 2% 2% 2% Other Personal Loans 5% 50% 20% 20%
Infra 1% 1% 1% 1% 1% Loans coll. by Deposits 57% -3% 7% 3%
NBFC 1% 1% 1% 1% 1% Infra -3% -25% -10% 62%
Others 2% 3% 5% 5% 7% NBFC -8% -1% 22% 13%
Jewel Loan* 22% 18% 14% 10% 9% Others 42% 120% 26% 56%

Source: Company data; *Including Agri Jewel Loan


Total Loans 6% 11% 17% 14%
Jewel Loan* -13% -16% -18% 4%
Loans ex Jewel Loan 11% 18% 23% 14%

Source: Company data; *Including Agri Jewel Loan

6 GWM
City Union Bank Ltd.

Jewel Loans de-growth from smaller base and slower place has already translated to lower drag
We note that CUB overall loan book growth was 6%, 11% and 17% in FY14, FY15 and FY16, respectively, whereas loan book excluding Jewel Loans grew 11%, 18%
and 23% in FY14, FY15 and FY16, respectively. This differential has narrowed significantly in FY17 with total loan book growing 13.5% whereas loan book ex Jewel
Loans grew 14.5%. This is because the Jewel Loan book is now (a) a small portion of overall loan book and therefore does not move the needle as much as it
used to and (b) de-growth of -13%, -16% and -18% yoy for the Jewel Loan book in FY14, FY15 and FY16 has given way to modest growth of 4% in FY17.

RBI Notification capping cash disbursal of Gold Loans at INR 20,000 an incremental positive
The relatively recent RBI Notification capping cash disbursal of Gold Loans at INR 20,000 (i.e. loans with ticket size exceeding INR 20,000 will have to be disbursed
through non-cash means e.g. cheque, etc) has, on balance, improved the regulatory setup somewhat in favour banks making loans against gold compared
with specialised gold loan NBFCs.

While Gold Loans of ticket size exceeding INR 1 lacs were already being disbursed through non-cash means (primarily cheque), now Gold Loans of ticket size
between INR 20,000 and INR 1 lac would have to be disbursed through non-cash means. What this means for specialised Gold Loan NBFCs is that they would
have to encourage borrowers falling in this bracket to develop a banking habit, which exposes these customers to being poached by banks.

It may be noted that, for Manappuram Finance, c.50% of loan book is to borrowers of loan ticket size exceeding INR 1 lac wheras, for borrowers below INR 1 lac
ticket size, the average ticket size is c.INR 15,000 indicating that most of such borrowers fall below the INR 20,000 threshold. Hence, for Manappuram, a relatively
lower c.10-15% of disbursals are potentially exposed to the poaching threat. For other specialised Gold Loan NBFCs, however, this sort of loan book skew (of very
large and very small ticket size loans) is not quite witnessed and hence, the vulnerability is higher. It may noted that the addressable NBFC universe (for poaching)
for banks engaged in Gold Loan business goes beyond just the well known players in this segment such as listed specalised Gold Loan NBFCs (Muthoot Finance,
Manappuram Finance), unlisted specialist Muthoot Fincorp and listed diversified NBFCs (IIFL, SCUF) as the number of players engaged in the Gold Loan business is
very large.

Furthermore, it may be noted that a bounce-back in the Gold Loan book, which has just taken root on a moderate scale in FY17, will also be yield-accretive for
CUB.

Slowdown in loan growth in FY17 is mainly on account of the transient impact of Demonetisation
De-monetisation has impacted certain components of the loan book viz. MSME, Retail Traders and Commercial Real Estate (comprising 39% of total loan book as
of FY17). We do not think the impact of De-monetisation would sustain as the economic activity linked to the aforementioned portion of the loan book is driven
by cash availability, which we believe would normalise soon given cash withdrawal limits have been completely removed.

It is worth noting that, if the growth rate of the affected portion of the loan book would have been the same as that in FY16, then the overall FY17 loan growth
(yoy) would have been significantly higher at 22% as opposed to the observed 13.5%. It may be noted that CUB did sell some PSLC backed by their MSME loans
and bought PSLC in the Agri segment. However, suffice to say that Re-monetisation is going to have a salutary impact on CUB loan growth going forward.

7 GWM
City Union Bank Ltd.

II. Ultra-long term advances trend underlines CUB as growth CUB has displayed the prescience to pull back prior to key financial crises
Further, we note that the growth rate differential steadily contracted from
engine with prudent risk management
FY1996 to FY2000, turned significantly negative in FY2006 and then, again in
FY2014. We note that these prudent relative growth pullbacks on the part of
We go as far back as FY96 and examine CUB and banking system advances’ CUB happened prior to key financial crises. It may be noted that the FY2000
growth trend since then. There are some interesting insights to glean from this crisis was led by the global tech slowdown, the FY2007-2008 crisis was the most
and overall, it establishes CUB as possessing judicious risk management debilitating global financial crisis since the Great Depresssion and FY2015-2016
expertise while delivering higher growth than the system. was a phase in which a China slowdown caused great stress to the Indian
Banking sector. In each of these cases, CUB has displayed great prescience
and slowed down lending to levels even lower than the system. This sense of
Advances growth (yoy) and Growth Differential – City Union Bank – FY96-FY16 counter-cyclicality and general risk management prudence displayed by CUB
50% earmarks it as a prime bank name to be owned over the long-term cycle.
42%
40% 36% 35%
30% 31% 31%
30% 27% 27%
24% 26%
24%
21% 20% 21%
20% 16% 15% 17%
14% 15%
12%
10% 6%

0%
FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16
-10%

-20% City Union Bank Differential with System

Source: RBI, Ace Equity

We note that CUB delivered an Advances CAGR of 23% over FY1995-2016


compared with banking system Advances CAGR of 18.6% over the same
period. The average differential of growth rate of CUB compared with the
system is 5% and the average multiple of growth rate of CUB compared with
the system is 1.3x.

