JM Financial - Indian Banking Sector - Mid Sized Private Banks - Winds of Change (Sector Initiation) (DCB, Federal, CUB)

th
06 November 2017 India | Indian Banking Sector | Sector Report
Indian Banking Sector

Mid sized private banks - Winds of change
We initiate coverage on three private sector banks DCB Bank (DCB), Federal Bank (FB) and
Sameer Bhise
City Union Bank (CUB) with BUY ratings. Our core investment thesis stems from the belief sameer.bhise@jmfl.com | Tel: (91 22) 66303489
that these banks should continue to record steady improvement in profitability (DCB, FB) as Jayant Kharote
growth remains healthy and efficiency measures come to fruition. Within a host of jayant.kharote@jmfl.com | Tel: (91 22) 66303099
smaller/mid-sized private sector lenders, we like these three given their a) healthy capital S Parameswaran
adequacy levels (average Tier-1 at 14.5%), b) lower stock of stressed assets that are already s.parameswaran@jmfl.com | Tel: (91 22) 66303075
past their peak and c) management reward structures that are comparable with larger Karan Singh CFA FRM
karan.uberoi@jmfl.com | Tel: (91 22) 66303082
successful franchises. We build RoA expansion of 23bps-31bps for FB/DCB over FY17-FY20E,
Nikhil Walecha
while CUB should continue with its ahead-of-peers RoA profile, averaging 160 bps over the nikhil.walecha@jmfl.com | Tel: (91 22) 66303027
same period. We forecast earnings to post 31%-35% CAGR over FY17-FY20E for FB and Bunny Babjee
DCB and expect 17% CAGR for CUB. While valuations may appear expensive in light of bunny.babjee@jmfl.com | Tel: (91 22) 66303263
modest near-term RoEs (especially for DCB and FB) currently, we see stock performance to
track profitability expansion that will be back-ended in nature over the next 24 months.
Among the three, we see highest upside for DCB Bank at 27%.
Operating profitability should inch up; growth not a challenge: FB and DCB have
suffered accentuated pressure on core profitability over the past few years, driven by
rapid branch expansion and asset quality pressures, respectively, which also manifested in
slower loan growth. We believe both banks are now past these challenges and should
Target
record improvement in operating profitability going forward. We expect 27bps -34bps Company Reco. CMP price Upside
improvement in PPOP/average assets over FY17-FY20E for FB and DCB, respectively. On DCB BUY 181 230 27.1%
the growth front, similar to their large private peers, structural opportunities continue to FB BUY 116 140 20.7%
exist for market share gains from PSU banks. Also, regional dominance for FB/CUB, along CUB BUY 163 185 13.5%
with growing presence outside home markets and the recently-completed branch
expansion for DCB will ensure that growth is not a challenge for these banks in the near
term. We build a loan book CAGR of 23%/25%/16% over FY17-FY20E for FB/DCB/CUB,
respectively
Low baggage of stressed assets; comfortable capital levels: The worst asset quality pains
for FB and CUB (emerging from their corporate exposures) have now passed and
slippages as well as credit costs should trend lower going forward. DCB, on the other
hand, has a fairly granular asset quality portfolio, which is primarily retail in nature. A
15bps-20bps decline in credit costs should aid profitability improvement for DCB/CUB
over FY17-FY20E, in our view. All three banks remain adequately capitalised (average
Tier-1 of 14.5%) without any dilution risk in the near term. JM Financial Research is also available on:
Bloomberg - JMFR <GO>,
RoA expansion to be back-ended over FY17-FY20E; rerating to follow: Driven by Thomson Publisher & Reuters
operational efficiencies and reduced asset quality stress, RoAs for FB/DCB are likely to S&P Capital IQ and FactSet
expand 23bps / 31bps over FY17-FY20E and RoEs are expected to increase by 3%-5%.
Improved return profiles, along with a stable earnings outlook, are likely to drive multiple Please see Appendix I at the end of this
rerating instances for both these banks. Even CUB is expected to improve its already report for Important Disclosures and
ahead-of-peers RoAs by c.12bps over FY17-FY20E, because of which, its premium Disclaimers and Research Analyst
Certification.
valuations are unlikely to de-rate, making it a healthy compounding play.
Exhibit 1. Valuation and financial summary

DCB FB CUB
FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E
EPS 8.8 11.8 16.0 5.8 7.5 9.6 8.6 10.5 12.2
BVPS 84.6 96.4 112.4 63.7 70.1 78.6 60.7 68.6 78.2
ROE (%) 11.9% 13.1% 15.3% 10.6% 11.2% 12.9% 15.1% 16.3% 16.6%
ROA (%) 1.02% 1.12% 1.24% 0.89% 0.95% 1.02% 1.52% 1.61% 1.62%
P/BV 2.1 1.9 1.6 1.8 1.7 1.5 2.7 2.4 2.1
Price to earnings (P/E) 20.7 15.3 11.3 19.9 15.5 12.1 18.9 15.5 13.4
EPS CAGR (%) 32% 26% 13%
BVPS CAGR (%) 18% 15% 10%
Source: Company, JM Financial
JM Financial Institutional Securities Limited

Indian Banking Sector 06 November 2017
Table of Contents
Contents Page No.

Indian Banks valuation matrix 3
Companies Section
DCB Bank (BUY, TP INR 230, 27.0% Upside) 13
Federal Bank (BUY, TP INR 140, 20.7% Upside) 24
City Union Bank (BUY, TP INR 185, 12.5% Upside) 34
JM Financial Institutional Securities Limited Page 2

Exhibit 2. JMFL : Indian Banks valuation matrix

Target
Rec Target Upside
Company Price Mkt Cap P/E (x) P/B (x) ROE P/B
(Rs) FY19E (x)
($mn) FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E
Government Banks
Bank of Baroda 175 6,225 29 17 10 1.1 1.0 1.0 3.8% 6.4% 9.9% BUY 190 1.0 9%
Punjab National Bank 206 6,755 33 49 15 1.1 1.1 1.1 3.6% 2.4% 7.4% HOLD 190 1.0 -8%
State Bank of India (Cons) 327 43,507 1079 30 14 1.4 1.4 1.3 0.1% 4.9% 9.1% BUY 360 1.4 10%
Canara Bank 406 3,741 22 16 9 0.9 0.8 0.7 4.1% 5.3% 8.7% SELL 375 0.7 -8%
Private Banks
Axis Bank 537 19,884 35 28 19 2.3 2.2 2.0 6.8% 8.1% 11.0% HOLD 475 1.8 -12%
HDFC Bank 1,833 73,201 32 27 22 5.3 4.6 3.9 17.9% 18.2% 19.3% BUY 2000 4.3 9%
ICICI Bank (Cons) 316 31,337 20 17 12 2.0 1.9 1.7 10.6% 11.5% 14.2% BUY 340 1.8 7%
KMB (Cons) 1,004 29,510 37 32 26 4.8 3.8 3.3 13.8% 13.5% 13.9% BUY 1075 3.6 7%
Yes Bank 327 11,560 22 17 14 3.4 2.9 2.4 18.6% 18.0% 19.0% BUY 390 2.9 19%
Indusind Bank 1,655 15,308 35 30 20 4.9 4.1 3.5 15.3% 15.7% 18.6% BUY 2120 4.5 28%
Federal Bank 118 3,563 25 20 16 2.3 1.9 1.7 9.8% 10.6% 11.2% BUY 140 2.0 18%
DCB 181 862 26 21 15 2.7 2.1 1.9 10.8% 11.9% 13.1% BUY 230 2.4 27%
City Union Bank 163 1,661 19 19 15 2.7 2.7 2.4 15.2% 15.1% 16.3% BUY 185 2.7 14%
Source: Company, JM Financial, Prices as on 6/Nov/2017
Exhibit 3. JMFL : Indian Banks valuation matrix
Company BVPS EPS EPS Growth ROA
FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E FY17 FY18E FY19E
Government Banks
Bank of Baroda 159 168 184 6 10 17 -126% 74% 68% 0.2% 0.3% 0.5%
Punjab National Bank 179 182 194 6 4 14 -131% -32% 228% 0.2% 0.1% 0.4%
State Bank of India (Cons) 228 241 260 0 11 23 -98% 3551% 106% 0.0% 0.3% 0.5%
Canara Bank 474 500 546 19 26 46 -136% 39% 75% 0.2% 0.3% 0.4%
Private Banks
Axis Bank 233 247 270 15 19 28 -55% 26% 47% 0.6% 0.7% 0.9%
HDFC Bank 349 401 466 57 68 84 17% 20% 23% 1.9% 1.8% 1.9%
ICICI Bank (Cons) 158 170 188 16 19 25 -9% 19% 34% 1.1% 1.2% 1.4%
KMB (Cons) 209 263 302 27 31 39 42% 17% 25% 1.9% 2.0% 2.1%
Yes Bank 97 113 134 15 19 24 21% 30% 24% 1.8% 1.8% 1.8%
Indusind Bank 339 403 472 48 54 81 25% 14% 49% 1.8% 1.8% 2.1%
Federal Bank 52 64 70 5 6 7 74% 21% 28% 0.8% 0.9% 0.9%
DCB 68 85 96 7 9 12 2% 25% 35% 0.9% 1.0% 1.1%
City Union Bank 59 61 69 8 9 11 13% 3% 22% 1.5% 1.5% 1.6%
Source: Company, JM Financial, Prices as on 6/Nov/2017

Initiate coverage with a positive stance

We initiate coverage on three private sector banks City Union Bank (CUB), DCB Bank (DCB)
and Federal Bank (FB) with a favourable stance and ascribe a BUY rating to all three. We
believe the investment case in small/mid-sized private sector banks has become stronger over
the past 12-18 months, given the structural challenges that PSU banks are facing.
We believe market share gains are now easier to come by than in the past and thus, benefits
of scale will reflect faster on profitability than was the case during FY11-FY14.
However, among a host of old/mid-sized private sector lenders, we prefer to be selective and
like the aforementioned three given the a) right alignment of management and employees
interests with those of shareholders through ESOP grants; b) successful execution of niche
models over the past 2-3 years that are now ready to be scaled up and c) efficiency measures
that were long under implementation should now bear fruition and drive profitability higher
(especially for DCB and FB).
Exhibit 4. Key metrics for small/mid-sized banks as on FY17 (%)

As on FY17 KVB SIB FBl DCB CUB
GNPA 3.6% 2.5% 2.3% 1.6% 2.8%
Net NPA 2.5% 1.5% 1.3% 0.8% 1.7%
Cost to income 49% 49% 53% 60% 41%
RoE 12.6% 9.4% 9.8% 10.8% 15.2%
RoA 1.01% 0.57% 0.79% 0.93% 1.50%
These banks do not have the baggage of high stressed assets like some larger private sector
peers and the impact of exposures to troubled NCLT cases is likely to be limited.
Consequently, we expect credit costs to come down by FY19E, unlike the larger corporate
banks (and PSU banks), where we expect elevated credit costs. Moreover, strong capital
adequacy levels cushion the three names mentioned above and should provide the right
ammunition to keep growth strong over the next 18-24 months.
In our view, these banks should transition to greater profitability levels by end-FY19 and the
sharp uptick will be visible in FY20E. The expansion will be driven by lower opex ratios and
normalisation of credit costs. We build RoA expansion of 23bps-31bps for FB and DCB and
expect CUBs RoA to expand to 1.62% by FY20E. Our profit estimates for these three banks
are 2%-10% above consensus for FY18-FY19E. The ability to generate greater fees remains a
key upside opportunity for RoA trajectory.
Exhibit 5. FY17-FY20 estimates for DCB, CUB and FB

FY17 FY18 FY19 FY20 CAGR CAGR
Earnings Per Share - EPS (INR) (FY17-19E) (FY17-20E)
CUB 8.4 8.6 10.5 12.2 12% 13%
DCB 7.0 8.8 11.8 16.0 30% 32%
FB 4.8 5.8 7.5 9.6 25% 26%
Book value per share - BVPS (INR)

CUB 59.4 60.7 68.6 78.2 7% 10%
DCB 68.2 84.6 96.4 112.4 19% 18%
FB 51.8 63.7 70.1 78.6 16% 15%
ROE (%)
CUB 15.2% 15.1% 16.3% 16.6%
DCB 10.8% 11.9% 13.1% 15.3%
FB 9.8% 10.6% 11.2% 12.9%
ROA (%)
CUB 1.50% 1.52% 1.61% 1.62%
DCB 0.93% 1.02% 1.12% 1.24%
FB 0.79% 0.89% 0.95% 1.02%

Low operating profitability has historically been a challenge

A closer look at the DuPont comparison of the old/mid-sized lenders vs. some larger (and
more profitable) private banks indicates that key impediments to sub-optimal profitability
were relatively modest fee streams and high operating costs (in particular, DCB bank), which
led to a weak PPOP profile. Larger private sector banks boast of a strong fee base and
reasonably strong NIMs.
Exhibit 6. FY17 Du Pont comparison (%)

FY17 DCB CUB FB HDFCB KMB IIB
NII / Assets (%) 3.72% 3.57% 2.91% 4.21% 3.99% 3.81%
Core other income / Assets (%) 0.95% 1.12% 0.74% 1.42% 1.38% 2.45%
Other income / Assets (%) 1.16% 1.44% 1.03% 1.56% 1.71% 2.62%
Total Income / Assets (%) 4.88% 5.02% 3.95% 5.78% 5.70% 6.44%
Employee Cost to Assets (%) 1.44% 0.89% 1.11% 0.82% 1.36% 0.96%
Other Cost to Assets (%) 1.49% 1.17% 1.00% 1.68% 1.40% 2.05%
Cost to Assets (%) 2.93% 2.05% 2.11% 2.51% 2.76% 3.01%
PPP / Assets (%) 1.95% 2.96% 1.84% 3.27% 2.94% 3.43%
Provisions / Assets (%) 0.52% 0.90% 0.59% 0.46% 0.41% 0.69%
PBT / Assets (%) 1.43% 2.07% 1.25% 2.82% 2.53% 2.74%
Core ROA (%) 0.93% 1.50% 0.79% 1.85% 1.68% 1.80%
ROA (%) 0.93% 1.50% 0.79% 1.85% 1.68% 1.80%
Exhibit 7. FY19E Du Pont comparison (%)

FY19E DCB CUB FB HDFCB KMB IIB
NII / Assets (%) 3.84% 3.62% 2.98% 4.26% 3.97% 4.41%
Core other income / Assets (%) 0.97% 1.04% 0.79% 1.31% 1.60% 2.49%
Other income / Assets (%) 1.08% 1.21% 0.93% 1.36% 1.84% 2.58%
Total Income / Assets (%) 4.93% 4.82% 3.91% 5.63% 5.81% 6.99%
Employee Cost to Assets (%) 1.37% 0.82% 0.95% 0.72% 1.32% 1.22%
Other Cost to Assets (%) 1.40% 1.12% 0.95% 1.56% 1.35% 2.03%
Cost to Assets (%) 2.77% 1.93% 1.90% 2.28% 2.67% 3.25%
PPP / Assets (%) 2.16% 2.89% 2.01% 3.34% 3.14% 3.74%
Provisions / Assets (%) 0.46% 0.71% 0.56% 0.48% 0.41% 0.55%
PBT / Assets (%) 1.69% 2.18% 1.45% 2.87% 2.73% 3.19%
Core ROA (%) 1.12% 1.61% 0.95% 1.89% 1.79% 2.11%
ROA (%) 1.12% 1.61% 0.95% 1.89% 1.79% 2.11%
.accentuated further by a tough credit environment

The problems of lower operating profitability were magnified when asset quality
deteriorated. Especially with FB, high credit costs impacted overall profitability and dragged
its ROA profile lower. While credit costs inched up for CUB as well, RoA was largely protected
driven by a sharp expansion in NIMs as cost of funds declined sharply over this period. DCB,
on the other hand, has managed to contain credit costs given its highly granular portfolio,
almost nil participation in large consortium lending and limited exposure to troubled sectors
during the past cycle.
Exhibit 8. Credit costs have impacted profitability (%)

Credit cost (bps) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
DCB 1.9% 4.1% 3.4% 1.3% 0.6% 0.3% 0.5% 0.5% 0.5% 0.6%
CUB 0.7% 0.7% 0.8% 0.8% 0.5% 0.7% 0.9% 1.0% 1.1% 1.1%
FB 1.1% 1.7% 1.7% 1.7% 0.6% 0.5% 0.5% 0.4% 1.0% 0.6%

