India Financials Sector

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1 Asia Pacific/India Equity Research Regional Banks (Diversified Financials IN (Asia)/Banks IN (Asia)) Research Analysts Sunil Tirumalai Ashish Gupta Kush Shah Chunky Shah Prashant Kumar India Financials Sector SECTOR FORECAST Retail loans: A second coming Figure 1: Retail lending segment could be a US$1.2 tn opportunity by 2020E 1,400 1,200 1, Retail loan assets in India (US$ bn) USD 279 bn 15% CAGR USD 440 bn 18% CAGR USD 1175 bn - FY09 FY14 FY20E Small business Gold CV's Auto Mortgage Others Consumer lending: a huge opportunity. We estimate the Indian consumer finance market will witness an 18% CAGR to a US$1.2 tn opportunity by While the market still remains underpenetrated (70%+ of households have no liabilities of any sort), the organised players (banks + NBFCs) have developed diverse products targeted at all segments of the income pyramid, across multiple secured and unsecured loan types. Overall, we believe consumer lending can be a significant growth driver for Indian financials in the coming years. A stronger second innings. While the experience of the last consumer loan cycle ( ) was bitter, we believe that a number of structural changes in the market could allow for a steady, profitable growth in the next few years. Important among these are the rise of credit bureaus (150 mn+ individuals are captured already), multiplicity of new secured loan options, and the emergence of large internal customer bases for most banks to tap into (especially for unsecured lending). To make matters better, the expected fall in rates should spur growth in rate sensitive segments such as mortgages and auto loans. Stock calls. We believe that players with established track records across cycles and leadership positions are best positioned to capture the expected profitable growth in consumer lending. Among banks, our top picks are HDFC Bank, Axis and IndusInd. Among NBFCs, our preference is for Shriram Transport, Bajaj Finance (initiating with OUTPERFORM, and TP of Rs4,350) and LIC Housing. We also initiate coverage on Indiabulls Housing (OUTPERFORM, TP Rs630), SKS Microfinance (NEUTRAL, TP Rs390) and SCUF (UNDERPERFORM,TP Rs1,570). DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 Focus charts and tables Figure 2: Consumer debt levels in India are still significantly lower than those of other countries 120% Consumer debt to GDP (%) 100% Figure 3: Private banks and NBFCs dominate retail lending, and could grow faster than the overall market Breakdown of retail and small business loan assets 80% 60% NBFC 34% Pvt Bank 24% 40% 20% 0% PSU Bank 42% Figure 4: The retail loan segment currently is well diversified with multiple segmental drivers (FY14) Credit card 1% Micro-credit 3% Consumer Durables 1% Gold 5% CV 7% Auto 8% Others 13% Housing 33% Source: RBI, company data, Credit Suisse research Figure 5: Many of the retail demand drivers are sensitive to interest rates 150% 100% 50% Growth in housing sales (YoY %) HDFC Home loan rate (inverse axis) RHS 8.00% 8.50% 9.00% 0% 9.50% -50% 10.00% 10.50% Small business lending (including LAP) 29% Figure 6: Retail exposures of key banks and NBFCs Retail Loans (Rs bn) -100% 1-Jul-08 1-Feb-09 1-Sep-09 1-Apr-10 1-Nov-10 1-Jun-11 1-Jan-12 1-Aug-12 1-Mar-13 1-Oct-13 1-May-14 Source: PropEquity, company data, Credit Suisse estimates Retail as % of total loan assets 11.00% 3, % 3,000 2,500 2,000 1,500 Banks NBFC's 90% 80% 70% 60% 50% 40% 1,000 30% % 10% - 0% India Financials Sector 2