8 GWM
City Union Bank Ltd.

III. South/Tamil Nadu focus adequate for growth over medium term We evaluated the branch presence breakdown data for Tamil Nadu
from the State Level Banking Committee and note that PSU banks
CUB currently does not have the intention to rapidly become a significantly pan- account for 65% of branches, indicating their significant penetration in
Indian bank and its South/Tamil Nadu focus is adequate for fueling growth over the the state. Private sector banks account for 30% of branches in the state.
next 4-5 years. We do not possess, strictly speaking, market share data for Tamil Nadu
and business per branch would alter the market share for a given branch
Market share gains expected at the expense of PSU Banks share. However, our understanding is that PSU banks have a somewhat
The market share of PSU banks in the key Southern state of Tamil Nadu is significantly lower market share than their branch share, while the opposite holds true
high and eating into their share remains one of CUB’s key growth drivers. Loss of for private sector banks. Moreover, brach share is a reasonable indicator
share for PSU banks is an overarching mega trend on account of their comparably of the penetration of the respective banks.
inadequate service levels.
Branch share in Tamil Nadu—CUB versus peers (9mFY17-end)
Competition from large private sector banks not intense for CUB 3.63%
3.51%
Competition from large private sector banks is also not a pressing concern since
these banks’ focus is on higher MSME ticket sizes (c. INR5cr), whereas CUB focuses
more on the INR25lacs –1cr segment. The average ticket size for the bank in the 2.49%
MSME segment is c. INR33lac. Consequently, large private sector banks are unable
to match CUB’s service levels for smaller-ticket MSME clientele.

Home state of Tamil Nadu as yet under-penetrated from CUB’s perspective

Branch share breakdown—Tamil Nadu (9m17-end)


0.16%
Semi 0.08%
Rural Urban Metro Total
Urban
Karur Vysya Bank City Union Bank Lakshmi Vilas RBL Bank DCB Bank
State Bank Group 12% 12% 15% 17% 13% Bank
Other Public Sector Banks 54% 49% 55% 50% 52% Source: Company data, SLBC TN; LVB, DCB numerators are as at H1FY17-end, FY16-end
Private Sector Banks 25% 33% 29% 32% 30%
CUB’s branch share in Tamil Nadu stands at 3.51%, Karur Vysya Bank’s at
Regional Rural Banks 10% 6% 1% 0% 5%
3.63% and Lakshmi Vilas Bank’s at 2.49%. From these numbers, we get a
Foreign Banks 0.0% 0.0% 0.2% 1.1% 0.2%
sense of the under-penetration of these smaller-sized TN-focused banks.
Source: SLBC Tamil Nadu
The differentiation among the 3 banks lies in the extent to which each
has sweated its branch network, which we discuss in the next section.

9 GWM
City Union Bank Ltd.

IV. CUB’s branch network as yet under-leveraged from a business Deposits per branch (INR cr / branch) – FY17 - City Union Bank vs Key peers
per branch perspective 160
145
140
Advances per branch (INR cr / branch) – FY17 - City Union Bank vs Key peers

FY17 Deposits / Branch (INR cr)


140 120
123
120 100
FY17 Advances / Branch (INR cr)

74 76
80
100
55 58
60
80
40
57 58
60
44 44 20
40
0
City Union Bank Lakshmi Vilas DCB Bank Karur Vysya RBL Bank
20 Bank Bank

Source: Company data; LVB data is for H1FY17


0
Lakshmi Vilas City Union Bank DCB Bank Karur Vysya Bank RBL Bank
Bank CUB’s deposit per branch stands at INR55cr compared to peers’ INR58-145cr.
Source: Company data; LVB data is for H1FY17
Thus, CUB remains significantly under-leveraged compared to key peers from
a business per branch perspective. Hence, we believe there is significant
We note CUB’s advances per branch is INR44cr compared with peers’ INR44-
upside for the bank from an operating leverage perspective.
124cr.

10 GWM
City Union Bank Ltd.

V. City Union Bank possesses Cost of Funds advantage over key Lower dependence on high-cost bulk deposits compared to peers
Another key aspect of CUB’s funding mix is low dependence on high-cost
peers
bulk deposits. There is no exposure to corporate bulk deposits and
certificates of deposit. Moreover, dependence on other bulk deposits at
CUB has a lower cost of funds compared to key small private sector banks. This
c.5% of deposit book is also low
feeds directly into higher net interest income for a given balance sheet size,
implying higher net interest margin, ceteris paribus. Bulk Deposits as % of Total Deposits – CUB versus peers (FY17)

22.5%
Cost of funds—CUB versus peers (FY17)
7.0% 7.0% 18.0%
6.7%
FY17 Cost of Funds

6.5% 15.0%
5.9%

5.0%

City Union Bank Karur Vysya Bank Lakshmi Vilas Bank DCB Bank RBL Bank

Source: Company data; DCB, RBL figures are simple averages of 4 FY17 quarters City Union Bank Karur Vysya Bank Lakshmi Vilas Bank DCB Bank

Source: Company data; KVB figure is Bulk Term Deposits to Total Term Deposits
Lower dependance on borrowings compared to peers
The bank has employed prudent approach and superior asset liability The dependence of key private sector peers on bulk deposits at 15-22.5% of
management to keep its cost of funds on the lower side. One of the aspects of total deposits is materially higher than CUB’s. Bulk deposits are typically
this approach is low dependence on borrowings in comparison with deposits, the higher cost deposits that banks lean on to fulfil their asset-liability
former being generally higher cost than the latter. management requirements.

Borrowings as % of Deposits and Borrowings—CUB versus peers (FY17)


18.7%

5.5% 6.2%
3.1%
1.7%

City Union Bank Karur Vysya Bank Lakshmi Vilas Bank DCB Bank RBL Bank

Source: Company data; *Figure for LVB is calculated

CUB’s proportion of borrowings as a percentage of total deposits and borrowings


as of FY17 is 1.7% compared with key peers at 3.1-18.7%.