However, efficiency measures should now bear fruition

This pertains specifically to FB and DCB, where we believe efficiency measures will now begin
to have a positive impact of profitability. Both banks, while totally different in terms of scale
and business models, suffered accentuated pressure on core profitability during the past few
years. At DCB, it was driven by a rapid branch expansion strategy (2x in 24 months) to
achieve the right scale from a medium-term perspective. On the other hand, at FB, it was due
to asset quality pressures in the corporate book (credit costs surged 102bps in FY16), which
also manifested in slower loan growth.
We believe both banks are past these challenges now and should record improvement in
profitability as a) DCBs branch investments start paying off and b) revenues scale up aided by
improvement in fees. In addition, declining credit costs too will aid RoA expansion.
Exhibit 9. DCB: Declining trend in cost-to-income Exhibit 10. DCB: Opex growth moderation
Cost to Income (%) 30%
100%
25% 28%
90%
24% 24%
20% 23%
80% 75%
71%
69%
15% 17%
70% 63% 16%
59% 58% 60% 59% 15% 15%
56% 10%
60% 53% 12%
5%
50% 7%
40% 0%
FY18E
FY19E
FY20E
FY15
FY11
FY12
FY13
FY14
FY16
FY17
FY18E
FY19E
FY20E
FY13
FY14
FY11
FY12
FY15
FY16
FY17
Source: Company, JM Financial Source: Company, JM Financial
Exhibit 11. FB: Improving asset quality trends Exhibit 12. FB: Credit costs (bps) trends to moderate
GNPA Std Rest SRs Other impairments LLP (ex- prov for std. adv.) (bps)
10% 210
9.0% 9.2%
9%
7.6% 180
8%
7% 150 167 166
6% 5.5% 5.6% 5.6%
120
5%
90
4% 102
3% 60
64 65 70
2% 62 62
30 46 52
1% 40
0
0%
FY18E
FY19E
FY20E
FY14
FY15
FY10
FY11
FY12
FY13
FY16
FY17
FY13 FY14 FY15 FY16 FY17 1QFY18
Growth not a challenge anymore

The fact that private banks are the real beneficiary of PSU banks challenges with respect to
a) stressed assets, b) growth capital and c) management bandwidth is no secret. However,
the sheer magnitude of the opportunity on offer is amplified when we take a look at the
market share of some smaller private lenders.
From the small/mid-sized bank set of Karur Vysya Bank (KVB), South Indian Bank (SIB), CUB,
FB and DCB, four of them (except DCB which has a pan-India presence), have a regional focus
on South India, with strong presence in their own home states: about half of SIB and FBs
branches are in Kerala, and about half and two-third, respectively, of KVB and CUBs
branches are in Tamil Nadu. The overall market share of all these 5 midcap banks outlined in
Exhibits 11 and 12 is only c.2.4% of both system loans and deposits.

Exhibit 13. Loans market share Exhibit 14. Deposit market share
FY13 FY14 FY15 FY16 FY17 FY13 FY14 FY15 FY16 FY17
1.0% 1.0%
0.88% 0.87%
0.8% 0.8%
0.56% 0.59%
0.6% 0.49% 0.6%
0.48%
0.4% 0.4%
0.29% 0.27%
0.19% 0.17%
0.2% 0.2%
0.0% 0.0%
KVB SIB Federal DCB CUB KVB SIB Federal DCB CUB
Source: RBI, Company, JM Financial Source: RBI, Company, JM Financial
Of course, a regional focus would imply that they are limited by their geographies, but we
argue that incrementally this is not the case for all. The largest of these FB ventured
outside its home base of Kerala to grow its loan book: 80% of its corporate loan book is now
ex-Kerala. DCB is a pan-India corporate lender. The advent of digital channels of distribution
implies that these banks are not constrained by geography even for retail products. About
45% of FBs retail loan book is ex-Kerala and growing faster than its Kerala-based retail loan
book. For CUB, 36% of its total loan book is ex-Tamil Nadu.
Exhibit 15. Loan growth trends continue to remain strong

Loan growth YoY (%) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
DCB 23.5% 23.7% 24.6% 23.6% 28.6% 23.5% 22.4% 26.0% 25.0% 24.0%
CUB 35.4% 31.1% 25.6% 5.6% 11.6% 17.2% 13.2% 15.0% 16.0% 17.0%
FB 18.6% 18.2% 16.8% -1.5% 18.1% 13.3% 26.2% 24.0% 23.0% 21.0%
Exhibit 16. CASA market share Exhibit 17. Branch market share
0.9% 1.2%
0.8% 0.78%
1.0%
0.7% 0.87%
0.6% 0.8%
0.5% 0.59%
0.36% 0.38% 0.6% 0.49%
0.4%
0.38%
0.3% 0.4%
0.2% 0.17% 0.18%
0.11%
0.2%
0.1%
0.0% 0.0%
KVB SIB Federal DCB CUB KVB SIB Federal DCB CUB
Source: RBI, Company, JM Financial Source: RBI, Company, JM Financial
Aggresion by PSU banks remain a key risk to growth: Post the recent policy announcement of
recapitalisation in PSU banks, (SOE Banks | Recapitalisation bonds a new lease of life? )a
major risk in form of increased competition has emerged for these banks. However, as per
our calculations, the quantum of capital announced for PSU banks is merely meeting its
provisioning requirements leaving little on the table as growth capital. Also, most of these
PSU banks do not have strong underwriting capability and understanding for lending to the
small businesses and may not enter the space aggressively. However, any intervention by GOI
in terms of directed lending to MSMEs under MUDRA etc can be major risk to growth for
these banks.

Stressed assets low baggage, no major casualties expected

We believe the three small/mid-sized lenders compare favourably with larger corporate
lenders from PSUs as well as the private sector. FB and CUB were impacted by some of their
corporate exposures in FY16 and FY17. However, large, chunky exposures to troubled sectors
have been already recognised or included in their watch-lists. Therefore, for FB and CUB, we
do not expect any major negative shocks with respect to corporate asset quality, outside the
guided watch-list.
In our view, having identified and provided against the risky exposures over FY16-17, the
worst asset quality pains for FB and CUB have now passed and slippages as well as credit
costs should trend lower going forward. DCB, on the other hand, has a fairly granular asset
quality portfolio, which is primarily retail in nature. As a result, asset quality has held up fairly
well. A decline in credit costs should aid profitability improvement over the next few years, in
our view.
Exhibit 18. Midcap banks: Exposure to stressed sectors

As on 1QFY18 FB CUB DCB
Total funded exposure (INR mn) 914,043 276,912 185,142
Sensitive sectors
Steel 11,627 10,530 3,056
Power 14,790
Infra (ex -power) 47,758 1,842 1,776
Construction 1,146 9,713 16,190
Textile 14,720 30,028 5,158
Telecom 5,399
Real estate 3,274
Total 95,440 52,112 29,454
As a % of total funded exposure 10.4% 18.8% 15.9%
Exhibit 19. Total stress on books as on 1QFY18 (% of loan book)

Stressed Assets GNPA (%) Std Rest (%) Other impaired (%) Watch-list (%) Total impaired (%)
AXSB 5.5% 1.4% 2.0% 2.5% 11.4%
ICICI 9.0% 0.5% 2.3% 5.4% 17.1%
HDFCB 1.2% 0.0% 0.0% 0.0% 1.2%
KMB 2.6% 0.1% 0.0% 0.0% 2.6%
IIB 1.1% 0.2% 0.3% 0.0% 1.6%
CUB 3.0% 0.6% 1.4% 0.5% 5.5%

DCB 1.7% 0.0% 0.0% 0.0% 1.7%
Federal 2.4% 1.5% 1.7% 0.0% 5.6%
Exhibit 20. Corporate downcycle led to higher LLP over FY14-FY17 Exhibit 21. LLP to stabilise/come off for mid-sized lenders.
FY15 FY16 FY17 FY16 FY17 FY18E FY19E FY20E
3.5%
3.1% 3.3% 1.4%
3.0% 1.2% 1.2%
1.1% 1.0%
2.5% 1.0% 0.9%
2.0%
0.8% 0.7%
0.7%
1.5% 0.6%
1.1% 0.6% 0.5%
0.6% 0.5%
1.0% 0.7%
0.6% 0.6% 0.4%
0.5%
0.5%
0.2%
0.0%
0.0%
AXSB ICICI HDFCB KMB IIB CUB DCB Federal
CUB DCB Federal

Exhibit 22. . Elevated GNPA ratios to decline over the next 2yrs Exhibit 23. Improving coverage to also bring down NNPA
3.0% FY16 FY17 FY18E FY19E FY20E 60% FY16 FY17 FY18E FY19E FY20E
2.8% 52% 52% 51%
2.4% 49% 47%
2.5% 2.2% 2.3% 50% 45%
2.0% 40%
1.5% 1.5%
1.5% 30%
1.0% 20%
0.5% 10%
0.0% 0%
CUB DCB Federal CUB DCB Federal
Capital - ample for growth

Unlike some other old/mid-sized private sector banks, these three banks have comfortable
capital adequacy, which should continue to support growth over the next few years.These
banks compare favourably to other old/mid-sized lenders with respect to capital adequacy
and their capital levels are almost similar to those of larger private sector lenders.
Exhibit 24. Midcap banks well capitalised compared with large Pvt. Peers (1QFY18)
CET1 AT1
25%
20% 18.4%
15.7% 14.6% 15.4% 14.7%
15% 13.6% 13.8% 12.6% 13.4%
10%
5%
0%
HDFCB IIB KMB YES ICICIBC AXSB CUB DCB Federal
Deposit Franchise
CUB and DCB have room for improvement on the CASA front, as can be seen in the
comparison with leading private banks. This is reflective of their fledgling retail franchises vs.
FB which has a higher CASA and more granular deposits (Exhibit 25), and is likely to improve
as they scale up (FBs loan book is 3x of CUB, 4x of DCB). All 3 banks offer 4% on SA
balances.
Exhibit 25. FB, CUB have granular deposits like leading pvt. peers Exhibit 26. CASA: CUB and DCB have room for improvement
Top 20 deposits as % of total deposits (as of FY17) CASA (%) (1QFY18)
30% 60%
25.0% 49.0%
49.2%
25% 50% 44.0% 43.9%
37.8% 36.8%
20% 40%
33.4%
13.8% 26.9%
15% 30%
11.1% 11.6% 23.3%
9.8% 9.7%
10% 7.0% 20%
5.0% 5.5%
5% 10%
0% 0%
FB CUB DCB IIB YES AXSB ICICI HDFCB KMB FB CUB DCB IIB YES AXSB ICICI HDFCB KMB

Management reward structures are comparable with leading

private banks
One of the key reasons for our positive stance on these three private banks is the
management reward structure. ESOP grants now form a significant proportion of top
executives compensation at these banks and overall ESOP grants, too, have been significantly
high.
In fact, ESOP grants at these three banks are the highest among the old/mid-sized private
sector banks (except RBL Bank). ESOPs outstanding at DCB and FB are almost comparable
with those of leading private sector banks such as IndusInd and Yes Bank.
We are fundamentally strong proponents of the ESOP-led reward structure, having seen
strong benefits play through for minority shareholders at IndusInd, and to a certain extent at
RBL Bank.
Exhibit 27. DCB, CUB and FB have significantly higher ESOP grants compared with peers
ESOPs o/s (% of shared o/s) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
SIB 0.0% 0.0% 2.7% 2.7% 2.4% 1.6% 2.5% 1.8% 1.7% 0.9%
KVB 0.0% 0.2% 0.2% 0.1% 0.1% 0.3% 0.3% 0.1% 0.0% 0.0%
LVB 0.0% 0.0% 0.0% 0.0% 1.4% 0.4% 0.4% 0.3% 0.7% 1.6%
IIB 3.1% 4.4% 3.6% 2.3% 4.1% 3.1% 3.1% 2.3% 2.2% 2.0%
YES 1.3% 1.8% 1.7% 1.4% 1.3% 1.1% 1.1% 0.9% 0.9% 0.7%
FB 0.0% 0.0% 0.0% 0.0% 1.8% 3.2% 4.3% 4.7% 4.4% 4.2%
DCB 4.8% 4.1% 3.0% 4.9% 3.7% 4.3% 4.1% 3.9% 3.1% 3.6%
CUB 0.0% 6.3% 5.7% 5.0% 4.1% 3.0% 2.7% 5.4% 2.6% 1.9%
ESOPs granted (% of shared o/s) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17
SIB 0.0% 0.0% 2.7% 0.0% 0.1% 0.1% 1.6% 0.2% 0.0% 0.0%
KVB 0.0% 0.2% 0.2% 0.0% 0.0% 0.3% 0.0% 0.0% 0.0% 0.0%
LVB 0.0% 0.0% 0.0% 0.0% 1.7% 0.0% 0.0% 1.0% 0.7% 1.0%
IIB 3.1% 4.4% 0.3% 1.4% 0.8% 0.1% 3.1% 0.7% 0.5% 0.4%
YES 1.9% 0.9% 0.6% 0.4% 0.4% 0.3% 0.2% 0.1% 0.2% 0.1%
FB 0.0% 0.0% 0.0% 0.0% 2.0% 1.4% 1.5% 0.7% 0.1% 0.1%
DCB 0.0% 1.3% 1.5% 2.3% 0.0% 0.9% 0.0% 0.9% 0.2% 1.0%
CUB 0.0% 6.3% 0.0% 0.8% 0.0% 0.0% 0.0% 1.6% 0.3% 0.0%

Improving return metrics to aid valuations

Sensing the large growth opportunity that has become now even easier to tap into, these
banks have rerated over the past 12-18 months (Exhibit 28). While these banks have
historically traded in the range of 0.8-1.5x fwd book, all three have witnessed expansion in
their valuation multiples and currently trade in 1.7-2.5x range. CUB has witnessed relatively
better and stable valuations owing to its consistent return profile. As these small banks gain
size and scale, we expect the valution range for these firms to expand further. DCB / FB
trades at 1.9x / 1.7x FY19E BVPS while CUB trades at 2.3x FY19E BVPS. We see a case for
multiple expansion in both DCB and FB as their ROEs and ROAs improve over FY17-19E.
Although CUB may not witness significant re-rating until it achieves a meaningful scale and
income diversification, but it continues to remain a robust compounding story with consistent
returns.
Exhibit 28. CUB, FB and DCB have outperformed the market over last 12-18 months
DCB FB CUB S & P Bankex S&P Midcap Sensex
Apr-16
Jul-16
Aug-16
Sep-16
Apr-17
Jul-17
Aug-17
Sep-17
May-16
Jan-17
Jun-16
Dec-16
May-17
Jun-17
Nov-16
Oct-16
Feb-17
Mar-17
Oct-17
Healthy asset quality demands higher multiples: Adjusting for all residual stress on the books
(assuming 60% coverage on NPAs, 40% haircut on SDR, S4A and SRs, 15% haircut on 5/25
loans and 35% haircut on std. restructured books), we arrive at the fully adjusted book
values for these bank. The book value so taken reflects the true networth adjusted for any
potential shocks due to forbearances and is better suited for a like-to-like comparison across
banks. With hardly any meaningful exposure to the leveraged corporates of this NPA cycle,
CUB and DCB have minimal adjustments on its book value.
Lower funding costs contributed meaningfully to improved NIMs over FY15-FY17: Over the
past 3 years, the Central Bank has reduced borrowing rates by almost 200bps, leading to
improved borrowing costs for mid-sized lenders. However, while larger banks had to pass on
the benefits to customers (due to their large share of corporate customers), smaller lenders
have not proportionately passed on these rate benefits, leading to improved margins for
most. Additionally, in recent months, Demonetisation and Savings Account rate cuts by large
players have added to funding cost benefits for smaller lenders. However, rising competition
from some large banks and NBFCs has started to impact yields and the current level of NIMs
is likely to come off once the impact of these one-off benefits wanes off. We however, do
not expect a sharp decline in NIMs due to the SME nature of their loan books.

Exhibit 29. Banks with lower slippages have improved NIMs over Exhibit 30. Margins (calculated) to stabilise or slightly come off from
FY14-FY17 these levels for DCB/CUB
FY15 FY16 FY17 FY16 FY17 FY18E FY19E FY20E
5.0% 4.5%
4.4% 3.9% 4.0% 3.9%
4.5% 4.2% 4.0% 3.7%
4.0% 3.9%
4.0% 3.7%
3.5%
3.4% 3.1% 3.2%
3.5% 3.1% 3.1% 3.0%
3.0%
2.5%
2.5%
2.0%
2.0%
1.5% 1.5%
1.0% 1.0%
0.5% 0.5%
AXSB ICICI HDFCB KMB IIB CUB DCB Federal CUB DCB Federal
Fee income to remain an option value: The core thesis for these banks will largely be around
growth, margins and improving cost ratios as fees remain weak. The loan books of these
banks carry a large proportion of SME loans, which have historically never been providers of
lucrative fee incomes due to their simple and unstructured loans. Even if the banks further
invest in their product suites and trade/treasury operations, fee traction is unlikely to come
unless risky/structured corporate exposures are taken that allow for bundling. A low retail
proportion and the purchase of retail assets by some banks will keep lucrative retail fee
incomes limited. Hence, there appears no near-term trigger for fee income in DCB/CUB. FBs
effort to step up its corporate and retail presence may help improve its weak fee income
profile. However, fee income is likely to remain an option value for these banks, which will be
an add-on if it comes through.

