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Business growth on track; RoA to sustain at >1%

Asset quality outlook remains positive

We attended the analyst meet hosted by the entire top management team of Union Bank (UNBK). The management emphasized the bank's efforts in delivering profitable growth while continually making investments in the business and enhancing the technological capabilities of the bank. Management has conservatively guided FY25E NIMs of 2.8-3.0%, while RoA will be healthy at >1%. Following are the key takeaways from the meet:

Loan growth to remain healthy at 10-12%

UNBK is experiencing robust loan growth, driven by sustained momentum in Retail, Agriculture, MSME, Corporate, and Overseas lending segments. Additionally, there is a notable increase in demand for education loans. The bank anticipates a credit growth of ~10-12% in FY25, supported by strong credit demand. Presently, the bank has a healthy corporate pipeline of INR300b under discussion, along with around INR400b already sanctioned and prepared for disbursement. The bank foresees its deposit base growing healthily at a rate of 9-11%, bolstered by retail deposits via CASA and retail TDs. With a current CD ratio of 71%, the bank has mechanisms in place to further boost loan growth, aiming for a CD ratio within the range of 75-77%. Moreover, the bank holds excess SLR reserves amounting to INR700b, which can be utilized to enhance credit availability.

Margin outlook steady; NIM to be at 2.8-3.0% on a conservative basis

Although management has taken a cautious stance regarding NIM guidance, the bank possesses various mechanisms to optimize its margins. The bank forecasts margins in the range of approximately 2.8-3.0%. Despite a repo rate increase of 250bp, the bank has implemented only ~155bp of this increase, retaining flexibility to utilize the remainder when necessary. Additionally, the bank aims for a dummy interest of ~INR30b, which could contribute positively to margins in the future. Combined with the potential for further enhancement in the CD ratio, these factors could provide additional support to margins in FY25.

Limited impact from the RBI’s draft circular on project finance

UNBK maintains a limited exposure to project finance loans. Out of its total corporate exposure of INR4.07t, only 28% is attributed to project loans, with 68% of this portion linked to completed projects. Consequently, only 32% of project loans are subject to provisioning requirements, leading the bank to anticipate minimal impact. Nevertheless, the bank remains in communication with the regulator to assess feedback and ascertain the potential provisioning requirement. The bank plans to transfer any impact to the borrowers and will vigilantly monitor corporate developments.

Asset quality robust; recoveries to maintain a healthy run-rate

UNBK's asset quality demonstrates ongoing enhancement, characterized by a consistent decline in NPA ratios. The bank has effectively contained slippages at 50% of total recoveries. For FY24, it achieved total recoveries amounting to INR185b and anticipates a similar figure of ~INR160b in FY25. With a total NPA pool of INR1.23t, ~INR800b is classified as TWO accounts, wherein the bank observes a 7% increase in recoveries. Currently, the bank is engaged in discussions regarding 11 A/Cs with the NARCL, aiming to recover INR20 billion in FY25. Encouragingly, the bank foresees favorable recoveries from ARCs, given the granular and staggered nature of recoveries witnessed in FY24. Maintaining confidence, the bank expects to sustain credit costs at their current level, thereby likely remaining below 1%.

Strong focus on profitability with UNBK being the fourth-largest PSU bank

UNBK has consistently demonstrated strong profitability, securing its position as the fourth-largest PSU in terms of profitability. With one of the lowest C/I ratios in the industry, UNBK sees potential for further improvement in operational expenditure by outsourcing certain business functions. Having already met its FY24 targets for RoA and ROE at 1% and 17%, respectively, UNBK aims to sustain a RoA of over 1% in FY25. To achieve this, the bank has implemented various initiatives focused on controlling credit costs, enhancing the CASA ratio, and maintaining robust margins.

Other highlights

* UNBK anticipates favorable conditions with a good monsoon, supportive Fed policies, and expected ease in liquidity, which should contribute to sufficient trading income.

* The bank prioritizes maintaining its profit level without compromising its revenue. Despite initially forecasting lower guidance, the bank has observed better-than-expected growth.

* Management is confident that deposit growth will not hinder loan growth.

* Deposit growth was stronger in the first half of the year, while credit growth remained robust in the second half.

* The bank does not maintain floating provisions and currently has standard asset provisions.

* UNBK plans to transition to lower tax rates of 25-27%, which were previously inflated due to the reversal of DTAs.

* The transition of the mobile banking platform is scheduled for the beginning of the next financial year.

Valuation and view

UNBK has been reporting a healthy performance, with earnings driven by healthy revenue, loan growth, and controlled provisions. Fresh slippages have been under control which, coupled with healthy recoveries and upgrades, have resulted in an improvement in asset quality ratios. Further, a low SMA book and controlled restructuring provide a better outlook on asset quality. Loan growth has been trending well and has been broad-based, with its focus likely to remain on further credit growth improvement. We estimate loans to grow at ~12% over FY24-26, with RoA/RoE at 1.1%/16% by FY26. We reiterate our BUY rating with a revised TP of INR165 (premised on 1x FY26E ABV)

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