11 GWM
City Union Bank Ltd.

CASA ratio for CUB is broadly comparable with peers City Union Bank not participating in Savings Account interest rate competition
CUB’s FY17 CASA ratio of 23.4% is broadly comparable with key peers whose We note that City Union Bank offers a Savings Account (SA) interest rate of 4%
CASA ratio ranges between 19.1% and 27.7%. Hence, even from a headline across accounts and hence, the headline CASA ratio needs to be viewed in
CASA ratio perspective, this is neither a material negative or positive for the the context of SA interest rate competition, which City Union Bank is not
bank from a cost of funds perspective for CUB. participating in. Consequently, CUB’s cost of SA deposits will be concomitantly
lower compared with banks that are participating in this rate competition.
CASA ratio—CUB versus peers (FY16, H1FY17, FY17)
30.0%
Highest SA interest rate—CUB versus peers
27.7%

24.0% 23.4%
25.0% 7.1%
22.0%
6.5%
19.1%
20.0%

15.0%

4.0% 4.0% 4.0%


10.0%

5.0%

0.0%
Karur Vysya Bank DCB Bank City Union Bank RBL Bank Lakshmi Vilas
Bank

FY16 H1FY17 FY17


City Union Bank DCB Bank Karur Vysya Bank Lakshmi Vilas Bank RBL Bank
Source: Company data
Source: Company data

We note that Lakshmi Vilas Bank and RBL Bank offer higher SA interest rates of
6.5% and 7.1% p.a., respectively, on certain savings account offerings.

12 GWM
City Union Bank Ltd.

VI. City Union Bank has higher Yield on Advances compared We note that CUB’s MSME exposure is 48% of FY17 loan book compared to key
peers at 12-35%. Total small-ticket loans (SME + Retail) are 68% of loan book
with key peers compared with 30-64% for key peers. To arrive at the advances breakdown, we
have made certain reasonable assumptions / approximations to enable an
CUB has a higher Yield on Advances compared with key small private sector apple-to-apple comparison across these companies. We are well into the MCLR
bank peers. This feeds directly into higher net interest income for a given regime and CUB has sustained its yield and maintained its margin leadership.
balance sheet size, implying higher net interest margin, ceteris paribus.
CUB’s Loan book granularity positive for Yield on Advances
Yield on advances—CUB versus peers Granularity of CUB’s loan book is significantly higher compared to peers. This
12.10%
12.03%
results in higher loan yield for the bank since higher granularity implies that it
operates in a higher yield bracket from a target client and ticket size
FY17 Yield on Advances

perspective.

Top 20 borrowers as a % of loan book—CUB versus Peers (FY16)


11.34% 11.29% 11.25% 14.0%
11.4%
9.8%
8.1%
5.3%

City Union Bank DCB Bank Karur Vysya Bank Lakshmi Vilas RBL Bank
Bank City Union Bank DCB Bank Karur Vysya Bank Lakshmi Vilas Bank RBL Bank
Source: Company data Source: Company data

Small-ticket MSME expertise of CUB feeding into higher Yield on Advances We note that the share of Top 20 Borrowers as a proportion of FY16 loan book
We note that CUB is an small-ticket MSME specialist on the lending front. stood at 5.3% for City Union Bank compared with 8.1%-14% for key peers,
Small-ticket MSME loans are higher-yielding assets leading to superior yield indicating higher granularity for City Union Bank and concomitantly higher yield
on advances for the bank compared to peers. bracket (lower ticket size). Higher granularity also implies lower loan book risk,
ceteris paribus, due to lower concentration risk.
Advances breakdown—CUB versus peers (FY17)
City Union Bank’s Net Interest Margin higher compared with peers
100%
Consequent to its Yield and Cost of Funds leadership, CUB delivers higher NIM
80%
compared with key peers, implying higher RoE, ceteris paribus.
60% 20%
40% 15% Net interest margin—CUB versus peers (FY17)
52%
20% 48% 20% 10%
35% 4.17% 4.04%
12% 12% 20% 3.70%
0% 3.50%
CUB DCB KVB RBL LVB 2.85%

MSME Retail Agri Corporate

Source: Company data, Edelweiss Investment Research City Union Bank DCB Bank Karur Vysya Bank RBL Bank Lakshmi Vilas Bank

Source: Company data; LVB figure is avg. of quarterly figures

13 GWM
City Union Bank Ltd.

VII. City Union Bank has lower Cost to Income Ratio compared with CUB’s cost per empoyee at INR 6.1lacs is significantly lower than peers’ INR 6.2-
key peers 9.1lacs. There are 2 key reasons for this:

City Union Bank has a lower Cost to Income Ratio compared with key small CUB has successfully negotiated the bi-partite settlement between
private sector banks. This feeds into higher Profit after Tax for a given Total management and staff union officers’ association. This is not related to the
Income, implying higher Return on Equity, ceteris paribus. settlement negoatiated by Indian Banking Association (IBA) on behalf of banks
that agree to IBA negotiating on their behalf.
Cost to income ratio—CUB versus peers
It is to be noted that CUB employees were granted a significant wage revision in
60% FY17, which is expected to stand for the medium term. This implies that the INR
FY 17 Cost / Income Ratio

53% 6.2 lac cost per employee for FY17 is now at an increased level (INR 4.7 lac for
51% FY16) which would rise only at a moderate pace in the coming years, keeping
45% employee cost under control.
41%
The second reason is that CUB has a prudent human resource strategy and has
worked to maintain a young workforce, implying lower employee cost, ceteris
paribus. The average age of its employees is 27 years, indicating a young
City Union Bank Karur Vysya Bank Lakshmi Vilas RBL Bank DCB Bank
employee base.
Bank

Source: Company data Moreover, the bank’s business acquisition cost is on the lower side. It has a
focused approach for MSME clients due to which client retention is higher and
We note that CUB’s cost-to-income ratio stands at 41% compared to 45-60% business acquisition costs are concomitantly lower.
for key peers.
High proportion of transactions through non-branch channels also lowers opex
Lower cost per employee one of the key drivers of lower cost-to-income
materially
ratio CUB has been able to successfully transfer its branch transactions to non-branch
One of the key drivers of lower cost-to-income ratio compared to peers is channels. 2 years ago, c.50-60% of transactions happened via non-branch
the bank’s lower cost per employee channels but this has now moved up to c.85% thereby reducing cost.
Furthermore, this also releases branch personnel to focus on business promotion
Cost per employee (INR lacs) —CUB versus peers (FY17) activities. City Union Bank’s thrust on technology is typified by its investment in
9.1
robotics as its was able to introduce India’s first banking robot ‘Lakhsmi’ in
8.2
November 2016. (We expand further on the efficacy of City Union Bank’s digital
7.8 strategy in the next section).
(INR lakh)