6 November 2017 India | Indian Banking Sector | Initiating Coverage
DCB Bank | BUY

Hitting critical mass
DCB has currently reached critical mass of 300 branches as it enters the next growth phase Sameer Bhise
where increased synergies and efficiencies would contribute to building a stronger retail sameer.bhise@jmfl.com | Tel: (91 22) 66303489
franchise and drive better fee income accretion. Larger private peers have also seen similar Jayant Kharote
improvement across their retail franchise, fee profile and cost metrics during a similar growth jayant.kharote@jmfl.com | Tel: (91 22) 66303099
phase. DCBs cost ratios will improve meaningfully from current elevated levels as branch S Parameswaran
s.parameswaran@jmfl.com | Tel: (91 22) 66303075
expansion completes and investments made in customer-facing and frontline-enabling
technologies start paying off. It is on track with its new strategy (rolled out in FY16) to create Karan Singh CFA FRM
a diversified and largely secured loan portfolio along with focus on greater retailisation of
Nikhil Walecha
deposits. With consistent growth, healthy NIMs, improving operating costs and strong asset nikhil.walecha@jmfl.com | Tel: (91 22) 66303027
quality, we believe DCB Bank can deliver robust earnings CAGR of 25%+ over the next 4-5 Bunny Babjee
years. We value the bank at 2.4x FY19E BVPS to arrive at a 12-month TP of INR 230. bunny.babjee@jmfl.com | Tel: (91 22) 66303263
Granularity of loan book a key strength; corporate and SME to remain in focus: DCB
Bank remains a play on the self-employed/small business segment with a highly granular
loan book (70% loans < INR 30mn) and a strong mortgage/LAP franchise (44% of loan
book). The bank should double its loan book over the next 3 years even as it continues to Recommendation and Price Target
Current Reco. BUY
emphasize on secured lending (96% of loans secured by tangible assets). Incrementally
Current Price Target (12M) 230
though, the bank should see greater share of corporate and SME loans which is likely to Upside/(Downside) 27%
rub off on its fee revenues.
Open ratios to trend meaningfully lower; asset quality stable: With DCB Banks rapid Key Data DCB IN Equity
Current Market Price INR181
branch expansion coming to an end, we see meaningful improvement in opex ratios over
Market cap (bn) INR55.8/$0.9
the next there years and estimate cost-income ratio will drop to 53% by FY20E (from
Free Float 86.7%
60% in F17). The impact of such rapid expansion in network was mitigated by sharp
Shares in issue (mn) 307.77
expansion in NIMs which offset the impact on RoAs to a reasonable extent even as Diluted share (mn) 307.77
operating costs grew 26% in FY16/FY17. As the newer branches break even (over the 3-mon avg daily val (mn) INR348.5/US$5.4
next 18months), we see benefits of the cluster strategy coming through and drive an RoA 52-week range 213/100
expansion even as NIMs moderate from current heady levels. DCB Banks execution has Sensex/Nifty 33,677/10,446
remained reasonably strong with asset quality holding up at comfortable levels (even after INR/US$ 64.7
demonetisation impacted the self-employed segment) despite worries on LAP as a
product. Portfolio risks remain low considering the fact that DCB Banks portfolio is Price Performance
% 1M 6M 12M
highly granular in nature in our view. We build average credit costs of 65bps over FY17-
Absolute -2.3 -5.1 40.9
20E. Relative* -8.2 -17.9 17.4
Valuations - rerating likely as RoA inches up: Amongst the three small/mid-size private * To the BSE Sensex
sector banks, we believe DCB Bank offers the strongest case for a multiple expansion
(despite trading 20% premium to its 10-year average). Its highly granular book, steady
25%+ growth in earnings and assets and ROA expansion to 1.24% by FY20E could
potentially see DCB Bank trading at close to 2.5x P/BV multiples. We conservatively build
our target price of Rs230 valuing the bank at 2.4x FY19E P/BV (~25% discount to target
multiple for our private banks coverage universe) building in a sustainable RoE of 16% for
DCB Bank. Sharp slowdown in SME segment and DCB Banks inability to reduce its opex
ratios remain key risks to our call.
Financial Summary (INR mn)

Y/E March FY16A FY17A FY18E FY19E FY20E
Net Profit 1,945 1,997 2,700 3,647 4,942
Net Profit (YoY) (%) 1.7% 2.7% 35.2% 35.0% 35.5%
Assets (YoY) (%) 18.6% 24.8% 23.6% 22.0% 22.0%
JM Financial Research is also available on:
ROA (%) 1.11% 0.93% 1.02% 1.12% 1.24%
ROE (%) 11.9% 10.8% 11.9% 13.1% 15.3%
Thomson Publisher & Reuters
EPS 6.8 7.0 8.8 11.8 16.0
S&P Capital IQ and FactSet
EPS (YoY) (%) 0.9% 2.3% 25.1% 35.0% 35.5%
PE (x) 26.3 25.7 20.6 15.2 11.2
Please see Appendix I at the end of this
BV 61 68 85 96 112
report for Important Disclosures and
BV (YoY) (%) 12.5% 11.5% 24.0% 14.0% 16.6%
Disclaimers and Research Analyst
P/BV (x) 2.94 2.64 2.13 1.87 1.60
Certification.
Source: Company data, JM Financial. Note: Valuations as of 3/Nov/2017

DCB Bank 6 November 2017
Exhibit 31. Growth in the number of MSME enterprises in India Exhibit 32. DCB: Loan book as a % of banking credit to MSMEs (%)
MSME working enterprises (mn) 5.0%
60 4.3%
51.1 51.3
48.8 4.0%
50 46.8 3.5%
44.8
41.1 42.9
37.7 39.4
40 36.2 3.0% 2.8%
2.3%
30
2.0%
20
1.0%
10
0 0.0%
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY14 FY15 FY16 FY17
Source: GOI Ministry of Micro, Small and Medium Enterprise Annual Report FY16, JM Financial Source: Company, JM Financial
Exhibit 33. DCB: Loan book mix to favour corporates and MSMEs (%) Exhibit 34. DCB: Loan growth (%)
Loans (Rs. bn) YoY Growth (%)
MSME 350 75%
Other retail
13% 11% 300
55%
250
Agri and PSL 29% 26% 25% 24% 35%
200 23% 24% 25% 24% 23% 22%
17%
150 15%
100
Corporate -5%
Mortgage 50
15%
44% 43 53 66 81 105 129 158 199 249 309
0 -25%
FY18E
FY19E
FY20E
FY12
FY11
FY13
FY14
FY15
FY16
FY17
Source: Company JM Financial Source: Company, JM Financial
LAP book vintage provides adequate comfort on the quality of book: Under its new strategy
to push for secured lending post FY11, DCBs mortgage business began to grow aggressively
and now makes up 44% of its loan book (from 25% in FY11). The book has grown strongly
at c.30% CAGR during FY13-17. A large part of this book (c.70%) consists of Loan against
property (LAP) extended to MSME businesses (on basis of business cashflows) with their
residential property as collateral. This improves the credit profile for the bank (as against
lending through unsecured products) and also aids in targeting its intended customer
segment in a calibrated fashion. Average Loan-to-Value (LTV) of its mortgage book is around
70% while pure mortgage loans within the book have slightly higher LTVs (~75%). In recent
times, yields on LAP business have come under serious pressure with rising competition from
NBFCs and some PSU banks. Of the mortgage portfolio, home loans make up c.30% of this
book and management aims to keep this split stable at current levels. However, we expect
yields to trends lower from current levels given the competitive intensity in this segment.
Importantly, asset quality of this book has been stable over the last 3 years with NPLs ranging
around 90bps. Even when the industry was facing headwinds in terms of higher
delinquencies on this book, DCBs portfolio remained intact due to the nature of its loans.
However recent quarters post demonetisation witnessed slight deterioration in asset quality
with NPLs inching up nearly to 140bps in this book. However, these trends are expected to
reverse as impact of these one-off shocks wanes off. Going ahead, we expect continued
growth in this segment as management focus on secured lending to small businesses
continues.

Exhibit 35. DCB: Growth in mortgage book (INR mn) Exhibit 36. DCB: NPLs in Mortgage book (%)
Mortgage book -(INR mn) - (RHS) Growth - YoY (%) (LHS) NPL NPL ratio
30% 80,000 1.20% 800

29% 68,016
70,000 700
27% 1.00% 0.84%
55,562 60,000 0.82% 1.05%
24%
25% 0.77% 600
24% 0.81%
44,585 50,000 0.80% 0.66%
24% 500
31,293 40,000 0.60% 400

23%
21% 23,980 22% 30,000 300
0.40%
15,510 20,000 200
18% 0.20%
10,000 100
103 197 240 362 464 717
15% 0 0.00% 0
FY12 FY13 FY14 FY15 FY16 FY17 FY12 FY13 FY14 FY15 FY16 FY17
FY09-15 - A period of restructuring and consolidation: DCB Banks management underwent

a significant change as Mr. Murali Natarajan took charge as a CEO. In line with its vision, DCB
Bank adopted a new business strategy in FY10 with clear focus areas - a) targeting mainly
self-employed / small business segments (traders, shop keepers, MSMEs and SMEs). It chose
to have limited presence in the salaried segment. b) Focus of secured products, particularly
mortgages. In FY13, the Bank re-launched Commercial Vehicle loans and Gold loans in the
retail segment. c) Avoid unsecured & big ticket lending and create a diversified portfolio. d)
Focus on CASA and Retail Term Deposits to manage/improve the cost of funds. e) Relentlessly
focus on managing risks, strengthen credit processes and underwriting quality. f) Expand
branches primarily in Tier II to Tier VI locations and h) Be at the forefront of digital
innovations and use sophisticated process improvement techniques.
Most of the measures have yielded significant results across parameters for the bank with
improvement in profitability (PBT to assets improved to 1.5% from 0.44% in FY11), asset
quality (gross NPLs reduced to 1.6% from 5.9% in FY11) and growth (loan growth CAGR of
24% over FY11-17 Vs 11% over FY05-11).
FY16-18 - a big reset on profitability trends, but branch network doubles: In FY16, DCB Bank
embarked on an ambitious journey to expand its branch network to 300 branches over a
period of 24 months. The management was fully aware of the impact on profitability/opex
ratios and was willing to undertake the pains while undergoing such a rapid network
expansion.
The expansion is now complete with DCB Bank hitting 310 branches in 2QFY18. However,
the pains of this expansion have been lesser than anticipated. Part of the expansion impact
on profitability has been offset by a steep expansion in NIMs over this period. As result,
despite the fact that cost-to-assets expanded by c.20bps, Pre-tax RoA* just dipped by 6bps
during this period.
Exhibit 37. DCB: Limited impact on PBT RoA of rapid branch expansion
Cost to assets (%) PBT Return on assets (%)*(RHS)
3.50% 2.50%
2.93%
3.00% 2.79% 2.00%
2.74%
2.50% 1.50%
1.44% 1.49% 1.43%

2.00% 1.00%
1.50% 0.50%
FY15 FY16 FY17
Source: JM Financial, Company * We have compared Pre-tax RoA instead of RoA as DCBs tax rate normalised only from FY17 onwards.

Critical mass achieved at 300 branches: DCB has now reached a network of 310 branches,
which in our view is a first step towards achieving critical network mass for gains to flow
through improved organization branding, larger product suite and better sweating of assets.
While direct comparisons are tough to make here, we try to track the journey of retail banks
like IIB, KMB that had witnessed similar improvement across retail loans, deposit accretion
and fee income as their network scaled up from 300 to 600 branches.
There is a case for banks like DCB to witness such a trajectory as these branches sweat and
reflect in greater utilisation and thus profitability. For example, metrics such as retail loans per
branch, fee income per branch and deposits per branch could see a material uptick as the
new branches sweat.
Given DCBs lower RoA, we believe even if part of this trajectory is achieved, the gains to
profitability could be substantial.
Exhibit 38. DCB: Branch network has reached critical mass Exhibit 39. DCB: Retail loans pick up as network expands
Retail loans per branch (Rs mn) at different branch levels
Branches (LHS) Employees (RHS)
300
300 6,000
~300 ~450 ~600
247
250
250 5,000 227
189 190
200 4,000 200
150 3,000 150 136

101
100 2,000 100 79
50 1,000 50 39
80 84 94 130 154 198 262 290 6
0 0
0
FY11 FY12 FY13 FY14 FY15 FY16 FY17 1QFY18
IIB YES KMB
Liability franchise - lot of room to improve: DCB has historically had a strong presence in the
NRI deposits market. Have strategically stayed away from the salaried individual customer
segment though, has also impacted the CASA trajectory. DCBs CASA has averaged 25%
over FY13-16. However, the granularity of the deposit base, reflected in lower deposit
concentration and ~80% of deposits being retail in nature reflects at a steady funding
franchise.
Recently, demonetization has currently pushed both overall deposit growth (29% YoY for
FY17) and CASA levels (~26% as on 2QFY18). While some of these deposits will flow out
over the current year, DCB banks scaled up branch network at 300 branches will aid in retail
deposit accretion (Exhibit 38). Going ahead, we build deposit CAGR of 24% over FY17-20E
with a stable CASA profile.
Exhibit 40. DCB: Growth in total deposits Exhibit 41. DCB: Deposit split
Deposits (INR bn) Growth Savings deposits (INR bn) Current deposits (INR bn)
400 35%
Term deposits (INR bn) CASA %
350 30%
200 40%
300
25% 35%
250 150 30%
20%
200 25%
15%
150 100 20%
10% 15%
100
50 10%
50 5%
5%
0 0% 0 0%
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17

Exhibit 42. DCB: SA deposit movement as branch network expands Exhibit 43. DCB: Retail deposits inch up as branch network expands
SA per branch (Rs mn) at different branch levels Yes Bank
140
Deposits per branch (Rs mn) Retail deposits per branch (Rs mn)
~300 ~450 ~600 1800
120
103 1600
99
100 1400
79 1200
80 68
1000
60 49 800
39 600
40 34
27 400
20 200
6
0
0
300 450 600
IIB YES KMB
Margins - sitting on a high base, sustainability is key: While DCB banks reported NIMs have
significantly improved to 4.22% in 2QFY18 from 3.2% in 1QFY13, large part of gains have
been due to reduced cost of funds as interest rate cuts began in FY15.
We believe DCBs NIMs are already factoring in a large part of the funding cost benefits,
especially in light of the banks modest CASA franchise. Incremental NIM gains may be tough
to come by, in our view.
DCB Bank has stayed away from large corporate lending even over the past couple of years,
partly driven by its strategy to focus on retail/SME segment and partly also by its inability to
price itself profitably in the highly competitive large corporate lending market. Consequently,
DCB Banks spreads have remained quite stable over the past couple of years. We expect any
gains on funding costs to be offset by declining yields and overall margins will remain
rangebound. Management guides for sustainable NIMs in the 3.7-3.75% range. We expect
our calculated margins to remain stable at current levels of c.3.9% over FY17-20E.
Exhibit 44. DCB: Cost of funds and Yield on Advances (%) Exhibit 45. DCB: Net Interest Margins (%)
Cost of Funds (%) Yield on Advances (%) NIM
5.0%
14%
4.5%
12%
3.99%
3.91%
10% 4.0% 3.72%
8% 3.5% 3.16%
2.97%
6%
3.0%
4% 2.50%
2.5%
2%
0% 2.0%
FY18E
FY19E
FY20E
FY16
FY10
FY11
FY12
FY13
FY14
FY15
FY17
FY18E
FY19E
FY20E
FY16
FY10
FY11
FY12
FY13
FY14
FY15
FY17
Fee revenues - some benefits likely but long way to go: DCBs fee revenues have a long way
to go, in our view, and can provide the much needed fillip to the RoA profile of the bank. Its
fee to assets ratio has been stable at c.110bps over the last 6 years. Banks focus remains on
garnering repeatable granular fee income as opposed to bulky one-offs. We believe DCB
needs to improve its ability to cross-sell as well sweat its sizeable self-employed/SME customer
base with respect to fee products.
What also limits the banks ability to generate fee revenues is the lower strategic focus on the
corporate lending market and thus the absence from syndication opportunities. Given the
economic environment and low investment credit demand, corporate loans and thus the fee
opportunity are currently muted. However, DCB could use this relatively benign competitive
environment to establish a presence over the next couple of years and then capitalize as the
market turns.
An aspirational example would be YES and IIB, which on their journey from 300 branches
towards 600, witnessed improving fee to assets as well as improving fee per branch driven by
sweating of existing assets, better brand recognition and increasing retail relationships.
As per the management, fee income streams begins coming from new branches once they
achieve 1500-2000 customer levels. As more branches begin to break even and corporate
products add to fees, we believe DCB too shall witness improving fee profile with c.3bps
improvement in its fee to assets over FY17-20E.
Exhibit 46. Fee income split