3 India Financials Sector 3 Figure 7: Profiles of key retail lending stocks we like Banks Current Target Upside Rating price (Rs) price (Rs) (%) Retail assets as % of total Why we like? HDFC Bank Proven track record and execution; the largest retail loan book among the private lenders; market leader in car 968 1,178 22% O 48% loans, small business loans (within the private sector), credit cards and personal loans IndusInd Established track record in vehicle loans (across CV, car and two-wheeler); likely to benefit from a turn in the CV % O 43% cycle Axis % O 38% Growing focus on the retail segment ICICI Bank NBFCs % N 40% Among top three retail loan books in the industry; a sharp uptick in growth in recent years (25%+ CAGR); among top three in home loans, LAP, car loans, credit cards HDFC 1,130 1,305 16% O 71% Market leader with an established track record in home loans; likely to benefit from a fall in wholesale rates Shriram Transport 1,042 1,400 34% O 100% Market leader with an established track record in CV loans; likely to benefit from a turn in the CV cycle Bajaj Finance O 94% Top 3 player across consumer durables, personal loans, two-wheeler loans; strong focus on cross-selling allows 3,451 4,350 26% to keep credit costs low LIC Housing Finance % O 97% Top player in home loans; highly leveraged to movement in wholesale rates Indiabulls Housing O 79% Mortgage and real estate specialist, with expertise in the self-employed segment; likely to benefit from a fall in % Finance wholesale rates SKS Microfinance % N 100% The second-largest MFI in India, and the only one listed Rating key: O = OUTPERFORM; N = NEUTRAL; U=UNDERPERFORM. Figure 8: Changes to earnings/recommendations/initiations Stock Rating Target price Change to EPS Comments (Rs) Old New Old New FY15 FY16 FY17 Banks HDFC Bank O O 1,099 1, % 0.9% 2.0% Increases retail loan growth estimate with share increasing to 53% by FY17 IndusInd Bank O O % 3.3% 7.5% Higher loan growth estimate from auto demand recovery and expansion in NIMs ICICI Bank N N % 3.0% 3.8% Slight increase loan growth and NIM estimate Axis Bank O O % 2.9% 3.8% Increase loan growth estimate NBFCs Bajaj Finance NA O NA 4,350 Initiation Expect strong growth to continue, supported by aggressive cross-selling activity LIC Housing O O % 1.9% 7.5% Expectation of higher NIM expansion on the back of lower wholesale rates Indiabulls Housing Finance NA O NA 630 Initiation Attractively valued for strong growth and tailwind from ratings upgrade SKS Microfinance NA N NA 390 Initiation On a firm recovery path but, after the recent rally, the stock looks richly valued SCUF NA U NA 1,570 Initiation Changes in business strategy and high capitalisation should cap returns and earnings growth near term, while the valuation is high

4 Retail loans: A second coming Consumer lending: A large opportunity We see the consumer lending space in India as an US$1.2 tn opportunity for the organised lenders (banks and NBFCs), implying an 18% CAGR over the next six years (up from 15% in the previous five years). Unlike in the past, the coming round of growth will likely be driven by multiple engines as the banks/nbfcs have developed diverse product lines (including multiplicity of secured lending options). Targeted offerings to all sections of the income pyramid could ensure faster penetration (even now, all forms of organised and unorganised finance reach less than 30% of Indian households). In particular, we believe the private lenders (both banks and NBFCs) have opened new loan segments which were hitherto solely controlled by the PSU banks (e.g., small business loans). Overall, we believe that select banks and NBFCs will be able to leverage their expertise and established market positions to grow their retail loan books faster than the market projections we have painted above. A stronger second innings This is not the first attempt at consumer loans by Indian banks the experiences from the previous cycle of were mixed. From a sub-10% share of total assets even as late as 2002, retail loans grew sharply (a 70%+ CAGR) in the above timeframe, including a sharp surge in unsecured lending. What followed was a painful period of high losses. However, we believe the next round of retail lending growth could remain orderly and profitable, due to the multiple structural factors that have evolved in recent years. A number of secured lending options have emerged (such as gold loans and loans against property). Secondly, credit bureaus have matured, and brought a sea change in the banks' approach to retail loans. Credit bureaus help not only in screening at origination, but, probably more importantly, in constant monitoring of portfolio post disbursements (thanks to rich analytics capabilities). Thirdly, the leading banks have grown their own customer bases over the past few years (mostly on the liability side) that they have a ready customer base to tap into (indeed, the bulk of unsecured lending is happening to internal customers of banks, as we understand from our discussions). To add to this fertile environment, the expected fall in rates could trigger higher growth in many rate sensitive segments such as mortgages and auto loans. Indeed, for the wholesale funded entities like NBFCs, the fall in rates could also lead to higher profitability. Strong retail asset franchises to outperform We believe players with established track records across cycles and market leadership positions are best positioned to capture the expected profitable growth in consumer lending. Among banks, we like HDFC Bank (for its proven track record in retail execution, and market leadership in multiple segments), IndusInd Bank (experience and leadership in vehicle financing) and Axis Bank (growing focus in retail segment). NBFCs should also benefit on the funding side, in addition to the underlying growth on the asset side. Our preference is for Shriram Transport (the market leader with a proven track record in CV finance, and at the sweet-spot of a turn in the CV cycle), Bajaj Finance (strong focus on cross-selling should ensure stable asset quality despite industry leading growth) and LIC Housing Finance (a beneficiary of the expected fall in rates). This report features a deep-dive analysis of the competitive landscape, player strategies and profitability profiles of seven sectors that account for over 85% of overall retail loan assets of the Indian banking system based on our interviews with over 30 industry experts (ranging from top management to feet-on-street). Consumer lending space in India could be a US$1.2 tn opportunity for the organised lenders (banks and NBFCs), growing at 18% CAGR over the next six years The experiences from the previous cycle of were mixed...the next round of retail lending growth could remain orderly and profitable, due to the multiple structural factors that have evolved in recent years We believe players with established track records across cycles and market leadership positions are best positioned to capture the expected profitable growth in consumer lending India Financials Sector 4