6.1 6.2

City Union Bank DCB Bank Lakshmi Vilas Karur Vysya Bank RBL Bank
Bank

Source: Company data; CUB excl. one-off ex-gratia provision; LVB is FY16 figure

14 GWM
City Union Bank Ltd.

City Union Bank’s best-in-class digital strategy a key factor driving lower opex Monthly ATM transaction value (Oct-16; INR) per card—CUB versus peers
We compare the digital strategy outcomes of City Union Bank and note that it
is the only bank in our set of key peers that is in the top 2 on all parameters. 5752 5682 5628

Monthly ATM transaction value (Oct 2016) as a % of deposits—CUB versus

(INR)
2988 2919
peers
4.5%

CUB KVB DCB RBL LVB


3.2%
Source: RBI

We also compare the monthly ATM transaction value per card for October
1.2% 1.2% 2016 and note that this is INR5,752 for CUB compared with INR2,919-5,682 for
0.6% key peers.

Monthly POS transaction value (Oct-16; INR) per card—CUB versus peers
KVB CUB LVB DCB RBL

Source: RBI, Company data 779

We compare the monthly ATM transaction value for October 2016 as a

(INR)
percentage of deposits (H1FY17-end) and note that this is 3.2% for CUB with 398 380
only Karur Vysya Bank higher at 4.5%; balance 3 peers are at 0.6-1.2%. 313
170
Monthly POS transaction value (Oct-16) as a % of deposits—CUB versus peers

DCB CUB RBL KVB LVB


0.25%
0.22%
Source: RBI

0.16%
We also compare monthly POS transaction value per card for October 2016
and note that this is INR398 for CUB with only DCB Bank higher at INR779;
0.07% 0.07% balance 3 key peers are at INR170-380.

KVB CUB DCB LVB RBL

Source: RBI, Company data

We also compare the monthly POS transaction value for October 2016 as a
percentage of deposits (H1FY17-end) and note that this is 0.22% for CUB with
only Karur Vysya Bank higher at 0.25%; balance 3 peers are at 0.07-0.16%.

15 GWM
City Union Bank Ltd.

Debit cards as a multiple of deposits (Oct-16; per INR cr)—CUB versus peers Android downloads as a multiple of deposits (Oct-16; per INR cr)—CUB versus
peers
79 3.7
3.5

2.8
55
(INR cr)

(INR cr)
42 1.9 1.8

21 18

LVB CUB DCB KVB RBL


KVB CUB LVB DCB RBL
Source: Google Play Store, Company Data
Source: RBI, Company data
We also compare the number of downloads on the Android platform cards as
We also compare the number of Debit Cards at the end of October 2016 as a of October 2016 as a multiple of deposits at H1FY17 end. It stands at 3.5
multiple of Deposits at H1FY17-end and note that this is 55 cards / INR cr for downloads / INR cr for CUB with only Lakshmi Vilas Bank higher at 3.7
City Union Bank with only Karur Vysya Bank higher at 79 cards / INR cr with the downloads / INR cr; balance 3 peers are at 1.8-2.8 downloads / INR cr.
remaining 3 key peers at 18-42 cards / INR cr.
Thus, we note that CUB is in the top 2 among key peers across all parameters
considered, implying greater traction for its digital strategy compared to key
peers. This implies lower opex cost for CUB, ceteris paribus, compared to peers.
N.B. We looked at October 2016 as the period for this analysis as we wanted to exclude the partly
transient impact of Demonetisation.

16 GWM
City Union Bank Ltd.

VIII. City Union Bank has middling asset quality and is not a Exposure to stressed sectors within peer range
We compare CUB’s exposure to key stressed sectors of the Indian economy
major concern and note that it is well within the peer range, indicating no significant
concern from an underlying asset quality perspective on this metric.
CUB’s asset quality is of middling nature and is not a major concern in absolute
terms. Credit exposure* to stressed sectors – H1FY17 - City Union Bank vs Key peers
Gross total stress—CUB versus peers (FY17)
25.0% 22.6% 22.9%
20.7%
20.0% 17.8%
2.0% 3.8% 17.0%

0.6% 15.0%
0.3%
0.3% 3.6%
2.8% 2.8% 10.0%
1.2% 1.6%

RBL Bank DCB Bank City Union Bank Karur Vysya Bank Lakshmi Vilas Bank 5.0%

GNPA Ratio Std. Restr. Ratio


0.0%
Source: Company Data; LVB data as of Q3FY17 DCB Bank RBL Bank City Union Bank Lakshmi Vilas Bank Karur Vysya Bank

While CUB’s headline GNPA ratio (as of FY17) is 2.8% compared to 1.2-3.6% for Metals Construction Gems & Jewellery Infra Mining Textiles Engineering
key peers, its gross stock of total stress (the sum of GNPA ratio and Standard
Restructured Assets Ratio) stands at 3.4% compared to peers’ 1.5-6.6%. Source: Company Data; *Loan book + Credit substitutes
Notably, Standard Restructured Assets Ratios for Karur Vysya Bank and Lakshmi
Vilas Bank at 2.0% and 3.8, respectively, are significantly higher than CUB’s I
0.6%.

Management commentary in the Q4FY17 results conference call with regard


to asset quality has been significantly positive, particularly on the recovery
front. Recovery in Q4FY17 was INR 56cr, which is the highest and 3 years and
this momentum, if it continues, could result in the bank making up for the lower
trading profit on high FY17 base. Recovery rate, at the portfolio level, has been
c.80% and this is expected to continue going forward.