Fee income split (INR mn) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY14-17 CAGR
Comm./Exchg./Brkrg. 661 787 893 1,011 1,193 1,405 1,657 18%
P/L on Exchange Transactions 90 69 72 57 76 145 104 22%
P/L on Sale of Invsts. 253 118 139 225 277 423 454 26%
Other & Misc. Income 117 54 66 95 112 232 280 44%
Total Non-interest Income 1,121 1,027 1,170 1,387 1,657 2,205 2,495 22%
Growth (%) -8.4% 13.9% 18.5% 19.5% 33.0% 13.2%
Core Non-interest income (Ex-Treasury) 868 910 1,031 1,162 1,380 1,782 2,040 21%
Growth (%) 4.8% 13.4% 12.7% 18.8% 29.1% 14.5%
Exhibit 47. DCB: Other income/Total assets (%) Exhibit 48. DCB: Core fee income/Total other income
Core fee Income/ Assets (%) Core fee income/ Other Income (%)
1.6% 100%
1.5% 1.49%
95% 92%
1.4%
88%
1.3% 90%
1.14% 84%
1.2% 85% 89%
1.1% 1.01% 0.98%
0.96% 0.96% 80% 83%
1.0% 81%
75%
0.9%
0.8% 70%
FY18E
FY19E
FY20E
FY12
FY10
FY11
FY13
FY14
FY15
FY16
FY17
FY20E
FY18E
FY19E
FY10
FY11
FY12
FY13
FY14
FY15
FY16
Source: Company, JM Financial Source: Company, JM Financial FY17
Exhibit 49. DCB: Fee-to-assets as branch network grows Exhibit 50. DCB: Fee per branch with increasing presence
Fee to assets (Rs mn) at different branch levels Fee per branch (Rs mn) at different branch levels
0.6% 12.0
0.5% ~300 ~450 ~600 ~300 ~450 ~600
0.5%
0.5% 10.0 8.9
0.4%
0.4%
0.4% 0.4% 8.0 7.6 7.4
0.3%0.3% 6.8 6.9 6.7
0.3%
0.3% 0.3% 5.4 5.3
6.0
4.7
0.2% 4.0
0.1% 2.0
0.0% 0.0
IIB YES KMB IIB YES KMB

Cost Ratios to meaningfully improve going ahead: In order to accelerate the business
momentum further, in October 2015, the Bank announced its plan to double its branch
network to 310 in 24 months (As on Oct 17- 310 branches). While each branch takes INR 6-
6.5mn cost for setting up, branches generally achieve break even between 18 to 22 months
and payback in 36 to 40 months.
DCB has not only added c130 new branches in last 7 quarters, it has also been investing
heavily on customer facing and frontline enabling technologies. Besides, the rate employee
addition is likely to slow down as c45% of the current c.5,000 employee strength has been
added in the last 3 years. As the current phase of aggressive expansion comes to an end, we
see C-I and Cost to assets ratio beginning to improve on account of reduced branch addition
expenditure and better income profile as the newly added 150 branches begin to break even.
We build an improvement of 33bps in Cost to assets ratio over FY17-20E and nearly
c.680bps improvement in the cost to income ratio.
Exhibit 51. DCB: Branch additions to slow down Exhibit 52. DCB : Employee addition rate to reduce
Branch addition Employee addition
70 1,000 896
64
58
60 800 731 701 674
634 646
50 44 583
40 40 600 498
40 36
400
30 24
170
200
20
10
10 0
4
0
0 -200 -124
FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E
Exhibit 53. DCB: Cost-to-Income Ratio Exhibit 54. DCB: Cost-to-assets (%)
Cost to Income (%) Cost to assets (%)
100% 3.3%
3.2%
3.2%
90%
3.1%
80% 75% 3.0% 2.9%
71%
69% 2.9%
70% 63% 2.7%
59% 58% 60% 59% 2.8%
56%
60% 53% 2.7% 2.60%
2.6%
50%
2.5%
40% 2.4%
FY18E
FY19E
FY20E
FY18E
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY19E
FY20E
FY17
FY11
FY12
FY13
FY14
FY15
FY16
Asset quality not a major concern: DCB banks asset quality is likely to improve from current
GNPA levels which have slightly inched up in 1QFY18 due to demonetization impact waning
off, reduction in MFI stress.
Gross NPLs have declined steadily from 8.7% in FY10 to 1.8% in 2QFY18. Within this,
Mortgages and SME have witnessed stable trends with GNPLs of 1.6% each. It is largely the
outcome of robust underwriting process despite operating in relatively riskier self-
employment segment. DCBs asset quality has remained robust even during the recent phase
of corporate stress with its restructured book of only 0.2% in FY17. Corporate GNPLs too
have declined from their peak of 4.4% in FY16 to under 2.3% in 2QFY18. We build
improving asset quality with GNPLs of 1.5% by FY20E with credit costs ranging from 60bps
70bps over FY17-20E.

Exhibit 55. DCB: NPA Profile Exhibit 56. DCB: LLP (%)
GNPA (%) NNPA (%) PCR (%) LLP (ex- prov for std. adv.) (bps)
140
7% 105% 129
120
6% 90%
100
5% 75%
4% 60% 80
59 60 60
54 56
3% 45% 60 47 45 48
40 29
2% 30%
1% 15% 20
0% 0% 0
FY18E
FY19E
FY20E
FY12
FY11
FY13
FY14
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Strong earnings momentum and attractive valuations offer significant value creation for
potential investors: We believe DCB is likely to expand its balance sheet by c.23% over FY17-
FY20E. Earnings growth in FY16 and FY17 was impacted due to normalisation of tax rates
(0% in FY14 to 34.5% in FY17E) and aggressive distribution expansion. From FY18E, DCB
could deliver rising ROAs, from 93bps in FY17 to 124bps in FY20E, resulting in earnings
CAGR of c.35%. Given the recent capital raise, DCB would not be required to raise capital in
the near term.
Exhibit 57. DCB: Tier 1 ratio and recent capital raise

Tier 1 ratio Tier 2 ratio
20% Raised INR 3.9bn in QIP
18%
15% 15%
16% 14% 14% 14%
13% 13% 13% 14%
14% 12%
12%
10%
8%
6% 14% 13% 12% 13% 13% 13%
12% 11% 11% 12%
4%
2%
0%
1QFY17
1QFY16
2QFY16
3QFY16
4QFY16
2QFY17
3QFY17
4QFY17
1QFY18
2QFY18
Exhibit 58. DCB: RoAs to expand as one-offs have passed Exhibit 59. DCB: Return profile to improve
RoA (%) RoE (%)
1.6% 18.0%
1.4% 1.3% 16.0% 15%
1.3% 1.2% 15% 15%
1.1% 14.0% 13%
1.2% 1.1% 12% 12%
1.0% 12%
0.9% 1.0% 12.0% 11%
1.0%
10.0%
0.8% 0.7% 8%
8.0%
0.6%
6.0%
0.3% 4%
0.4% 4.0%
0.2% 2.0%
0.0% 0.0%
FY18E
FY19E
FY20E
FY18E
FY19E
FY20E
FY15
FY11
FY11
FY12
FY13
FY14
FY16
FY17
FY12
FY13
FY14
FY15
FY16
FY17

High-quality management team with execution ability: Mr. Murali Natrajan (MD & CEO)
joined DCB in April 2009 and has extensive banking experience of over 25 years across Asia.
He has previously worked as Global Head for SME Banking at Standard Chartered Bank
(SCB), based in Singapore; he has also worked with Citibank and American Express in the
past. DCB has already seen improvement across parameters over the past 8 years, leaving few
doubts about any large execution risks in the near term.
Exhibit 60. Background and experience of Key Management Persons

Name Designation Past experience
Mr. Natrajan served as the Global Head for SME banking in Standard Chartered Bank. He was responsible for
providing strategic context and business development capabilities to drive a distinctive and consistent business
model across 27 markets in Asia, Africa and the Middle East. A Fellow Member of the Institute of Chartered
Accountants of India, Mr Natrajan started his career with American Express TRS in India where he worked for 5
Murali M Natrajan MD & CEO
years in Business Planning, Finance and Operations. In 1989, he joined Citibank where he spent 14 years in
various disciplines such as Operations, Credit, Finance, Product Management and Business Management of
Consumer Banking. Prior to joining Standard Chartered Bank in October 2002, he had successful stints as
Cards Business Director in Citibank India, Hong Kong and Indonesia.
Mr. Sampat has over 25 years of experience in senior positions with reputed organizations such as ABN Amro
Bharat Sampat CFO
Bank, ANZ Grindlays Bank, Standard Chartered Bank, Hoechst India and Larsen & Toubro.
Mr. Bose has over 26 years of experience in Banking & Financial Services sector. He has managed Sales and
Distribution, Products, Credit Risk Management and Audit in markets such as India, Asia Pacific, Middle East
Abhijit Bose Chief credit Officer and Africa. Previously, he was with Standard Chartered Group and the last position held was as Risk Head -
Consumer Banking for Southern African markets. Prior to which he has worked in Citibank, GIC Housing
Finance Ltd & Eldeco Group
Mr. Vishwanath has over 19 years of rich experience in all aspects of Credit Risk Management. Prior to joining
J.K Vishwanath Head - Corporate Banking DCB Bank, he has worked with Fullerton India Credit Company Ltd. and Citigroup. He began his professional
career with Eicher Ltd.
Mr. Kutty brings with him around 19 years of banking experience. He has worked with Citibanks Indian and
Praveen Kutty Head - Retail & SME Banking international operations where he successfully managed multiple consumer banking businesses including
Credit Cards, Personal Loans, Home Loans, Branch Banking and Wealth Management.
Source: JM Financial, Company
Valuation: DCB currently trades at 1.9x FY19E BVPS which is at a 20% premium to its long
term average driven by strong margin gains and steady branch expansion without hurting the
return profile. We believe sufficient headroom exists for RoA expansion over the medium
term driven by operating leverage post expansion and continuous growth. With a strong
profitability outlook and a granular book with stable asset quality, we see a case for multiple
re-rating. DCB could trade at multiples comparable to strong retail banks discounted for scale
and lower ancillary income. We value DCB at 2.4x FY19E fully adjusted BVPS arriving at a 12
month TP of INR 230/sh
We value DCB bank on a two-stage Gordon Growth Model. Our assumptions are as follows:
Exhibit 61. DCB: Valuation Summary

Initial no of years 10
Growth rate for the first 10 years (%) 14.6%
Payout ratio for the first 10 years (%) 12.5%
Perpetual growth rate (%) 4%
Perpetual payout ratio (%) 77.0%
K1 2.19
K2 12.33
Fully adjusted FY19E BVPS (Rs) 95.1
Target P/BV (x) 2.4x
Fair value (rounded off) 230

Exhibit 62. Valuation comparison with larger peers on key metrics

Valuation (INR bn) IIB YES KMB DCB
Market Cap ( INR bn) 988 737 1,922 56
Assets 1,907 2,221 2,264 243
Loans 1,164 1,400 1,424 163
Deposits 1,337 1,502 1,635 192
CASA 505 552 718 51
MCAP to Assets 0.52 0.33 0.85 0.23

MCAP to Loans 0.85 0.53 1.35 0.34
MCAP to Deposits 0.74 0.49 1.18 0.29
MCAP to CASA 1.96 1.33 2.68 1.09
Exhibit 63. One-year-forward Price/BVPS Exhibit 64. One-year-forward Price/earnings

DCB Fwd. P/BV (x) SD+1 SD-1 Average DCB Fwd. P/E (x) SD+1 SD-1 Average
6.0 30
5.0 25
4.0 20
3.0 15
2.0 10
1.0 5
0.0 0
Mar-12
Mar-13
Mar-14
Mar-15
Mar-16
Mar-17
Nov-12
Nov-16
Nov-11
Jul-12
Jul-13
Nov-13
Jul-14
Nov-14
Jul-15
Nov-15
Jul-16
Jul-17
Nov-17
Nov-15
Nov-17
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
Nov-14
Nov-16

Financial Tables (Standalone)

Profit & Loss (INR mn) Balance Sheet (INR mn)
Y/E March FY16A FY17A FY18E FY19E FY20E Y/E March FY16A FY17A FY18E FY19E FY20E
Net Interest Income 6,195 7,971 10,191 12,549 15,234 Equity Capital 2,844 2,854 3,084 3,084 3,084
Profit on Investments 423 454 350 350 350 Reserves & Surplus 14,560 16,614 22,995 26,641 31,583
Exchange Income 145 104 119 143 174 Deposits 149,260 192,892 239,186 296,591 367,773
Fee & Other Income 1,637 1,937 2,426 3,038 3,739 Borrowings 11,479 12,758 13,528 14,869 15,119
Non-Interest Income 2,205 2,495 2,895 3,531 4,264 Other Liabilities 12,540 12,781 15,334 17,631 20,097
Total Income 8,400 10,465 13,086 16,080 19,498 Total Liabilities 190,683 237,899 294,126 358,816 437,656
Operating Expenses 4,909 6,283 7,708 9,039 10,363 Investments 43,333 58,179 67,520 81,475 98,220
Pre-provisioning Profits 3,490 4,182 5,378 7,041 9,135 Net Advances 129,214 158,176 199,302 249,128 308,918
Loan-Loss Provisions 760 1,082 1,287 1,516 1,647 Cash & Equivalents 8,916 11,925 15,607 19,241 22,132
Provisions on Investments 36 -1 0 0 0 Fixed Assets 1,978 2,321 2,869 3,321 3,832
Others Provisions 83 34 0 0 0 Other Assets 7,242 7,298 8,827 5,652 4,554
Total Provisions 879 1,115 1,287 1,516 1,647 Total Assets 190,683 237,899 294,126 358,816 437,656
PBT 2,611 3,067 4,092 5,525 7,487 Source: Company, JM Financial

Tax 666 1,070 1,391 1,879 2,546
PAT (Pre-Extraordinaries) 1,945 1,997 2,700 3,647 4,942
Extra ordinaries (Net of Tax) 0 0 0 0 0
Reported Profits 1,945 1,997 2,700 3,647 4,942
Dividend paid 0 0 0 0 0
Retained Profits 1,945 1,997 2,700 3,647 4,942
Key Ratios Dupont Analysis

Growth (YoY) (%) NII / Assets 3.52% 3.72% 3.83% 3.84% 3.83%
Deposits 18.4% 29.2% 24.0% 24.0% 24.0% Other Income / Assets 1.25% 1.16% 1.09% 1.08% 1.07%
Advances 23.5% 22.4% 26.0% 25.0% 24.0% Total Income / Assets 4.78% 4.88% 4.92% 4.93% 4.90%
Total Assets 18.6% 24.8% 23.6% 22.0% 22.0% Cost / Assets 2.79% 2.93% 2.90% 2.77% 2.60%
NII 21.9% 28.7% 27.9% 23.1% 21.4% PBP / Assets 1.99% 1.95% 2.02% 2.16% 2.29%
Non-interest Income 33.0% 13.2% 16.1% 22.0% 20.7% Provisions / Assets 0.50% 0.52% 0.48% 0.46% 0.41%
Operating Expenses 23.8% 28.0% 22.7% 17.3% 14.7% PBT / Assets 1.49% 1.43% 1.54% 1.69% 1.88%
Operating Profits 25.8% 19.8% 28.6% 30.9% 29.7% Tax rate 25.5% 34.9% 34.0% 34.0% 34.0%
Core Operating profit 22.8% 21.5% 34.9% 33.1% 31.3% ROA 1.11% 0.93% 1.02% 1.12% 1.24%
Provisions 26.6% 26.8% 15.4% 17.8% 8.7% RoRWAs 1.62% 1.30% 1.40% 1.55% 1.72%
Reported PAT 1.7% 2.7% 35.2% 35.0% 35.5% Leverage 10.7 11.6 11.7 11.7 12.4
Yields / Margins (%) ROE 11.9% 10.8% 11.9% 13.1% 15.3%
Interest Spread 2.97% 3.15% 3.31% 3.26% 3.20% Source: Company, JM Financial
NIM 3.72% 3.89% 3.99% 3.97% 3.91%
Profitability (%) Valuations