5 India Financials Sector 5 Sector valuation summary Figure 9: Indian financials valuation summary (Rs) CS Current Target +/- Mkt cap BVPS (Rs) P/B (x) P/adj B (x) EPS growth P/E (x) RoE (%) rating price price (US$ bn) (%) Private sector Rs Rs (%) FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E Axis O % HDFC Bank O 965 1,178 22% ICICI N % Kotak Mahindra N 1,373 1,210-10% Yes Bank O % J&K Bank O % (16) IndusInd O % ING Vysya N % Public sector Bank of Baroda O 1,079 1,215 13% , Bank of India U % PNB N % SBI N % Union Bank U % IOB U % Non-bank financials Bajaj Finance O 3,451 4,350 26% , HDFC O 1,130 1,305 16% IDFC O % (11) (0) Indiabulls O % LIC Housing Finance O % L&T Finance U % Magma O % M&M Finance O % SCUF U 1,983 1,570-21% (2) Shriram Transport O 1,042 1,400 34% SKS Microfinance N % Core business ICICI N HDFC O Note: Priced as of 12 January 2014.

6 Consumer lending: A large opportunity We see the consumer lending space in India as an US$1.2 tn opportunity for the organised lenders (banks and NBFCs), implying an 18% CAGR over the next six years (up from 15% in the previous five years). Unlike in the past, the coming round of growth will likely be driven by multiple engines as banks/nbfcs have developed diverse product lines (including multiplicity of secured lending options). Targeted offerings to all sections of the income pyramid could ensure faster penetration (even now, all forms of organised and unorganised finance reach less than 30% of Indian households). In particular, we believe that the private lenders (both banks and NBFCs) have opened new loan segments that were hitherto solely controlled by the PSU banks (e.g., small business loans). Overall, we believe that select banks and NBFCs will be able to leverage their expertise and established market positions to grow their retail loan books faster than the market projections we have painted above. A US$1.2 tn business opportunity by 2020E Retail loans currently account for ~24% of Indian banking system loan assets, at US$310 bn. We expect this segment to witness a CAGR of 18% over the next six years to become a US$830 bn opportunity. Including loans to small businesses (which are increasingly being approached as retail loans at least by private banks and NBFCs), the market size could reach ~US$1.2 tn by Figure 10: Retail loans account for 24% of total assets (banks + NBFCs) Breakdown of advances 2014 (banks + NBFCs) Small business 14% Agriculture 10% Figure 11: We expect an 18% CAGR in retail loans by FY20 1,400 1,200 1, Retail loan assets in India (US$ bn) 18% CAGR USD 1175 bn Retail 24% Corporate 52% USD 279 bn 15% CAGR USD 440 bn - FY09 FY14 FY20E Small business Gold CV's Auto Mortgage Others Source: RBI, Company data, Credit Suisse estimates Market still remains underpenetrated Consumer debt penetration in India is low Note: (1) Charts based on banks + NBFCs lending; (2) CAGR numbers are on an INR basis. Source: RBI, Company data, Credit Suisse estimates Consumer debt levels in India are significantly below those seen in other emerging and developed economies, suggesting this will remain an important growth driver for the Indian banking system in the coming years. India Financials Sector 6