17 GWM
City Union Bank Ltd.

We drew up a list of key stressed sectors of the Indian economy as follows: Credit exposure* to Metals and Infra—CUB versus peers (H1FY17)
Metals, Construction, Gems & Jewellery, Infra, Mining and Textiles. We note that 20.0%
CUB’s credit exposure to these stressed sectors stands at 20.7% of credit (loan
18.0%
book + credit substitutes) compared with 17-22.9% for key peers, indicating that
CUB is not undertaking any meaningful incremental risk from an underlying 16.0% 14.3%
sector perspective. 14.0%
12.0% 10.7%
We do note that the relative stress of each sector is not identical. Furthermore, 10.0%
we also acknowledge there would be differences across individual banks in 8.0% 6.6%
credit appraisal standards to the same sector. Additionally, credit risk across 5.6%
6.0%
projects within the same sector would also vary. Nevertheless, a sum of
respective exposures to these stressed secors gives us some sense of the 4.0% 2.6%
potential gross underlying stress for a given bank. 2.0%
0.0%
We further note that among the selected sectors, in terms of concentration risk, DCB Bank City Union Bank RBL Bank Karur Vysya Bank Lakshmi Vilas
Bank
City Union Bank’s exposure is the highest to Textiles at 10.3% of credit, which is
Metals Infra
expected given its main area of operation is Tamil Nadu.
Source: Company Data; *Loan book + Credit substitutes

Most importantly, we also note that City Union Bank’s credit exposure to the
We note that City Union Bank’s credit exposure to Metals and Infra is 5.6% of
two most stressed sectors of the Indian economy viz. Metals and Infra is lower
credit with DCB Bank at 2.6% and the remaining 3 key peers higher at 6.6-
than peers, barring DCB Bank. (Power and Telecom are subsumed in Infra
14.3%. The nature of Infra exposure, particularly expsoure to Power
exposure.)
Generation and Distribution, across peer banks considered may vary but this
exposure data was not available across banks and we have made the
apple-to-apple comparison based on data available.

From a 30,000 feet view, it is important to appreciate that CUB carries very
little of the loan book risk that has arisen in the wider banking sector from
exposure to large corporates (7% of FY17 loan book) in riskier sectors, project
financing of long-gestation projects (Working Capital Loans are 65% of loan
book) and concomitant consortium lending (c.1% of loan book). We shall
discuss these aspects and more in detail in the subsequent section. Hence,
to that extent, the possibility of the accretion of large lumpy corporate NPA
is low for CUB.

18 GWM
City Union Bank Ltd.

IX. CUB’s water-tight credit appraisal and lending approach also (5) Additional document – Any additional document that provides useful and
incremental knowledge about the business is also considered for credit
indicates sound underlying asset quality
appraisal. For example, stock (inventory) report for the business.

We looked deeply into CUB’s credital appraisal process and overall approach (6) Existing bank account – If a potential borrower already has an existing
to lending and note that they follow a fairly conservative process which bank account (savings / OD) with CUB, it is considered as an additional
precludes an outsized accretion of bad loans. input for the credit appraisal team. Such a bank account can provide
valuable information about the businessman’s cash flow profile in the past.
CUB requirements for making an MSME loan point to a water-tight credit
appraisal method Other factors in CUB’s overall lending approach provide underlying asset
quality comfort
(1) Income Tax Return filing of the last 3 years – While this may not be stressed
upon by lenders and NBFCs operating in the MSME space, IT Return filings (1) Focus on secured lending - It may be noted that as much as 99% of CUB’s
for last 3 years are viewed as critical by CUB. This enables CUB to make a lending is collateralised.
more informed decision about a businessman’s earning capacity and
analyse better the plausibility of cash flow projections of his business. The (2) Use of Personal Guarantee – CUB also often obtains personal guarantee
proportion of SME borrowers who submit IT Return filings are as much as along with collateral. This also acts as a deterrent reducing a borrower’s
c.80%. probabiliy of defaulting, ceteris paribus.

(2) Immovable propety as collateral – CUB has a strong preference for (3) Single banker relationships – CUB generally avoids consortium lending and
immovable property as collateral as opposed to movable property and opts for single-banker relationships instead. This helps them arrive at a
shares. Hence, the quality of collateral is superior for CUB loan assets. better understanding of their clients’ cash flows and liquidity position and
Usually, the immovable property in question is residential property. Not thereby, take more informed lending decisions. Consortium lending cases
only does immovable property provide sound value as collateral, its value amount to only about c.1% of total loan book.
to the borrower also acts as a deterrent and reduces the latter’s (4) Higher granularity in loan assets – The average ticket size of MSME loans is
probability of defaulting. Nearly all of the secured loan book is c.INR 33 lacs as opposed to c. INR 5 cr for larger private sector bank peers.
collateralised by immovable property. The average recovery rate for CUB This means their MSME exposure is ‘retail-like’ in nature and possesses a
is c.85% which compares very favourably with the national average of different risk profile compared to larger ticket MSME exposure, which
India at 26% (as per World Bank statistics). carries greater macro risk
(3) Project report (business plan) – This includes a description of the business (5) Focus on Working Capital lending – 63% of loan book is Working Capital
and estimation of cash flows for the business going forward. While, as a loans. This means that the macro risk present in term loans made during
standalone document, this would be of lesser value, when analysed in long-term project lending is low for CUB.
conjunction with the last 3 years’ Income Tax Return filings, it enables the
credit appraisal team to take a more informed decision about the
business proposal.
(4) CIBIL score – This is invariably downloaded from the relevant third-party
source on the basis of identity proof (PAN) submitted to CUB. A poor or
non-existant credit history translates into a low CIBIL score, which is not
viewed positively by the bank’s credit appraisal team