Non-IR to Income 26.2% 23.8% 22.1% 22.0% 21.9% Y/E March FY16A FY17A FY18E FY19E FY20E
Cost to Income 58.4% 60.0% 58.9% 56.2% 53.2% Shares in Issue 284.4 285.4 308.4 308.4 308.4
ROA 1.11% 0.93% 1.02% 1.12% 1.24% EPS (INR) 6.8 7.0 8.8 11.8 16.0
ROE 11.9% 10.8% 11.9% 13.1% 15.3% EPS (YoY) (%) 0.9% 2.3% 25.1% 35.0% 35.5%
Assets Quality (%) PER (x) 26.3 25.7 20.6 15.2 11.2
Slippages 2.18% 2.04% 1.80% 1.75% 1.60% BV (INR) 61 68 85 96 112
Gross NPA 1.52% 1.59% 1.53% 1.56% 1.50% BV (YoY) (%) 12.5% 11.5% 24.0% 14.0% 16.6%
Net NPAs 0.75% 0.79% 0.74% 0.74% 0.72% ABV (INR) 59 65 81 92 108
Provision Coverage 50.6% 51.1% 52.0% 53.0% 52.0% ABV (YoY) (%) 13.5% 10.9% 24.6% 13.6% 16.4%
Specific LLP 0.54% 0.60% 0.60% 0.56% 0.48% P/BV (x) 2.94 2.64 2.13 1.87 1.60
Net NPAs / Networth 5.60% 6.39% 5.67% 6.20% 6.46% P/ABV (x) 3.06 2.76 2.21 1.95 1.67
Capital Adequacy (%) DPS (INR) 0.0 0.0 1.0 1.5 2.0
Tier I 12.79% 11.87% 12.81% 11.91% 11.34% Div. yield (%) 0.0% 0.0% 0.6% 0.8% 1.1%
CAR 14.11% 13.76% 14.47% 13.37% 12.61% Source: Company, JM Financial


Federal Bank | BUY

Upping the ante
FB is a diversified lender that we believe could be at the cusp of an RoA turnaround. A Sameer Bhise
historically weak PPoP profile (1.8% average over FY15-FY17), has kept RoAs muted over the sameer.bhise@jmfl.com | Tel: (91 22) 66303489
past 2 years, but we believe FB is fast acquiring the artillery to improve this metric. With Jayant Kharote
relationship banking at the core of managements new philosophy, FB has started delivering jayant.kharote@jmfl.com | Tel: (91 22) 66303099
robust growth on the corporate front (c.39% YoY in 1QFY18) and we believe it is only a S Parameswaran
matter of time before benefits percolate into FBs fee and liability profiles. Our turnaround
story also depends on managements delivery on costs; with branch expansion largely behind Karan Singh CFA FRM
us, FBs focus remains on sweating existing assets. Moreover, pre-emptive focus on digital
Nikhil Walecha
banking (32% capex spends in software over FY16-FY17 vs. 26% by HDFCB) is helping FB nikhil.walecha@jmfl.com | Tel: (91 22) 66303027
augment its pan-India traction. This is evident from the fact that non-Kerala loans Bunny Babjee
consistently outperform their Kerala counterparts on growth (21% YoY vs. 10% YoY in bunny.babjee@jmfl.com | Tel: (91 22) 66303263
1QFY18). With the tapering of credit costs (65 bps over FY18-FY20E) stemming from
reduced stress on FBs books, we believe return profile could improve significantly over FY18-
20E. We initiate coverage with a BUY rating and a 12-month TP of INR 140, valuing it at 2.1x
fully adjusted FY19E BVPS. Recommendation and Price Target
Current Reco. BUY
Resurgence in growth led by corporate and retail: FBs loan book is showing clear signs of Current Price Target (12M) 140
resurgence on the corporate and retail fronts. Corporate loan growth has seen a sharp Upside/(Downside) 20.7%
uptick to 45% in FY17 from 19% (annualised) in FY14-FY16. Focus on a relationship
manager (RM) led model is clearly helping FB climb up the value chain in this segment, Key Data FB IN Equity
with c.70% of the system reeling under bad loans. On the retail front, FB is expected to Current Market Price INR118
Market cap (bn) INR230.8/$3.6
receive a fillip from the recent pan-India marketing campaign, after its QIP in 1QFY18. FBs
Free Float 86.2%
customer base now stands at c.8 million (vs c.9 million for KMB, which has 2x the loan
Shares in issue (mn) 1,948.83
book), giving it an immense opportunity to further mobilise its retail assets. Growth in non-
Diluted share (mn) 1,948.83
Kerala loan books continues to outpace their Kerala counterparts, at 15%, 34% and 24%
3-mon avg daily val (mn) INR1,162.4/US$18.0
vs. 8%, 4% and 14% for wholesale, SME and retail (ex-gold), respectively. Robust growth 128/62
52-week range
trends are bound to positively impact FBs fee and liability profiles over FY19E. Sensex/Nifty 33,677/10,446
Cost profile can only improve: With branch expansion largely completed, FBs incremental INR/US$ 64.7
focus remains towards sweating existing assets. FB has been proactive on the digital front,
with 32% capex spends in software over FY16-FY17 vs. 26% by HDFCB. Digital initiatives Price Performance
are helping FB gain traction on the retail front: over Mar16-Jun17, the number of active % 1M 6M 12M
Absolute 0.7 1.8 54.6
digital users grew ~2x to c.0.93 million, with incremental digital on-boarding at the rate of
Relative* -5.2 -11.0 31.2
c.42,000 accounts per quarter. We believe the focus on digital expansion will help FB
* To the BSE Sensex
continue to gain traction on loans without incurring incremental costs. Telling signs are
visible in its non-Kerala loan book over FY16-FY17, which grew despite the non-addition of
branches during this period. On the employee front, however, concerns persist as FB has
relatively high payouts per employee (c.INR 1 million as of FY17), 32% higher than HDFCB.
80% of its workforce is IBA-linked and the average age remains on the higher side (~38),
which could pose upside risks to cost.
Valuations: With the tapering of operating and credit costs, we believe return profile could
improve significantly over FY18-20E. Our TP of INR140 values FB at 2.1x fully adjusted
FY19E BVPS (5% premium over AXSB, 15% discount to DCB).

Net Profit 4,757 8,308 11,322 14,512 18,554
Net Profit (YoY) (%) -52.7% 74.7% 36.3% 28.2% 27.9%
Assets (YoY) (%) 14.2% 21.6% 21.8% 19.1% 17.5%
JM Financial Research is also available on:
ROA (%) 0.54% 0.79% 0.89% 0.95% 1.02%
ROE (%) 6.0% 9.8% 10.6% 11.2% 12.9%
Thomson Publisher & Reuters
EPS 2.8 4.8 5.8 7.5 9.6
S&P Capital IQ and FactSet
EPS (YoY) (%) -52.9% 74.1% 21.1% 28.2% 27.9%
PE (x) 41.9 24.1 19.9 15.5 12.1
Please see Appendix I at the end of this
BV 47.0 51.8 63.7 70.1 78.6
report for Important Disclosures and
BV (YoY) (%) 4.2% 10.2% 22.9% 10.0% 12.1%
Disclaimers and Research Analyst
P/BV (x) 2.47 2.24 1.82 1.66 1.48
Certification.

Federal Bank 6 November 2017
Loan book Signs of revival

FB aims to be an equal parts corporate, SME and retail lender. Although growth on the SME
front slowed down in FY17 (Exhibit 65), there has been a resurgence on the corporate and
retail loan fronts. Increased focus on an RM-led corporate banking model has helped FB climb
a few rungs in the wholesale lending pecking order. We believe FB is well-equipped to
continue to make market share inroads in this segment, with PSU banks (c.70% of system
loans) reeling under the pressure of bad loans. Also, the recapitalisation quantum by GOI
seems insufficient for growth post provisioning requirements.
On the retail front, FB continues to improve its pan-India footprint. It now has a customer
base of c.8 million (vs. 9 million for KMB). We expect FB to continue to mobilise assets on the
retail front, with a shot in the arm from the recent QIP and traction from the subsequent
successful marketing campaign. The SME segment might continue to see pressure in the
medium term as asset quality concerns on the legacy books remain an overhang.
Exhibit 65. FB: Loan book split and growth rates

Loan book (INR mn) FY14 FY15 FY16 FY17
Corporate 138,730 165,880 196,520 284,230
SME 110,210 129,180 151,720 163,610
Agri 51,390 63,120 66,360 74,980
Retail 141,240 161,350 173,300 217,930
Gross advances 441,570 519,530 587,900 740,750
YoY growth rates (%)

Corporate -27% 20% 18% 45%
SME 36% 17% 17% 8%
Agri 9% 23% 5% 13%
Retail 6% 14% 7% 26%
Gross advances -2% 18% 13% 26%
Loan mix (%)

Corporate 31% 32% 33% 38%
SME 25% 25% 26% 22%
Agri 12% 12% 11% 10%
Retail 32% 31% 29% 29%
Gross advances 100% 100% 100% 100%
Especially heartening is FBs increasing penetration outside its Kerala home market on all loan
book fronts (Exhibits 66-67). Ex-Kerala loan books are growing faster than their Kerala
counterparts for all 3 segments; corporate, SME and retail (ex-gold) loan growth rates were
15%, 34% and 24% vs. 8%, 4% and 14% for the corresponding Kerala books in 1QFY18.
Focussed efforts on the digital banking front are expected to continue to reap rich dividends
for FB; this growth was achieved despite no incremental branch addition in FY16-FY17.
Exhibit 66. FB: Kerala loan book growing slower (1QFY18) Exhibit 67. FB: Growth in non-Kerala loans continues to outperform
Proportion of Kerala Business (%) Growth rate (%) Proportion of non-Kerala Business (%) Growth rate (%)
100% 90% 79%

91%
90% 80%
76%
80% 70%
70% 56%
60% 50%
60% 55%
50% 50% 45%
50% 44%
34% 40% 34%
40%
30% 21%
30% 24% 24% 25%
15% 18%
14% 17% 17% 20% 13%
20% 8% 9%
10% 4% 10%
0% 0%
Wholesale SME Retail (ex- NR SA CA Wholesale SME Retail (ex- NR SA CA
gold) Business gold) Business

Corporate loan book - Robust growth with increased focus on RM-led model: FBs corporate
loan growth saw a sharp uptick to 45% in FY17 from 19% (annualised) in FY14-FY16. Focus
on an RM-led model under Mr. G Sankaran (ED - Corporate Banking; ex-HDFC Bank) has
clearly helped FB pluck the relatively low-hanging fruit in this segment, and we expect this
story to continue to play out well into FY19E. The banks ex-Kerala corporate loans now
constitute c.80% of FBs wholesale loan book, indicating an improving pan-India footprint.
There are heartening signs of breakthroughs into better-rated mid corporates as well:
AAA/AA corporates now account for 71% of its loan book (up from 20% in FY13).
Moreover, we expect benefits of robust growth trends on this loan book to spill over to FBs
largely retail-driven fee and CASA profiles from FY19E.
Exhibit 68. FB: Corporate growth has seen sharp uptick (INR bn) Exhibit 69. FB: Breaking into better-rated corporates
Corporate loans Corporate YoY (%)
350 50% <BBB & Others BBB A AAA/AA
45% 301 100%
300 40% 16%
90% 20%
30% 28%
80% 40%
250
20% 70%
71%
200 10% 60%
0% 50%
150
40%
-10%
100 30%
-20%
20%
50 -30% 10%
0 -40% 0%
1QFY18
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY13
FY14
FY15
FY16
FY17
SME loan book - Proceeding with caution: SME remains at the core of FBs lending
operations, but this book has been impacted by structural issues over the past 2 years,
impairing asset quality and growth. Management responded by expanding its geographical
reach: 50% of its SME book is now ex-Kerala and is growing at 34% as of 1QFY18 vs. 4%
for its Kerala counterpart.
FBs SME loan book faced significant pressure over FY14-FY17, which led to elevated
slippages (260bps-400bps) and muted growth (14% CAGR) during this period. Its Kerala loan
book too faced a slew of challenges over FY15-FY17, including: a) stress in local rubber,
cashew, tourism and hotel industries; b) the erstwhile UDFs liquor restriction policy and c) a
slowdown in remittance-based repayments due to NRI-related issues in the Middle East.
Although this is the highest yielding portion (c.11%) of FBs book, we expect management to
keep the foot off the pedal on SME lending in the medium term and believe moderate mid-
teen growth should persist over FY19E.
Exhibit 70. FB: SME loan growth has slowed down (INR bn) Exhibit 71. FB: Annualised SME slippage rates (bps) remain high
SME loans SME YoY (%)
180 40% 450
160 168 400
30% 413
140 350
20% 300
120 8% 318
308 307
100 10% 250
267
80 200
0%
60 150
-10% 100
40
-20% 50
20
0
0 -30%
1QFY18
FY14
FY15
FY16
FY17
1QFY18
FY11
FY12
FY13
FY14
FY15
FY16
FY17

Retail loan book aspiring for a pan-India presence: FBs retail loan book grew 26% in FY17,
a marked improvement from 10.8% annualised growth during FY14-FY16. Its non-Kerala
retail loan book (ex-gold) is growing faster than its Kerala counterpart at 24% vs. 14% as
of 1QFY18 and now accounts for 45% of its retail loan book (ex-gold). FBs core strength in
retail lending lies in the housing/mortgage segment (60% of retail loans).
Continuing its pan-India retail focus, FB launched an aggressive media campaign after its QIP
in 1QFY18. The campaign is in line with FBs concerted efforts to reach a national audience
through digital channels and offer competitive pricing; its customer base now stands at c.8
million.
FB remains committed towards maintaining its overall CD ratio c.80% and will continue to
purchase retail portfolios in this pursuit. FB acquired retail portfolios (primarily
mortgages/housing loans) worth c.INR 30bn in FY17.
Exhibit 72. FB: Retail loans showing robust growth pick-up Exhibit 73. FB: Retail profile - predominantly housing/mortgage loans
Retail loans Retail YoY (%)
250 30%
26%
200 222 25%
20% 30%
150 Housing loan
42%
15% Mortgage loan
100
10% Gold loan
50 Other retail loan

5% 9%
0 0% 18%
1QFY18
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Healthy deposit franchise: FB had a healthy CASA of 33.4% as of 1QFY18. Granular deposits
(below INR 10mn) accounted for 92% of total deposits. Within CASA, current accounts (CA)
are yet to gain much traction (5.4% of total deposits), indicating FBs present low standing in
the corporate services pecking order. We expect benefits from the RM-led wholesale banking
(salary accounts, trade balances, etc.) to lead to meaningful accretion on the CASA front
from FY19E. Furthermore, FB boasts of a retail customer base of c.8 million, which provides
several incremental opportunities to tap into retail wallets for CASA.
FB has the highest market share of c.15% of NRI remittances (vs. 0.8% of system loans).
Management, however, is increasingly looking to diversify its geographical NRI customer base
rd
to Europe, US and Canada to reduce dependence on the Middle East (2/3 of FBs
remittances). NRE deposits (INR 374bn) account for 39% of FBs total deposits (45%
contribution to SA).
st
Exhibit 74. FB: CASA has largely sustained post-Demonetization Exhibit 75. FB: NRI SA% fell for the 1 time in FY17
Savings deposits (Rs bn) Current deposits (Rs bn) CASA % NRI SA (Rs bn) Resident SA (Rs bn) NRI SA %
400 40% 400 50%
33.4%
350 35% 350 48%
300 30% 300 45%
46%
250 25% 250
264 44%
200 20% 200
42%
150 15% 150
100 40%
100 10%
50 5% 50 38%
0 0% 0 36%
FY11
FY12
FY14
FY15
FY17
FY13
FY16
1QFY18
FY09
FY10
FY11
FY12
FY14
FY15
FY16
FY17
FY13

Margins to remain range-bound in the near term: FBs margin (calculated) largely sustained at
3.0%-3.1% over FY13-FY17. An improving CASA profile and the increasing proportion of
high-yielding SME loans in the loan mix (26% of the loan book in FY16) helped FB sustain
margins despite pressures on asset quality. However, pressures on margins may arise in the
medium term: a) CASA has fallen 130bps after Demonetization and b) SME loan growth
slowed down to 8% in FY17 (now 22% of loan book). Incrementally, FBs corporate loan
exposure tilts toward higher-rated companies (71% AAA/AA rated), which could keep yields
under pressure, although elevated capital levels could help NIMs sustain optically over the
medium term. We build NIMs (calculated) of 306bps/310bps/314bps for FY18E/FY19E/FY20E.
Exhibit 76. FB: Interest spreads to sustain at current levels Exhibit 77. FB: Improving CASA profile has helped NIMs sustain
Interest spread (%) CoF (%) YoA (%) CASA (%) (RHS) NIM (%) (LHS)
14% 4.0% 45%
3.1% 40%
3.5% 3.8% 3.1%
12% 3.1%
3.0% 35%
10% 3.1% 30%
2.5%
8% 25%
2.0%
6% 20%
1.5%
15%
4% 1.0% 10%
27.5%
26.9%
27.2%
31.2%
30.8%
37.9%
38.2%
37.7%
37.2%
36.9%
2% 0.5% 5%
0% 0.0% 0%
FY18E
FY19E
FY20E
FY14
FY11
FY12
FY13
FY15
FY16
FY17
FY19E
FY20E
FY18E
FY9
FY7
FY8
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
Fee profile to benefit from expanded corporate product suite: FBs current fee profile has
immense room for improvement. Its current core fee-to-assets ratio is the lowest among
private bank peers (Exhibit 78). A similar trend can be observed in FBs non-fund-based
exposure as well (Exhibit 79), which is indicative of relative inactivity on the LC/BG front. The
focus on RM-led corporate banking services aims at improving FBs relative low rank vs. peers
in servicing corporate/institutional clients. With FB moving up the value chain on the
corporate lending front with accelerated growth, we expect incremental benefits to spill over
into its fee profile.
Exhibit 78. FB: Core fee-to-assets (%) lowest for FB Exhibit 79. FB: Non-fund exposure as a % of gross exposure lowest
FY15 FY16 FY17
3.0% 30%
27.5%
24.9%
2.4% 25%
2.5%
20% 17.1%
2.0% 16.3%
15%
1.5% 1.5% 1.4% 11.5%
1.5% 1.4% 9.8%
1.1% 10% 8.2%
1.0% 5.8%
1.0% 5%
0.7%
0.5% 0%
AXSB ICICI HDFCB KMB IIB CUB DCB Federal AXSB ICICIBC HDFCB KMB IIB CUB DCB FB
Retail fees accounted for c.39% (c.INR 3bn) of FBs core fee income in FY17. On the retail
front, FB lags peers in the distribution of financial products (especially MFs), which have risen
disproportionately post-Demonetization, although insurance distribution did account for
c.INR 410mn in FY17. Management is optimistic about the GIFT city opportunity from a fee
perspective; this book stood at c.USD 200mn as of 1QFY18. Management has guided for this
book to double by FY18E.