7 Figure 12: Consumer debt penetration in India is still low 120% 100% Consumer debt to GDP (%) 80% 60% 40% 20% 0% Source: RBI, company data, Recent data from National Sample Survey Organisation (NSSO) show that less than 29% of Indian households have debt of any kind currently, a ratio that has been steadily rising over the years. Figure 13: Less than 29% of Indian households have debt of any form (including from unorganised lenders) 31.0% % of households with cash debt 29.0% 28.5% 27.0% 25.0% 23.0% 21.0% 19.0% 21.7% 23.7% 17.0% 15.0% Source: NSSO Large unorganised market yet to be tapped As per recent data from the NSSO, the banking system (including NBFCs and cooperative banks) accounts for less than 65% of total consumer debt outstanding in India. The share of the unorganised market (primarily money lenders) has been falling steadily, a process which we expect to continue. India Financials Sector 7

8 Figure 14: The unorganised market still accounts for 35% of the consumer debt in India Relatives and friends 7% Commercial Banks/NBFCs 38% Other informal sources Source: NSSO Organised lenders 65% 2% Unorganised lenders 35% Moneylenders 26% Co-op banks/societies 22% Other Formal sources 5% Figure 15: Penetration of consumer debt is lower in the northern, central and eastern parts of the country 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: NSSO Product diversity should help drive penetration Consumer lending is one of the youngest segments of banking in India, with true focus emerging only over the past 15 years. Back in the 1990s, retail loans accounted for a minuscule 5% of total bank assets (though there were some specialist NBFCs in specific sectors such as car loans and consumer durables). Further, just two segments (housing and consumer durables) accounted for nearly 80% of all retail loans of banks (Figure 18). Today, a number of new, scalable retail asset classes have emerged that have helped diversify risks over multiple underlying drivers (Figure 19). % of households with debt South West North Central East Figure 16: 18 years ago, consumer lending was ~5% of bank advances Breakdown of banking sector advances 1998 Figure 17: Today, retail loans account for 18% of bank advances Breakdown of banking sector advances 2014 Retail 5% Small business 20% Agriculture 12% Retail 18% Small business 16% Agriculture 13% Corporate 63% Corporate 53% Note: Banks only. Source: RBI, company data, Credit Suisse estimates Note: Banks only. Source: RBI, company data, Credit Suisse estimates India Financials Sector 8

9 Figure 18: In the 1990s, retail lending was dominated by housing and consumer durable loans Breakdown of retail loans: 1998 Figure 19: Today, banks have entered into multiple retail asset classes, with differing drivers Breakdown of retail loans: 2014 Others 21% Others 27% Consumer durables 17% Housing 62% Consumer Durables 1% Credit card 2% Gold 8% Auto 11% CV 7% Housing 44% Source: RBI, Company data, Credit Suisse research Multiple products across the income pyramid Note: The chart above excludes small business loans Source: Company data, Credit Suisse research With recent growth in newer segments such as MFI and gold loans, the organised banking industry now has multiple products to offer to all segments of the income pyramid. Figure 20: Players across the income pyramid on retail lending Annual income Mortgage-10m Credit Card-19m CV Loans-2m 4 wheeler-5m High income 52 mn hh Rs 1,80,000 Banks Middle income Gold-33m Consumer-32m 2 wheeler-17m 67 mn households Low income Rs 90,000 NBFCs 89 mn households Microfin-35m Absolutely poor 39 mn households Rs 45,000 MFIs Private lenders have unlocked small business opportunity, hitherto dominated by PSU banks The small business lending opportunity in our estimate (see chapter 3) is going to be ~US$340 bn by FY20E, making it the second-largest segment behind home loans at nearly 30% of total retail lending opportunity. However, until even five years ago, this segment was primarily catered to only by PSU banks (through working capital loans, overdraft facilities, etc). It is only over the past few years that private banks and NBFCs have entered the small business lending segment with specialised products, such as loans against property, and working capital loans. We believe the factors that helped the growth of private banks/nbfcs into the small business segment include growth of credit bureaus, penetration of banks into these businesses on the liability/fee products side and strengthening of regulatory mechanisms. India Financials Sector 9

10 Figure 21: Private banks and NBFCs have grown their share of small business loans from near zero a decade ago to the 30% level now Share of small business loans NBFCs 15% Pvt Banks 15% PSU banks 70% Source: Company data, Credit Suisse research India Financials Sector 10