19 GWM
City Union Bank Ltd.

(6) Streamlined, centalised loan approval structure f. We note that, in the Indian credit market, the macro risk in Large
Corporate loan exposure is comparably higher than in other segments.
a. All loan proposals are placed at the branch level.
Such exposure is lower for CUB compared with key peers.
b. The loan proposals are then analysed by 10 loan processing centers. If
g. We also note differences in classification where, in contrast, for
the proposal is rejected, then no further action is taken. If approved,
example, RBL Bank classifies companies with turnover exceeding INR
the proposal is forwarded to the respective regional DGM, which is a
1500 cr under C&IB (Corporate and Investment Banking) and
very senior level functionary in CUB hierarchial nomenclature.
companies with turnover between INR 250 and INR 1500 cr under
c. Importantly, the regional DGM (each of whom may handle upto 50-75 Commercial Banking. The MSME piece falls under Branch and Business
branches) is located at the Head Office. This, in effect, means the loan Banking (which also contains loans to individual consumers) and this
approval is highly centralised in nature. consists of MSME players with turnover lower than INR 250 cr. This implies
that even the small headline exposure of 7% to Large Industries of CUB
d. An intranet software is in place that enables seamless exchange of is of a different (lower risk) nature than alternate classifications of the
information across the organisation. nature discussed above.
e. All loans others than Loans collateralised by Deposits (2% of Q3FY17
loan book) and Jewel Loans (9% of loan book) required centralised CUB’s credit appraisal process gives us comfort that it will tackle the GST
approval meaning 89% of loan book has undergone centralised situation admirably
approval. We think that CUB will remain largely unscathed from the impact of GST
implemention on the MSME sector given that it largely operates in that portion
(7) Low exposure to Large Corporate Loans of MSME that is already tax-compliant. A small portion of the bank’s MSME
borrowers may, as per a certain hypothesis, see a moderate margin shrinkage
a. The only loan exposure truly in the nature of Large Coporate Loans is but this is not likely to lead to significant incremental NPA accruals. There can,
the 7% exposure (as of Q3FY17) to Large Industries. The ‘Large however, be a significant impact on disbursement to the MSME sector since
Industries’ classification followed by CUB is as per the MSMED Act 2006 the borrowers may become preoccupied with onerous compliance
and classifies loans to companies with investment in plant and requirements but we believe that this is likely to be transient and not persist
machinery in excess of INR 5 cr as under Large Industries. with materiality beyond H1FY18.
b. Furthermore, consortium lending cases amount to only about c.1% of
total loan book.
c. The 5% Commerical Real Estate exposure is mostly to contractors with
ticket size usually ranging between INR 20-50 lacs. Builders are usually
not the category being lent to though there is some exposure to
builders with ticket sizes usually not exceeding c.INR 5 cr and going up
to INR 10 cr at the most.
d. The Infra exposure of 1% of loan book is mostly legacy exposure to SEB.
e. The NBFC expsoure of 1% of loan book consists of exposure to Mutual
Benefit Fund and other NBFC exposure.

20 GWM
City Union Bank Ltd.

Key financial indicators


X. Higher capital levels implies lower dilution compared with peers FY16 FY17 FY18E FY19E FY20E

CUB raised its Tier-1 capital to 16.03% in FY15 and has since maintained higher Net Interest Income 981 1199 1452 1701 2008
capital levels than peers. Other Income 410 484 542 608 702
Total Income 1391 1683 1994 2309 2710
Tier 1 Capital ratio—CUB versus peers (FY15-FY17) Operating Expenses 558 689 795 929 1056
18.0% Pre-Provisioning Operating Profit 833 994 1200 1380 1654
15.36%
16.0% Provisions excl for Tax 231 301 336 370 408
14.0% 12.54%
11.87% Profit Before Tax 603 693 863 1010 1246
11.40%
12.0%
Profit After Tax 445 503 639 748 922
10.0% 8.75%
Basic EPS 7.4 8.4 10.7 12.5 15.0
8.0%
P/E 24 21.0 16.6 14.2 11.8
6.0%
Book value per share 51 60 69 80 104
4.0%
P/B 3.5 3.0 2.6 2.2 1.7
2.0%
Provisions on Average Advances 1.2% 1.3% 1.3% 1.2% 1.1%
0.0%
City Union Bank Karur Vysya Bank DCB Bank RBL Bank Lakshmi Vilas Bank GNPA Ratio 2.41% 3.10% 2.70% 2.40% 2.30%

FY15 FY16 H1FY17 FY17 NNPA Ratio 1.53% 1.97% 1.71% 1.52% 1.46%
C/I Ratio 40% 41% 40% 40% 39%
Source: Company data
Yield on Avg Advances and Investments 11.4% 10.7% 10.7% 10.8% 10.9%
We evaluate Tier 1 Capital Ratio for comparison instead of Total Capital Ratio Cost of Average Deposits and Borrowings 7.6% 6.8% 6.5% 6.7% 7.0%
(CRAR) since the regulator emphasises on the former and there is a separate
minimum level for the same. Net Interest Margin 3.8% 4.1% 4.4% 4.4% 4.4%
Return on Average Assets 1.50% 1.51% 1.69% 1.72% 1.82%
Higher Tier 1 Capital Ratio of 15.4% for CUB compared with 8.7-12.5% for key Return on Average Equity 15.5% 15.2% 16.6% 16.8% 16.3%
peers implies lower dilution of existing shareholders going forward, ceteris paribus,
Source: Company data, Edelweiss Investment Research
compared with those for key peers.

21 GWM
City Union Bank Ltd.

P/B vs RoE—CUB versus expanded set of private sector peers


Valuation 3.6 3.5 3.4 3.2
4.0 27%
2.3 2.2 2.2
We use the Residual Income Valuation Model to value CUB. We assume a 1.8 1.7 1.6 1.5 1.4 18%
2.0 1.1 1.0
long-term risk-free rate of 7% for India, a Beta of 1.05 for CUB and an India 9%
Equity Risk Premium of 6% and arrive at an overall Cost of Equity of 13.3% for 0.0 0%
CUB. We arrive at a price target of INR220, at which the stock will trade at 2.7x

Karur Vysya

South Indian
City Union Bank

Axis Bank
RBL Bank
Kotak Mahindra

Indusind Bank

DCB Bank

IDFC Bank
HDFC Bank

Lakshmi Vilas

ICICI Bank
Yes Bank

Federal Bank
FY19E book value.