Exhibit 80. FB: Fee profile

FB fee income split (INR mn) FY15 FY16 FY17 1QFY18
Loan processing fee 800 860 1,190 280
Comm. / Exch. / Brokerage 3,011 3,295 4,571 1180
Net profit on Forex transactions 1,162 1,305 1,277 340
Recovery from assets written off 1,068 889 552 370
Other fee income 142 142 142 1
Core fee income 6,183 6,491 7,732 2,171
Profit on sale of securities 2,557 1,275 3,087 1120
Income from subs 72 35 0 0
Total non-interest income 8,812 7,801 10,818 3,291
FB fee income mix (%) FY15 FY16 FY17 1QFY18

Loan processing fee 9% 11% 11% 9%
Comm. / Exch. / Brokerage 34% 42% 42% 36%
Net profit on Forex transactions 13% 17% 12% 10%
Recovery from assets written off 12% 11% 5% 11%
Other fee income 2% 2% 1% 0%
Core fee income 70% 83% 71% 66%
Profit on sale of securities 29% 16% 29% 34%
Income from subs 1% 0% 0% 0%
Total non-interest income 100% 100% 100% 100%
Focus on digital to be the key for RoA delivery: FBs cost-to-assets ratio has risen, from
c.1.8% in FY10-FY14 to 2.1% in FY17. Delivery on cost control remains at the heart of FBs
RoA turnaround story. Over FY15-FY17, FB meaningfully slowed down its branch expansion,
(only 5 new branches added). Management has guided that digital initiatives will continue to
be at the forefront of FBs operations; software spends accounted for 35% of capex in FY17
vs. 17% in FY14-FY16. Investments in digital have started paying rich dividends for FB over
Mar16-Jun17, with the number of active digital users doubling to 0.93 million.
FBs cost per employee (c.INR 1mn) is much higher than its private bank peers (32% higher
than HDFCB). Moreover, payouts for 80% of its workforce are IBA linked, and coupled with a
high average employee age (~38 years), could pose upside risks to costs. More recently, FB
has resorted to portfolio acquisitions (c.INR 30bn in FY17) and the run-rate for service
charges on these portfolios is INR 250mn per quarter.
Although marketing and digital spends are expected to continue to remain high in the near
term, management has committed to bring down cost-to-income to 50% by FY18 (53.4% in
FY17). We build a 22bps reduction in FBs cost-to-assets ratio to 1.89% over FY17-FY20E.
Exhibit 81. FB: Branch & employee additions to now stall Exhibit 82. FB: Investment in software as % of total capex
Branches (LHS) Employees (RHS) HDFCB ICICIBC AXSB FB
1,600 16,000
40%
1,400 14,000 36% 35%
34%
35%
1,200 12,000 29%
30%
1,000 10,000
25%
800 8,000 19%
20% 17%
600 6,000
15% 12%
400 4,000
10% 8%
200 2,000
5%
0 0
0%
FY18E
FY19E
FY20E
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY14 FY15 FY16 FY17

Asset quality: Improving trends

FB has been prudent in cutting down its exposure to stressed sectors over FY14-FY17. Power
exposure dropped meaningfully, from 5.5% of funded exposure in FY14 to 1.4% as of
1QFY18. Metals exposure also fell to 2.2% as of FY17 (4.0% in FY14). In telecom, FBs
exposure is towards healthier bluechips (c.INR 15bn). This reduction in exposure to stressed
sectors has been achieved through selldowns to ARCs, write-offs and restructuring.
Exhibit 83. FB: Stressed exposure as a % of fund based exposure Exhibit 84. FB:GNPA and NNPA ratio to improve incrementally
Metal & Metal products Power GNPA (%) NNPA (%) PCR (%)
4.0% 90%
6% 5.5% 3.5% 80%
5% 3.0% 70%
4.0% 4.1% 60%
3.6% 2.5%
4% 50%
2.0%
2.8% 2.8% 40%
3% 1.5%
2.2% 30%
2% 1.0% 20%
1.4%
0.5% 10%
1%
0.0% 0%
FY18E
FY19E
FY20E
FY11
FY10
FY12
FY13
FY14
FY15
FY16
FY17
0%
FY14 FY15 FY16 FY17
As a result of concerted management efforts, gross NPAs fell from 3.44% in FY13 to 2.42%
as of 1QFY18. Its standard restructured book also reduced meaningfully from 5.8% in FY14
to 1.5% (INR 11.4bn) as of 1QFY18. Tapering of credit costs will be a key driver for FB to
deliver 1%+ RoAs. Credit costs have trended lower from 160bps+ levels in FY09-FY11 to
62bps in FY17 as a result of managements concerted efforts.
Exhibit 85. FB: Total stress on the loan book drops meaningfully Exhibit 86. FB: Credit cost (bps) on a downward trend
GNPA Std Rest SRs Other impairments LLP (ex- prov for std. adv.) (bps)
10% 210
9.0% 9.2%
9%
7.6% 180
8%
7% 150 167 166
6% 5.5% 5.6% 5.6%
120
5%
90
4% 102
3% 60
64 65 70
2% 62 62
30 46 52
1% 40
0
0%
FY18E
FY19E
FY20E
FY14
FY15
FY10
FY11
FY12
FY13
FY16
FY17
FY13 FY14 FY15 FY16 FY17 1QFY18
Going forward, FB sees pockets of incremental stress in infrastructure (one private railroad
player) and in PSU aviation. It has pre-empted this stress by taking INR 600mn of accelerated
provisioning in 1QFY18. FBs restructured book primarily comprises exposures to a PSU
aviation major, some iron & steel stress and SEB bonds (INR 1.35bn). Elevated slippages on
the SME book have continued to persist and this will be a key area to watch out for over
FY18, especially FBs exposure to real estate/construction finance (5% of corporate book,
7.2% of SME book). We build average credit costs of 66bps over FY18-FY20E, with average
annualised gross slippages at 1.7%.

ESOPs rope in top talent

Top-notch leadership:
Shyam Srinivasan, MD & CEO: Mr Srinivasan has worked at FB since 2010. He is a career
banker with over 20 years of experience spanning leading multi-national banks (ex-Head of
Consumer Banking at Standard Chartered) with expertise in retail lending, wealth
management and SME banking. Mr Srinivasan holds the highest number of ESOPs (c.9
million) in FB.
Incrementally hiring top talent:

Ganesh Sankaran, ED - Corporate Banking: A former wholesale banker at HDFC Bank, he
has over 20 years of banking experience. He joined FB in FY16.
Shalini Warrier, Chief Operating Officer: Previously Head of Consumer Banking at Standard
Chartered Bank (Brunei) with over 25 years experience in banking. She joined FB in FY16.
Sumit Kakkar, Chief Credit Officer: A career wholesale banker, he has previously been
Chief Credit Officer at Yes Bank and Credit Risk Head at HDFC Bank. He joined FB in FY17.
Exhibit 87. FB: Better incentive structure to drive engagement Exhibit 88. FB: Driving share-price outperformance (INR)
140
ESOPs/ Total shares outstanding (%)
120
5%
4.4% 4.2% 100
4%
80
3% 60
2.4% 2.4%
2% 40
20
1%
0.2% 0.3% 0
Nov-12
Nov-13
Nov-14
Nov-15
Nov-16
Nov-17
0%
FY12 FY13 FY14 FY15 FY16 FY17
Source: JM Financial, Company Source: JM Financial, Bloomberg
FB has been successful in hiring top-notch banking talent, especially over the past 2 years,
with the help of ESOPs. Additional hires in senior management posts have been brought in
with sufficient skin in the game, with a new cost-to-company model that has significant
performance-based payouts. Our experience analysing other financial institutions (Bajaj
Finance, HDFC Bank, etc.) suggests this could be a trigger to drive further outperformance.
Exhibit 89. ESOP's granted to KMPs over the last five years
ESOPs granted ('000s) FY12 FY13 FY14 FY15 FY16 FY17 Total ESOPs granted ('000s)
MD & CEO - Shyam Srinivasan 5,131 1,283 1,283 1,283 - - 8,979
Executive Director - P C John 101 150 - - - - 251
Executive Director - Abraham Chacko 1,000 650 650 - - - 2,300
Executive Director - Ashutosh Khajuria 600 400 400 - - - 1,400
Ganesh Sankaran- Exec Director - - - - 625 300 925
Chief Operating Officer - Shalini Warrier - - - - 400 240 640
Chief Credit Officer - Sumit Kakkar - - - - - 225 225
Head Corporate Banking - Harsh Dugar - - - - - 200 200


Valuation and 12-month Target Price
Exhibit 90. FB: One-year forward P/BV Exhibit 91. FB: One-year forward P/E
Federal Fwd. P/BV (x) SD+1 SD-1 Average Federal Fwd. P/E (x) SD+1 SD-1 Average
2.0 30
25
1.5
20
1.0 15
10
0.5
5
0.0 0
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
Nov-14
Nov-15
Nov-16
Nov-17
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
Nov-14
Nov-15
Nov-16
Nov-17
Source: Bloomberg, JM Financial Source: Bloomberg, JM Financial
Exhibit 92. Fwd PB ratio of Private Banks/Fwd PB Ratio of FB
PvB/ FB SD+1 SD-1 Average
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
-
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
Nov-14
Nov-15
Nov-16
Nov-17
Source: JM Financial, Bloomberg

We value Federal Bank on a two-stage Gordon Growth Model. Our assumptions are as
follows:
Exhibit 93. FB: Valuation Summary

Pay-out ratio for the first 10 years (%) 20.0%
Perpetual growth rate (%) 4.0%
Perpetual pay-out ratio (%) 77.0%
K1 2.16
K2 11.04
Fully adjusted FY19E BVPS (INR) 63.6
Target P / Fully Adj BV (x) 2.1x

Source: JM Financial, Company


Y/E March FY16A FY17A FY18E FY19E FY20E Y/E March FY16 FY17 FY18E FY19E FY20E
Net Interest Income 25,042 30,526 37,221 45,674 55,609 Equity Capital 3,438 3,448 3,879 3,879 3,879
Profit on Investments 1,275 3,087 2,500 2,200 2,000 Reserves & Surplus 77,424 85,926 119,683 132,062 148,482
Exchange Income 1,305 1,277 1,468 1,762 2,114 Deposits 791,717 976,646 1,181,741 1,418,089 1,673,346
Total Income 32,906 41,344 49,476 59,996 72,467 Total Liabilities 945,764 1,149,719 1,399,868 1,666,656 1,958,550
Pre-provisioning Profits 14,238 19,249 24,634 30,859 38,198 Net Advances 580,901 733,363 909,370 1,118,525 1,353,415
Loan-Loss Provisions 5,848 4,836 6,287 7,413 9,917 Cash & Equivalents 54,198 74,522 82,150 95,641 108,952
Provisions on Investments 802 296 400 400 0 Fixed Assets 5,150 4,845 6,782 7,575 8,314
Others Provisions 392 1,052 350 750 100 Other Assets 53,959 55,029 67,136 52,555 29,855
Total Provisions 7,041 6,184 7,037 8,563 10,017 Total Assets 945,764 1,149,719 1,399,868 1,666,656 1,958,550

Tax 2,440 4,757 6,275 7,784 9,627
Dividend paid 1,450 1,864 2,134 2,134 2,134
Source: Company, JM Financial Dupont Analysis

NII / Assets 2.82% 2.91% 2.92% 2.98% 3.07%

Key Ratios
Other Income / Assets 0.89% 1.03% 0.96% 0.93% 0.93%
Total Income / Assets 3.71% 3.95% 3.88% 3.91% 4.00%
Growth (YoY) (%)
Cost / Assets 2.10% 2.11% 1.95% 1.90% 1.89%
Deposits 11.8% 23.4% 21.0% 20.0% 18.0%
PBP / Assets 1.60% 1.84% 1.93% 2.01% 2.11%
Advances 13.3% 26.2% 24.0% 23.0% 21.0%
Provisions / Assets 0.79% 0.59% 0.55% 0.56% 0.55%
Total Assets 14.2% 21.6% 21.8% 19.1% 17.5%
PBT / Assets 0.81% 1.25% 1.38% 1.45% 1.55%
NII 5.2% 21.9% 21.9% 22.7% 21.8%
Tax rate 33.9% 36.4% 35.7% 34.9% 34.2%
Non-interest Income -10.5% 37.6% 13.3% 16.9% 17.7%
ROA 0.54% 0.79% 0.89% 0.95% 1.02%
Operating Expenses 14.5% 18.4% 12.4% 17.3% 17.6%
RoRWAs 0.87% 1.27% 1.41% 1.50% 1.61%
Operating Profits -12.5% 35.2% 28.0% 25.3% 23.8%
Leverage 11.2 12.3 12.0 11.8 12.6
Core Operating profit -5.5% 24.7% 36.9% 29.5% 26.3%
ROE 6.0% 9.8% 10.6% 11.2% 12.9%
Provisions 559.7% -12.2% 13.8% 21.7% 17.0%
-52.7% 74.7% 36.3% 28.2% 27.9% Source: Company, JM Financial
Reported PAT
Yields / Margins (%)
Interest Spread 2.50% 2.79% 2.77% 2.76% 2.74% Valuations
Y/E March FY16 FY17 FY18E FY19E FY20E
NIM 2.96% 3.09% 3.08% 3.12% 3.15%
Shares in Issue 1,718.9 1,724.0 1,939.6 1,939.6 1,939.6
Profitability (%)
EPS (INR) 2.8 4.8 5.8 7.5 9.6
Non-IR to Income 23.9% 26.2% 24.8% 23.9% 23.3%
EPS (YoY) (%) -52.9% 74.1% 21.1% 28.2% 27.9%
Cost to Income 56.7% 53.4% 50.2% 48.6% 47.3%
PER (x) 41.9 24.1 19.9 15.5 12.1
ROA 0.54% 0.79% 0.89% 0.95% 1.02%
BV (INR) 47 52 64 70 79
ROE 6.0% 9.8% 10.6% 11.2% 12.9%
BV (YoY) (%) 4.2% 10.2% 22.9% 10.0% 12.1%
Assets Quality (%)
ABV (INR) 44 50 61 67 76
Slippages 3.72% 1.88% 1.90% 1.70% 1.60%
ABV (YoY) (%) -0.7% 11.6% 23.4% 9.8% 12.7%
Gross NPA 2.84% 2.33% 2.43% 2.34% 2.26%
P/BV (x) 2.47 2.24 1.82 1.66 1.48
Net NPAs 1.64% 1.28% 1.30% 1.26% 1.12%
P/ABV (x) 2.61 2.34 1.89 1.73 1.53
Provision Coverage 43.0% 45.5% 47.4% 46.9% 51.1%
DPS (INR) 0.8 1.1 1.1 1.1 1.1
Specific LLP 1.02% 0.62% 0.65% 0.62% 0.70%
Div. yield (%) 0.7% 0.9% 0.9% 0.9% 0.9%
Net NPAs / Networth 11.75% 10.53% 9.54% 10.33% 9.93%
Capital Adequacy (%)
Tier I 13.36% 11.81% 13.56% 12.72% 12.05%
CAR 13.93% 12.39% 14.26% 13.59% 12.95%