Bank

Bank
Bank
Bank
Valuation metrics
FY16 FY17 FY18E FY19E FY20E
Basic EPS 7.4 8.4 10.7 12.5 15.0 P/B (FY19E) Avg RoE (FY17-19E)
EPS growth 9% 13% 27% 17% 20%
Source: Edelweiss Investment Research, Bloomberg
P/E 23.8 21.0 16.6 14.2 11.8
Book value per share 51 60 69 80 104
We note that that all banks in our expanded universe which have an RoE of 14%
P/B 3.5 3.0 2.6 2.2 1.7
or higher, trade at a P/B of 3.2-3.6x except for City Union Bank, Yes Bank and
Return on Average Equity 15.5% 15.2% 16.6% 16.8% 16.3%
Lakshmi Vilas Bank, which trade at 2.2x, 2.3x and 1.6x, respectively. We examine
Source: Company data, Edelweiss Investment Research
RoA and implied Financial Leverage to get a clearer picture.
At CMP, CUB trades at P/B of 2.2x FY19E book, which we believe is attractive
The (P/B, RoA) pair also indicates undervaluation for CUB
given FY18E-20E RoE of 16-17%. Consequently, we believe the multiple of 2.7x
implied by our price target of INR 220 is reasonable. Since the average FY17-19E RoE is a period average, its value as a proxy for
sustainable long-term RoE is not necessarily all-encompassing. Hence, it is
The stock trades at P/E of 11.8x FY18E EPS for FY17-20E EPS CAGR of 21%. necessary to look at RoA, which indicates a bank’s underlying ability to sweat its
Hence, we conclude that CUB is attractive from P/E basis as well. assets to generate bottomline. When RoE is viewed in conjunction with RoA, we
get a better sense of the sustainability of the former, since an RoE achieved with
Is CUB a multiple re-rating candidate? We believe so high financial leverage indicates higher generic balance sheet risk and
concomitantly lower sustainability of RoE.
We carry out a multi-layered analysis to understand whether CUB deserves a
re-rating and find that a valuation gap exists between CUB’s FY19E P/B
multiple and what it should logically trade at. P/B vs RoA—CUB versus expanded set of private sector peers
3.6 3.5 3.4 3.2
4.0 2.7%
2.3 2.2 2.2
The (P/B, RoE) pair indicates undervaluation for CUB 1.8 1.7 1.6 1.5 1.4 1.8%
2.0 1.1 1.0
The (P/B, RoE) pair encapsulates all aspects of a bank’s internals and, 0.9%
theoretically, is sufficient to judge the bank’s valuation as long as the P/B is 0.0 0.0%
Mahindra …

calculated accurately and the RoE represents the accurate structural and

Karur Vysya
HDFC Bank

Yes Bank

Federal Bank

Lakshmi Vilas

ICICI Bank
Axis Bank

South Indian
RBL Bank

City Union

DCB Bank

IDFC Bank
Indusind Bank
Kotak

Bank
sustainable long-term RoE (the long-term growth rate of the “book” in the P/B

Bank

Bank
Bank
ratio).

We use the average FY17-19E RoE as a proxy for the sustainable long-term P/B (FY19E) Avg RoA (FY17-19E)
RoE for a bank and then compare the P/B multiples for a relevant private
Source: Edelweiss Investment Research, Bloomberg
sector banks’ universe.

22 GWM
City Union Bank Ltd.

We note that all banks in our universe which have an RoA of 1.6% of higher, P/AB+ (with incremental adjustment for unrecognized loan book stress)
trade at a P/B of 3.2-3.6x except for City Union Bank and Yes Bank. Lakshmi indicates undervaluation for CUB
Vilas falls significantly short of this RoA threshold with an RoA of 0.9% implying a
high Financial Leverage of 16.2x calling into question the sustainability of its RoE While the total stress recognized, measured as the sum of NNPA and Standard
of 15%. As for Yes Bank, it is unique in the banking universe as far as trading at Restructured Assets, is a reasonable measure of the quality of underwriting
its valuation for its return metrics. This has mostly to do with, among private standards, we must also provide for unrecognized stress. We do this by looking
largecaps, (a) the highest exposure to large corporate loans as a percentage at the credit exposures to two key stressed sector viz. Metals and Infra.
of loan book (68%) (b) high exposure to Infra and Metals sectors (c.12% of
H1FY17 credit) (c) the widest divergence with RBI with regard to NPA P/AB+ vs RoE—CUB versus expanded set of private sector peers
recognition.
5.0 3.9 28%
3.7 3.5
4.0 3.4
While Financial Leverage captures the overall potential generic balance sheet 21%
3.0 2.5 2.5 2.4 2.3 2.3 2.0 2.0 2.0
risk but to provide further colour on balance sheet risk, one needs to adjust for 1.5 1.4 14%
2.0
the quality of underwriting standards of banks. 1.0 7%
0.0 0%

Mahindra…
P/AB vs RoE—CUB versus expanded set of private sector peers

Karur Vysya
HDFC Bank

Yes Bank

Lakshmi Vilas

ICICI Bank
Axis Bank
RBL Bank

Federal Bank

South Indian
DCB Bank
City Union

IDFC Bank
Indusind Bank
Kotak

Bank
3.8 3.6

Bank
3.4

Bank
3.3

Bank
4.0 28%
3.0 2.4 2.4 2.3 2.1 2.1 21%
1.9 1.9 1.8
2.0 1.3 1.2 14%
1.0 7%
0.0 0% P/AB+ (FY19E) Avg RoE (FY17-19E)
City Union Bank

Axis Bank
RBL Bank

Lakshmi Vilas Bank


Kotak Mahindra

Indusind Bank

DCB Bank

IDFC Bank
ICICI Bank

South Indian Bank


HDFC Bank

Yes Bank

Federal Bank

Karur Vysya Bank


Source: Edelweiss Investment Research, Bloomberg
Bank

We adjust the book value further by 10% of Metals credit exposure and 5% of
Infra credit exposure and designate the same Adjusted Book Value+ (or AB+).
We understand the limitation of this exercise as headline Metals exposure
P/AB (FY19E) Avg RoE (FY17-19E) across banks may not be similar but this is done as best approximation. We treat
this as possible incremental recognition that is not currently part of recognized
Source: Edelweiss Investment Research, Bloomberg
stress and, to that extent, there is no overlap.
The adjustment for the quality of underwriting standards is achieved by
adjusting the book balue for Net NPA and Standard Restructured Assets book. The P/AB+ is the valuation mutiple of the respective bank having adjusted for
We adjust for 100% of Net NPA (since Net NPA has not been provided for) and recognized and certain unrecognized stress. We note that that all banks in our
25% of Standard Restructured Assets. expanded universe which have an RoE of 14% or higher, trade at a P/AB+ of
3.4-3.9x except for City Union Bank, Yes Bank and Lakshmi Vilas Bank, which
We note that that all banks in our expanded universe which have an RoE of trade at 2.5x, 2.5x and 2.4x, respectively. Given that Lakshmi Vilas Bank’s
14% or higher, trade at a P/AB of 2.4-3.8x except for City Union Bank, Yes Bank implied financial leverage of 16.2x is prohibitively high and Yes Bank has
and Lakshmi Vilas Bank, which trade at 2.4x, 2.4x and 2.1x, respectively. We idiosyncratic issues, we find that CUB is the most undervalued bank in our
note again that the analysis here does not account for the risk of high financial choice set on the basis of the our comprehensive set of valuation metrics as
leverage whereas an RoA-only analysis would have ignored the greater laid out in our extended analysis above.
significance of RoE, the direct driver of shareholder value.