City Union Bank | BUY

Standing tallsteadily!
CUB is a region-focused bank in South India with dominance in the state of Tamil Nadu. CUB
Sameer Bhise
has displayed marked consistency in its return profile (10 yr avg RoA of 1.5%) driven by its sameer.bhise@jmfl.com | Tel: (91 22) 66303489
strategy of calibrated growth and focus on high yielding SME and trader book (51% of loan Jayant Kharote
book). CUB was a huge beneficiary from falling funding costs over FY14-17 which have led jayant.kharote@jmfl.com | Tel: (91 22) 66303099
to its margins reaching 4.5% (1QFY18). This helped it absorb its slightly elevated credit cost S Parameswaran
and maintain the its RoAs. Going ahead, we expect margins to come off slightly driven by
competition but a simultaneous improvement in credit costs should keep earnings on an Karan Singh CFA FRM
improving track. At CMP of INR 160, CUB trades at 2.3x FY19E BVPS, which is a slight
Nikhil Walecha
premium to peers. We believe managements demonstrated ability to deliver RoEs of c.15% nikhil.walecha@jmfl.com | Tel: (91 22) 66303027
even when asset quality stress is peaking, its focus on prudent and conservative growth in Bunny Babjee
specified target segments and the availability of sufficient operating leverage to enhance its bunny.babjee@jmfl.com | Tel: (91 22) 66303263
return profile deserves this valuation. Moreover, the bank is sufficiently capitalised with Tier-1
capital of 15.9% as at 1QFY18. We expect CUB to continue on its steady growth path and
Recommendation and Price Target
once it achieves scale, gradually move to newer markets in South and West India. We believe Current Reco. BUY
CUB is a healthy compounding play with greater bottomline visbility over the medium term Current Price Target (12M) 185
and value it at 2.8x fully adjusted FY19E BVPS with a TP of INR 185. Upside/(Downside) 12.5%
Stable performance to continue over the medium term: CUBs loan book is expected to Key Data CUBK IN Equity
grow at a steady pace of 16% over FY18-20E with RoAs expanding c.12bps to 1.62% Current Market Price INR163
over FY17-20E.CUB has demonstrated its prudent underwriting in the past, and asset Market cap (bn) INR107.5/$1.7
quality remains in check (GNPA of 3% as of 1QFY18), despite the absence of a strong Free Float 79.2%
Shares in issue (mn) 661.17
retail franchise (12.5% of loan book). Moreover, 99% of CUBs loan book is secured in
Diluted share (mn) 661.17
nature and exposure to the unorganised sector is <10% (SME loans with ticket size <INR
3-mon avg daily val (mn) INR94.3/US$1.5
2.5mn). The bank is expected to continue to cherry pick its growth over FY18-20E. 186/116
52-week range
Credit cost to taper off any impact on loss of margins: Although calculated NIMs are Sensex/Nifty 33,677/10,446
INR/US$ 64.7
expected to remain high over FY18E (3.86%), they are expected to come off c.17bps to
3.69% by FY20E. CUBs yields are expected to come off on the back of rising competition
Price Performance
in the SME segment and high proportion of floating rate loans (90% of loans on MCLR). % 1M 6M 12M
However, the compression in margins is likely to be sufficiently offset by improvement in Absolute -0.8 7.1 19.6
credit costs (c.22bps reduction to 90bps over FY17-20E) as the outlook on asset quality Relative* -6.6 -5.7 -3.9
remains stable. * To the BSE Sensex
Returns to be driven by growth acceleration: At CMP of INR 160, CUB trades at 2.3x
FY19E BVPS and we expect present valuations to sustain, given its consistent delivery on
returns (RoEs of 15.8% of FY15-17 even as asset quality stress peaked out). Stock returns
are expected to track BVPS accretion as we do not expect present multiple to re-rate. We
value CUB 2.8x FY19E fully adjusted BVPS to arrive at our target price of INR 185.

Net Profit 4,446.9 5,027.0 5,716.0 6,959.4 8,067.6
Net Profit (YoY) (%) 12.6 13.0 13.7 21.8 15.9
Assets (YoY) (%) 14.1 10.9 13.9 14.8 15.7
ROA (%) 1.5 1.5 1.5 1.6 1.6 JM Financial Research is also available on:
ROE (%) 15.5 15.2 15.1 16.3 16.6 Bloomberg - JMFR <GO>,
EPS 7.4 8.4 8.6 10.5 12.2 Thomson Publisher & Reuters
EPS (YoY) (%) 12.3 12.5 3.4 21.8 15.9 S&P Capital IQ and FactSet
PE (x) 21.9 19.5 18.9 15.5 13.4
BV 51.0 59.4 60.7 68.6 78.2 Please see Appendix I at the end of this
BV (YoY) (%) 12.9 16.4 2.1 13.0 14.0 report for Important Disclosures and
3.19 2.74 2.69 2.38 2.09 Disclaimers and Research Analyst
P/BV (x)
Certification.

City Union Bank 6 November 2017
Geographically concentrated loan book, but diversified across industries: CUB being a region-
focussed bank, c.64% of its loan book is concentrated in the state of Tamil Nadu and 86% in
South India. This is in conjunction with its c.89% branches in South India. Bank expects to
continue growing its branch network in Tamil Nadu for another 2-3 years from where it will
move to next phase of expansion in Andhra Pradesh and Telangana.
Exhibit 94. CUB: Growth in number of branches and employees Exhibit 95. CUB: Growth in total loan book
Branches (LHS) Employees (RHS) Advances (INR bn) Loan growth
700 6,000 400 372 35%
600 350 318 30%

5,000
300 274
500 25%
4,000 238
250 211
400 20%
3,000 200 180
152 161
300 15%
150 121
2,000
200 10%
100
100 1,000 5%
50
300 375 425 475 525 550 575 600 650
0 0 0 0%
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY12
FY13
FY14
FY15
FY16
FY17
The banks lending focus remains on trading and MSME loans (c.51% of its loan book) where
it likes to operate in high-yielding, small ticket sizes of INR 10mn-20mn. CUB focuses more
on working capital loans and avoids risky products. Hence, term loans make up only 35% of
its book (largely Plant & machinery related) and 99% of its loan book comprises secured
lending. The banks focus on prudent lending is evident from the reducing exposure to large
corporates (only 7% of its loan book in FY17 vs. 14% in FY13) and jewellery loans (9% of its
loan book in FY17 vs. 22% in FY13). Further, most of it current gold loans are agri loans
secured by gold and giving further comfort on the quality of the book.
Exhibit 96. CUB: Branches concentrated in the home market Exhibit 97. CUB: Loan book growing outside South India too
Tamil Nadu Other South India Rest of India Tamil Nadu Other South India Rest of India
100% 100%
12 11 11 11 11 11 11 13 14 14
80% 22 20 20 20 20 20 80% 21 22 23 22
60% 60%
40% 40%
66 68 68 68 69 69 68 65 63 64
20% 20%
0% 0%
FY13 FY14 FY15 FY16 FY17 1QFY18 FY15 FY16 FY17 1QFY18
Exposure to unorganised sector <10%: CUBs total exposure towards the unorganised sector
MSMEs is less than 10%. While textile SMEs are facing some operational issues due to GST
introduction, any impact will be transient in nature and will not go beyond a few quarters.
CUBs strategy to focus on small business lending will only help it tap into the ongoing
structural reforms aiding shifting of unorganised sector to a more organised one.
CUB expanded conservatively in FY13-FY17 (12% CAGR) after strong performance in its early
years (FY07-FY12: CAGR of 30%) and is expected to moderately improve from here. While
management guides for 15-18% growth in the near term, we build loan CAGR of 16% over
FY17-FY20E.

Exhibit 98. CUB: Loan book split

Loan book split FY13 FY14 FY15 FY16 FY17
Agriculture 16% 19% 17% 16% 18%
Jewel (Retail + Agri) 22% 18% 14% 9% 9%
MSME 26% 30% 34% 34% 29%
Large Industries 14% 8% 6% 7% 7%
Retail traders 8% 7% 5% 5% 4%
Wholesale traders 11% 11% 12% 13% 13%
Commercial Real estate 5% 5% 5% 5% 5%
Loans collateralised by deposit 2% 2% 2% 2% 2%
Retail loans 16% 12% 11% 13% 12%
Infrastructure 1% 1% 1% 1% 1%
NBFC 1% 1% 1% 1% 1%
Others 2% 3% 5% 5% 7%
Total Loans 100% 100% 100% 100% 100%
Deposit accretion to remain stable; CASA unlikely to show meaningful upside: CUBs
granular deposit base, reliance on retail term deposits and a low proportion of corporate
deposits helps it maintain stable funding cost. The banks FD renewal rate exceeds 90% and
the preferred tenure of its term deposit base is 1 year, leading to annual re-pricing. While
overall deposit CAGR of 10% over FY13-FY17 was lower than earlier years (28% CAGR over
FY07-FY12), CASA growth was stronger, posting 20% CAGR during this period. The nature
and tenure of its term deposits as well as the improvement in CASA has helped the bank
reduce its cost of funds faster than the rate of falling yields, leading to meaningful
improvement in margins. CUBs CASA ratio currently stands at 23.4% vs. 16.8% in FY13.
However, we believe the bank may find it difficult to further scale up its CASA ratio beyond
25%, given its relatively small retail franchise. We build deposit CAGR of 15% over FY17-
FY20E.
Exhibit 99. CUB: Growth in total deposits Exhibit 100. CUB: Deposits split
Deposits (Rs bn) Growth (%) Savings deposits (Rs bn) Current deposits (Rs bn)
400 40% Term deposits (Rs bn) CASA %
400 30%
301
27% 350
300 25% 26% 272 30% 22% 23% 25%
24% 20%
241 300 20% 19%
220 18% 18%
203 17% 20%
250
200 163 20%
129 13% 200 15%
11%
103 8% 9%
150
100 10% 10%
100
5%
50
0 0%
0 0%
FY14
FY10
FY11
FY12
FY13
FY15
FY16
FY17
FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17

Geographically, CUBs deposit base is disproportionately elevated in its home states and the
proportion has been inching up consistently. While it displays the banks strength in the
home market, it also is an indicator of some branding challenges the bank will face beyond
its home markets. The share of South India in its overall deposit base currently stands at 93%
of total deposits.

Exhibit 101. CUB: Deposits are disproportionately concentrated in South India

Tamil Nadu Other South India Rest of India
100%
10 11 8 7
14 12 14 14
80%
60%
40% 76 77 78 79
20%
0%
FY15 FY16 FY17 1QFY18
NIMs to fall slightly as rising competition may impact yields: CUBs reported NIMs have
improved c.70bps over the past 3 years as a result of reduced costs of funding and stood at
4.2% in FY17. Greater reliance on retail term deposits with a preferred tenure of 1 year
(leading to annual re-pricing) bodes well in times of falling rates. Further, CUB has seen
meaningful CASA improvement on a low base in the past 3 years. Both these factors will
further aid the banks cost of funding over FY17-FY19E. However, its loan book yields have
begun to face pressure owing to the MCLR regime and increasing competition in the market.
Reported yields on loans stood at 11.8% as of 1QFY18. With rising competition in the SME
space from newer entities (small finance banks, NBFCs, etc.) and existing banks entering new
geographies to chase growth, CUB is likely to see some decline in its loan book yields, leading
to a c.17bps contraction in margins from current levels over FY17-FY20E.
Exhibit 102. CUB: Reported spread improved as the cost of funds declined faster
Reported NIM Reported Spread
4.5%
4.2%
4.0% 3.8%
3.6%
3.5% 3.5% 3.4%
3.4% 3.4%
3.5%
3.2% 3.6%
3.3% 3.3%
3.0%
3.2%
3.0% 3.0% 3.1% 3.0%
2.8%
2.5%
FY16
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY17

Exhibit 103. CUB: Calculated COF and yield on advances (%) Exhibit 104. CUB: Net interest margin (NIM) to fall slightly
Cost of Funds (%) Yield on Advances (%) Calculated NIM (%)
16% 4.0%
3.9%
14% 13.0% 13.2% 13.3% 12.7%
12.1% 3.8%
11.5% 11.5% 3.9%
12% 11.1% 10.9% 3.7%
3.7% 3.8%
3.6% 3.7%
10% 3.5%
8.0% 8.4% 8.3% 8.1%
7.5% 3.4%
8% 6.8% 6.5%
6.3% 6.2% 3.3% 3.4%
6% 3.2% 3.3% 3.1% 3.1%
3.3%
3.1%
4% 3.2%
3.0%
FY18E
FY19E
FY20E
FY17
FY12
FY13
FY14
FY15
FY16
FY19E
FY18E
FY20E
FY17
FY11
FY12
FY13
FY14
FY15
FY16
Fee income profile to marginally improve as levers are limited: CUBs fee income profile
largely comprises core fees, processing charges and recoveries, while treasury profits come to
its aid as per the prevailing rate cycle. There are no aggressive signs of a rise in corporate or
structured transactions, which can become a strong driver of fees, as seen in the case of
larger peers. Going ahead, CUB plans to continue to focus on its target segment (MSME),
which has historically been a low fee yielding segment. Unless some significant changes are
made to the banks loan book strategy, it is highly unlikely that its fee income profile will
change meaningfully from current levels. However, as the bank scales up its loan book and
steadily invests in branches, we expect marginal improvement, with a CAGR of 10% in core
fees over FY17-FY20E (vs. CAGR of 5% over FY15-FY17).
Exhibit 105. CUB: Fee income split and growth (INR mn)
Fee income split (INR mn) FY13 FY14 FY15 FY16 FY17 CAGR % (FY13-17)
Comm./Exchg./Brkrg. 1,544 1,743 1,967 2,105 2,175 8.9%
P/L on Sale of Invsts. 354 555 1,292 1,259 2,056 55.2%
Other & Misc. Income 655 501 782 736 608 -1.9%
Total Non-interest Income 2,553 2,799 4,041 4,100 4,839 17.3%
Core Non-Interest income 2,199 2,244 2,749 2,841 2,783 6.1%
Exhibit 106. CUB: Core fee income/Total assets (%) Exhibit 107. CUB: Core fee income/Total other income
Core fees (Ex-Treasury)/ Assets (%) Core fee income/ Other Income (%)
1.4% 100%
96% 96%
1.3% 94%
95% 92%
1.2% 1.3% 89%
1.2%
1.2% 1.2% 90% 87% 86% 88%
1.1% 1.0% 85%
1.2% 1.0%
1.0% 1.1%
1.1% 1.1% 85%
0.9% 78%
80%
0.8%
75%
0.7%
0.6% 70%
FY18E
FY19E
FY20E
FY15
FY11
FY12
FY13
FY14
FY16
FY17
FY20E
FY18E
FY19E
FY11
FY12
FY13
FY14
FY15
FY16
FY17

Cost ratios to remain stable with marginal improvement: CUB has a strong cost-to-income
ratio of 41%, driven by stable employee costs and a cautious branch expansion strategy. It
has added 50 branches each year since FY13 and guides for a similar strategy over the near
term. However, it added only 25 branches in FY17 against the initial plan of 50, as
demonetisation as well as a slow moving economy dis-incentivised near-term investments in
branches. Going ahead, CUBs management has guided that it may add 25 branches in FY18
if there is an improvement in economy. However, the banks continuous investments on the
digital front are likely to continue.
Management successfully negotiated a bi-partite settlement between itself and the staff
union (not related to IBA negotiations) in FY17, leading to a nearly 35% YoY jump in cost-
per-employee for the bank. Having recently completed the settlement payout, we expect
employee costs to remain stable over the medium term.
Thus, given stable employee costs and slow growth in other opex (due to calibrated branch
expansion), we expect CUBs cost-to-assets to improve 15bps over FY17-FY19E.
Exhibit 108. CUB: Cost-to-income ratio to inch downwards Exhibit 109. CUB: Cost-to-assets (%)
Cost to Income (%) Cost to assets (%)
45% 2.2%
44%
43% 2.0%
44% 2.1%
42% 2.0% 2.0%
43% 1.8% 1.9% 1.9% 1.9%
41% 1.9%
42% 1.8%
40% 41% 1.6% 1.7%
39% 40% 40% 40% 1.7%
40%
40% 1.4%
38%
37% 1.2%
36% 37%
35% 1.0%
FY18E
FY19E
FY20E
FY14
FY11
FY12
FY13
FY15
FY16
FY17
FY18E
FY19E
FY20E
FY12
FY16
FY11
FY13
FY14
FY15
FY17
Asset quality within control, credit costs to taper off over FY18-20E: Despite the absence of a
strong retail franchise (retail loans comprise c.12.5% of the overall loan book), CUB has kept
its asset quality in control, with GNPA of 3% and NNPA of 1.8% as of 1QFY18. Restructured
loans have shrunk from 1.5% in FY15 to 0.57% in FY17. CUB has begun reducing its
exposure to risky segments over the past 3 years as the corporate NPA cycle and stress in the
gems & jewellery sector cropped up. It has consistently reduced the proportion of corporate
loans (7% of loan book currently vs. 14% in FY13) and jewellery loans (9% of loan book
currently vs. 22% in FY13). Also, unsecured loans now form only 1% of its loan book.
CUB unwound its corporate book in the face of the NPA cycle and recent stresses brought on
by Demonetization; this drove a rise NPAs, but these may drop over FY17-FY19E. However,
its provision coverage at c.41% remains lower than most peers and improving it will add
to credit costs going forward. While management has indicated that it does not have
exposure to any of the 12 accounts identified for insolvency proceedings by the RBI, it guided
for potential slipping of 2-3 accounts, leading to 175bps-200bps of slippages in FY18E. We
expect LLP to touch 90bps and GNPA to improve to 2.25% by FY19E.