23 GWM
City Union Bank Ltd.

Financials
Income Statement (INR cr) Balance Sheet (INR cr)
Year to March FY16 FY17 FY18E FY19E FY20E As on 31st March FY16 FY17 FY18E FY19E FY20E
Interest income 2,944 3,174 3,604 4,232 5,067 CAPITAL AND LIABILITIES
Interest charges 1,963 1,975 2,151 2,531 3,058 Share Capital 60 60 60 60 63
Net interest income 981 1,199 1,452 1,701 2,008 Reserv es and Surplus 2,992 3,510 4,068 4,735 6,479
Other income 410 484 542 608 702 Deposits 27,158 30,116 34,550 40,212 46,567
Net rev enues 1,391 1,683 1,994 2,309 2,710 Borrowings 113 531 531 531 531
Operating expense 558 689 795 929 1,056 Other Liabilities & Prov isions 929 1,054 1,054 1,054 1,054
- Em ployee exp 214 299 359 430 495 Total 31,252 35,271 40,263 46,592 54,694
- Depreciation / am ortisation 52 54 54 62 71 ASSETS
- Other opex 291 336 382 436 490 Cash and Balances with RBI 1,363 1,484 1,633 1,796 1,975
Preprov ision op. profit 833 994 1,200 1,380 1,654 Balances with Banks & Call Money 1,238 1,395 1,534 1,688 1,856
Prov isions 231 301 336 370 408 Inv estments 6,324 7,031 7,693 8,420 9,220
PBT 603 693 863 1,010 1,246 Adv ances 21,057 23,833 27,884 33,740 40,488
Taxes 158 190 224 263 324 Fixed Assets 218 215 247 284 327
PAT 445 503 639 748 922 Other Assets 1,053 1,313 1,272 664 827
Extraordinaries 0 0 0 0 0 Total 31,252 35,271 40,263 46,592 54,694
Reported PAT 445 503 639 748 922
Basic number of shares (cr.) 59.8 59.8 59.8 59.8 61.3 RoAE Decomposition
Basic EPS (INR) 7.43 8.40 10.68 12.50 15.03 Year to March FY16 FY17 FY18E FY19E FY20E
Diluted number of shares (cr.) 61.2 61.2 61.2 61.2 62.7 Net Interest Income / Assets 3.3% 3.6% 3.8% 3.9% 4.0%
Diluted EPS (INR) 7.27 8.22 10.44 12.22 14.70 Other Income / Assets 1.4% 1.5% 1.4% 1.4% 1.4%
Net Rev enues / Assets 4.7% 5.1% 5.3% 5.3% 5.4%
Growth Ratios Operating Expense / Assets 1.9% 2.1% 2.1% 2.1% 2.1%
Year to March FY16 FY17 FY18E FY19E FY20E Prov isions / Assets 0.8% 0.9% 0.9% 0.9% 0.8%
NII growth 22% 22% 21% 17% 18% Taxes / Assets 0.5% 0.6% 0.6% 0.6% 0.6%
Net Rev enues growth 15% 21% 19% 16% 17% Total Costs / Assets 3.2% 3.5% 3.6% 3.6% 3.5%
Opex growth 7% 24% 15% 17% 14% Return on Assets 1.5% 1.5% 1.7% 1.7% 1.8%
PPOP growth 20% 19% 21% 15% 20% Assets / Equity 10.3 10.0 9.8 9.7 8.9
Prov isions growth 26% 31% 12% 10% 10% Return on Av erage Equity 15.5% 15.2% 16.6% 16.8% 16.3%
PAT growth 13% 13% 27% 17% 23%
Valuation Metrics
Operating Ratios Year to March FY16 FY17 FY18E FY19E FY20E
Year to March FY16 FY17 FY18E FY19E FY20E Basic EPS 7.4 8.4 10.7 12.5 15.0
Yield on Av erage Adv ances and Inv estments 11.4% 10.7% 10.7% 10.8% 10.9% EPS growth 9% 13% 27% 17% 20%
Cost of Av erage Deposits and Borrowings 7.6% 6.8% 6.5% 6.7% 7.0% Book v alue per share 51 60 69 80 104
Spread 3.7% 3.9% 4.2% 4.1% 4.0% Basic P/E 23.8 21.0 16.6 14.2 11.8
Net Interest Margin 3.8% 4.1% 4.4% 4.4% 4.4% Price - to - Book 3.5 3.0 2.6 2.2 1.7
Cost to Income Ratio 40% 41% 40% 40% 39%
Tax Rate 26% 27% 26% 26% 26%

24 GWM
City Union Bank Ltd.

Edelweiss Broking Limited, 1st Floor, Tower 3, Wing B, Kohinoor City Mall, Kohinoor City, Kirol Road, Kurla(W)
Board: (91-22) 4272 2200

Vinay Khattar

Head Research

vinay.khattar@edelweissfin.com

Rating Expected to

Buy appreciate more than 15% over a 12-month period

Hold appreciate between 5-15% over a 12-month period

Reduce Return below 5% over a 12-month period

City Union Bank 5 years price chart

200

160

120

80

40

0
May-13

May-14

May-15

May-16

May-17
Sep-13

Sep-14

Sep-15

Sep-16
Mar-13

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25 GWM
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26 GWM
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28 GWM