Exhibit 110. CUB: Increasing PCR to add to credit costs Exhibit 111. CUB: Credit costs (bps) to inch up marginally
GNPA (%) NNPA (%) PCR (%) LLP (ex- prov for std. adv.) (bps)
3.0% 70% 130
112 120
120
2.5% 60% 105
110 100
50% 95 97
2.0% 100 90
40% 90 84
1.5%
30% 80 71
1.0% 70
20%
60 53
0.5% 10%
50
0.0% 0%
40
FY18E
FY19E
FY20E
FY12
FY11
FY13
FY14
FY15
FY16
FY17
FY16
FY11
FY12
FY13
FY14
FY15
FY17
FY18
FY19
FY20
Premium valuations justified: CUB trades at 2.3x FY19E BVPS, which is a slight premium to
peer midcap banks such as DCB (1.9x FY19E BVPS) and FB (1.7x FY19E BVPS). We believe
managements demonstrated ability to deliver RoAs of c.1.5%, even when asset quality stress
is peaking, its focus on prudent and conservative growth in specified target segments and the
availability of some operating leverage to enhance its return profile deserves this valuation.
Moreover, the bank is sufficiently capitalised, with Tier-1 capital of 15.8% as of FY17, and
dilution risk is minimal as management has indicated it will raise capital only when this
breaches 14%.
Exhibit 112. CUB: Return profile to improve on the back of cost improvement
RoA (LHS) (%) RoE (RHS) (%)
1.9% 30%
25%
1.7% 20%
15%
1.5% 10%
5%
1.3% 0%
FY18E
FY19E
FY20E
FY11
FY12
FY13
FY14
FY15
FY16
FY17

Exhibit 113. One-year-forward Price/BVPS Exhibit 114. One-year-forward price/earnings

CUB Fwd. P/BV (x) SD+1 SD-1 Average CUB Fwd. P/E (x) SD+1 SD-1 Average
3.0 25
2.5 20
2.0
15
1.5
10
1.0
0.5 5
0.0 0
Nov-15
Nov-17
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
Nov-14
Nov-16
Nov-07
Nov-12
Nov-08
Nov-09
Nov-10
Nov-11
Nov-13
Nov-14
Nov-15
Nov-16
Nov-17

We value CUB on a two-stage Gordon Growth Model. Our assumptions are as follows:
Exhibit 115. Valuation Summary

Payout ratio for the first 10 years (%) 6.6%
Perpetual growth rate (%) 4.0%
Perpetual payout ratio (%) 80.0%
K1 0.84
K2 14.59
Fully adjusted FY19E BVPS (INR) 64.3
Target P/BV (x) 2.8x


Y/E March FY16A FY17A FY18E FY19E FY20E Y/E March FY16 FY17 FY18E FY19E FY20E
Net Interest Income 9,810 11,988 13,966 15,604 17,883 Equity Capital 598 601 661 661 661
Profit on Investments 453 1,078 605 705 705 Reserves & Surplus 29,922 35,101 39,451 44,682 51,020
Exchange Income 806 978 1,027 1,130 1,243 Deposits 271,581 301,157 343,319 394,817 457,988
Total Income 13,910 16,826 18,637 20,805 23,561 Total Liabilities 318,040 352,708 401,859 461,175 533,703
Pre-provisioning Profits 8,333 9,937 11,133 12,464 14,145 Net Advances 210,569 238,327 274,076 317,928 371,976
Loan-Loss Provisions 2,262 2,595 3,180 3,093 3,274 Cash & Equivalents 26,501 28,790 31,265 36,185 41,965
Provisions on Investments 0 490 78 27 27 Fixed Assets 2,176 2,151 2,258 2,371 2,490
Others Provisions 44 -75 -64 -61 -58 Other Assets 10,530 13,126 14,306 11,981 9,697
Total Provisions 2,306 3,010 3,194 3,060 3,243 Total Assets 318,040 352,708 401,859 461,175 533,703

Tax 1,580 1,900 2,223 2,445 2,835
Dividend paid 925 198 1,306 1,729 1,729
Key Ratios Dupont Analysis

Growth (YoY) (%) NII / Assets 3.29% 3.57% 3.70% 3.62% 3.60%
Deposits 12.8% 10.9% 14.0% 15.0% 16.0% Other Income / Assets 1.37% 1.44% 1.24% 1.21% 1.14%
Advances 17.2% 13.2% 15.0% 16.0% 17.0% Total Income / Assets 4.66% 5.02% 4.94% 4.82% 4.74%
Total Assets 14.1% 10.9% 13.9% 14.8% 15.7% Cost / Assets 1.87% 2.05% 1.99% 1.93% 1.89%
NII 21.5% 22.2% 16.5% 11.7% 14.6% PBP / Assets 2.79% 2.96% 2.95% 2.89% 2.84%
Non-interest Income 1.5% 18.0% -3.5% 11.3% 9.2% Provisions / Assets 0.77% 0.90% 0.85% 0.71% 0.65%
Operating Expenses 7.5% 23.5% 8.9% 11.1% 12.9% PBT / Assets 2.02% 2.07% 2.10% 2.18% 2.19%
Operating Profits 20.3% 19.2% 12.0% 12.0% 13.5% Tax rate 26.2% 27.4% 28.0% 26.0% 26.0%
Core Operating profit 24.6% 12.4% 18.8% 11.7% 14.3% ROA 1.49% 1.50% 1.52% 1.61% 1.62%
Provisions 26.3% 30.5% 6.1% -4.2% 6.0% RoRWAs 2.43% 2.33% 2.30% 2.42% 2.39%
Reported PAT 12.6% 13.0% 13.7% 21.8% 15.9% Leverage 10.4 10.1 10.0 10.1 10.3
Yields / Margins (%) ROE 15.5% 15.2% 15.1% 16.3% 16.6%
Interest Spread 2.72% 3.12% 3.26% 3.13% 3.03% Source: Company, JM Financial
NIM 3.42% 3.73% 3.86% 3.75% 3.69%
Profitability (%) Valuations

Non-IR to Income 29.5% 28.8% 25.1% 25.0% 24.1% Y/E March FY16 FY17 FY18E FY19E FY20E
Cost to Income 40.1% 40.9% 40.3% 40.1% 40.0% Shares in Issue 598.2 601.1 661.2 661.2 661.2
ROA 1.49% 1.50% 1.52% 1.61% 1.62% EPS (INR) 7.4 8.4 8.6 10.5 12.2
ROE 15.5% 15.2% 15.1% 16.3% 16.6% EPS (YoY) (%) 12.3% 12.5% 3.4% 21.8% 15.9%
Assets Quality (%) PER (x) 21.5 19.1 18.5 15.2 13.1
Slippages 2.42% 2.31% 2.10% 1.75% 1.75% BV (INR) 51 59 61 69 78
Gross NPA 2.41% 2.83% 2.76% 2.42% 2.24% BV (YoY) (%) 12.9% 16.4% 2.1% 13.0% 14.0%
Net NPAs 1.53% 1.71% 1.54% 1.28% 1.16% ABV (INR) 49 57 59 67 77
Provision Coverage 36.9% 40.1% 44.8% 47.6% 48.6% ABV (YoY) (%) 12.7% 16.5% 3.1% 14.0% 14.3%
Specific LLP 1.05% 1.12% 1.20% 1.00% 0.90% P/BV (x) 3.14 2.69 2.64 2.33 2.05
Net NPAs / Networth 10.59% 11.44% 10.53% 8.98% 8.36% P/ABV (x) 3.26 2.80 2.72 2.38 2.09
Capital Adequacy (%) DPS (INR) 1.5 0.3 2.0 2.6 2.6
Tier I 15.09% 15.35% 14.93% 14.50% 14.09% Div. yield (%) 1.0% 0.2% 1.2% 1.6% 1.6%
CAR 15.58% 15.83% 15.34% 14.86% 14.39% Source: Company, JM Financial

APPENDIX I
JM Financial Inst itut ional Secur ities Lim ited

Corporate Identity Number: U65192MH1995PLC092522
Member of BSE Ltd. and National Stock Exchange of India Ltd. and Metropolitan Stock Exchange of India Ltd.
SEBI Registration Nos.: BSE - INZ010012532, NSE - INZ230012536 and MSEI - INZ260012539, Research Analyst INH000000610
Registered Office: 7th Floor, Cnergy, Appasaheb Marathe Marg, Prabhadevi, Mumbai 400 025, India.
Board: +9122 6630 3030 | Fax: +91 22 6630 3488 | Email: jmfinancial.research@jmfl.com | www.jmfl.com
Compliance Officer: Mr. Sunny Shah | Tel: +91 22 6630 3383 | Email: sunny.shah@jmfl.com
Definition of ratings
Rating Meaning
Buy Total expected returns of more than 15%. Total expected return includes dividend yields.
Hold Price expected to move in the range of 10% downside to 15% upside from the current market price.
Sell Price expected to move downwards by more than 10%
Research Analyst(s) Certification
The Research Analyst(s), with respect to each issuer and its securities covered by them in this research report, certify that:
All of the views expressed in this research report accurately reflect his or her or their personal views about all of the issuers and their securities; and
No part of his or her or their compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed in this research
report.
Important Disclosures
This research report has been prepared by JM Financial Institutional Securities Limited (JM Financial Institutional Securities) to provide information about the
company(ies) and sector(s), if any, covered in the report and may be distributed by it and/or its associates solely for the purpose of information of the select
recipient of this report. This report and/or any part thereof, may not be duplicated in any form and/or reproduced or redistributed without the prior written
consent of JM Financial Institutional Securities. This report has been prepared independent of the companies covered herein.
JM Financial Institutional Securities is registered with the Securities and Exchange Board of India (SEBI) as a Research Analyst, Merchant Banker and a Stock
Broker having trading memberships of the BSE Ltd. (BSE), National Stock Exchange of India Ltd. (NSE) and Metropolitan Stock Exchange of India Ltd. (MSEI). No
material disciplinary action has been taken by SEBI against JM Financial Institutional Securities in the past two financial years which may impact the investment
decision making of the investor.
JM Financial Institutional Securities provides a wide range of investment banking services to a diversified client base of corporates in the domestic and
international markets. It also renders stock broking services primarily to institutional investors and provides the research services to its institutional
clients/investors. JM Financial Institutional Securities and its associates are part of a multi-service, integrated investment banking, investment management,
brokerage and financing group. JM Financial Institutional Securities and/or its associates might have provided or may provide services in respect of managing
offerings of securities, corporate finance, investment banking, mergers & acquisitions, broking, financing or any other advisory services to the company(ies)
covered herein. JM Financial Institutional Securities and/or its associates might have received during the past twelve months or may receive compensation from
the company(ies) mentioned in this report for rendering any of the above services.
JM Financial Institutional Securities and/or its associates, their directors and employees may; (a) from time to time, have a long or short position in, and buy or
sell the securities of the company(ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other
compensation or act as a market maker in the financial instruments of the company(ies) covered under this report or (c) act as an advisor or lender/borrower to,
or may have any financial interest in, such company(ies) or (d) considering the nature of business/activities that JM Financial Institutional Securities is engaged
in, it may have potential conflict of interest at the time of publication of this report on the subject company(ies).
Neither JM Financial Institutional Securities nor its associates or the Research Analyst(s) named in this report or his/her relatives individually own one per cent or
more securities of the company(ies) covered under this report, at the relevant date as specified in the SEBI (Research Analysts) Regulations, 2014.
The Research Analyst(s) principally responsible for the preparation of this research report and members of their household are prohibited from buying or selling
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JM Financial - Indian Banking Sector - Mid Sized Private Banks - Winds of Change (Sector Initiation) (DCB, Federal, CUB)

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JM Financial - Indian Banking Sector - Mid Sized Private Banks - Winds of Change (Sector Initiation) (DCB, Federal, CUB)

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06 November 2017 India | Indian Banking Sector | Sector Report

Indian Banking Sector

Exhibit 1. Valuation and financial summary

JM Financial Institutional Securities Limited

Contents Page No.

Federal Bank (BUY, TP INR 140, 20.7% Upside) 24

City Union Bank (BUY, TP INR 185, 12.5% Upside) 34

JM Financial Institutional Securities Limited Page 2

Exhibit 2. JMFL : Indian Banks valuation matrix

Exhibit 3. JMFL : Indian Banks valuation matrix

Company BVPS EPS EPS Growth ROA

JM Financial Institutional Securities Limited Page 3

Initiate coverage with a positive stance

Exhibit 4. Key metrics for small/mid-sized banks as on FY17 (%)

Exhibit 5. FY17-FY20 estimates for DCB, CUB and FB

Book value per share - BVPS (INR)

JM Financial Institutional Securities Limited Page 4

Low operating profitability has historically been a challenge

Exhibit 6. FY17 Du Pont comparison (%)

Exhibit 7. FY19E Du Pont comparison (%)

.accentuated further by a tough credit environment

Exhibit 8. Credit costs have impacted profitability (%)

JM Financial Institutional Securities Limited Page 5

However, efficiency measures should now bear fruition

Source: Company, JM Financial Source: Company, JM Financial

FY13 FY14 FY15 FY16 FY17 1QFY18

Source: Company, JM Financial Source: Company, JM Financial

Growth not a challenge anymore

JM Financial Institutional Securities Limited Page 6

Exhibit 15. Loan growth trends continue to remain strong

JM Financial Institutional Securities Limited Page 7

Stressed assets low baggage, no major casualties expected

Exhibit 18. Midcap banks: Exposure to stressed sectors

Exhibit 19. Total stress on books as on 1QFY18 (% of loan book)

CUB 3.0% 0.6% 1.4% 0.5% 5.5%

JM Financial Institutional Securities Limited Page 8

Capital - ample for growth

Source: Company, JM Financial Source: Company, JM Financial

JM Financial Institutional Securities Limited Page 9

Management reward structures are comparable with leading

JM Financial Institutional Securities Limited Page 10

Improving return metrics to aid valuations

Source: Company, JM Financial

JM Financial Institutional Securities Limited Page 11

JM Financial Institutional Securities Limited Page 12

DCB Bank | BUY

Financial Summary (INR mn)

JM Financial Institutional Securities Limited

JM Financial Institutional Securities Limited Page 14

30% 80,000 1.20% 800

31,293 40,000 0.60% 400

Source: Company, JM Financial Source: Company, JM Financial

FY09-15 - A period of restructuring and consolidation: DCB Banks management underwent

1.44% 1.49% 1.43%

JM Financial Institutional Securities Limited Page 15

150 3,000 150 136

Source: Company, JM Financial Source: Company, JM Financial

JM Financial Institutional Securities Limited Page 16

Source: Company, JM Financial Source: Company, JM Financial

Exhibit 46. Fee income split

Source: Company, JM Financial Source: Company, JM Financial FY17

JM Financial Institutional Securities Limited Page 18

Source: Company, JM Financial Source: Company, JM Financial