11 A stronger second innings This is not the first attempt at consumer loans by Indian banks the experiences from the previous cycle of were mixed. From a sub-10% share of total assets even as late as 2002, retail loans grew sharply (a 70%+ CAGR) in the above timeframe, including a sharp surge in unsecured lending. What followed was a painful period of high losses. However, we believe the next round of retail lending growth could remain orderly and profitable, due to the multiple structural factors that have evolved in recent years. A number of secured lending options have emerged (such as gold loans, and loans against property). Secondly, credit bureaus have matured, and brought a sea change in the banks' approach to retail loans. Credit bureaus help not only in screening at origination, but, probably more importantly, in constant monitoring of portfolio post disbursements (thanks to rich analytics capability). Thirdly, the leading banks have grown their own customer bases over the past few years (mostly on the liability side) that they have a ready customer base to tap into (indeed, bulk of the unsecured lending is happening to internal customers of banks, as we understand from our discussions). To add to this fertile environment, the expected fall in rates could trigger higher growth in many rate-sensitive segments such as mortgages and auto loans. Indeed, for the wholesale funded entities like NBFCs, the fall in rates could also lead to higher profitability. Mixed experience in the past decade's consumer lending cycle Even until 2002, retail loans were sub-10% of total loan assets of Indian banks. However, the boom years of 2004 to 2007 saw a rapid build-up for retail loan portfolios of banks, leading to retail loans quickly reaching a quarter of overall banking assets. Thus, between 2004 and 2007, retail lending accounted for 35% of incremental loan assets of Indian banking system, and retail loan portfolio of the system witnessed a scorching 70% CAGR over these years. This short, sudden surge in growth was followed by a painful and prolonged (5-year) period of consolidation, with the share of retail assets falling to a low of 17.4% in FY12. However, over the past couple of years, retail lending has again picked up in growth, albeit at moderate pace (a 17% CAGR over two years). Figure 22: History of retail lending in India 30% 12% 25% 10% 20% 8% 15% 6% 10% 4% 5% 2% 0% FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 0% Retail loans as % of total bank credit Consumer debt as % of GDP (RHS) Source: RBI, company data, Credit Suisse research India Financials Sector 11

12 experience: Rise in unsecured loans, followed by the overall drop in asset quality While the three years up to 2007 saw a rapid build-up in banks' retail portfolios, the following three years saw the fallout of this reckless growth on asset quality. Overall asset quality metrics showed sharp deterioration, especially on the non-housing retail loan books. Figure 23: Retail-focused banks saw a sharp rise in credit costs over Credit cost for Retail focused Banks (%) Figure 24: Retail NBFCs saw a sharp rise in credit costs between 2007 and 2010, while housing finance companies did not 3.0% Credit Costs (%) Housing NBFC's Retail NBFC's (RHS) 2.5% % % 1.0% 0.5% - FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 0.0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Note: Includes HDFC Bank, ICICI Bank, Kotak, IndusInd Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research In particular, unsecured loans (personal loans and credit cards) had grown significantly within the retail portfolios, and these showed the sharpest deterioration in asset quality. Figure 25: Share of credit card loans has come off sharply since the last consumer lending boom 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% Credit card loans as % of total retail 2.0% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Source: Company data, Credit Suisse research But stronger, profitable growth ahead With slowing loan growth on the corporate side, the Indian banking system is increasingly focusing on retail loan assets loan growth on retail assets has largely held steady while corporate loan growth has been falling over the past couple of years. India Financials Sector 12

13 Figure 26: Retail loan growth has held steady against slowing corporate loan growth YoY growth in banking system loan assets 25% 20% 15% 10% Figure 27: CS expects the share of retail loans to continue to rise for banks 80 Share of consumer loans (%) FY12 1H15 FY17E % % FY11 FY12 FY13 FY14 Oct-14 Corporate Retail & small business 20 Axis# ICICI HDFCB IndusInd Kotak* Source: RBI, company data, Credit Suisse research Multiple structural factors give confidence on the retail story * Corporate + commercial loans; # Axis incl retail agri loans We believe that a number of structural changes over the past four to five years could ensure that the growth in retail lending that we envisage for the rest of the decade could remain orderly, and prevent some of the excesses of the past cycle. These include the maturing of credit bureaus and growth of large liability customer bases of banks (which become a ready market for lending). In addition, the expected fall in interest rates should accelerate growth. Structural factor #1: Multiple secured products give comfort on growth Banks and NBFCs have withdrawn significantly from the unsecured loan market (personal loans, credit cards, etc.) after the previous cycles' bust. Instead, these unsecured loans have been replaced by secured loan products, as seen below: Figure 28: Unsecured loan products being replaced by secured loan products o Unsecured Personal Loans Ticket Size < Rs 100,000 LTV Unsecured Yield 35-40% Loss Rate 10-15% o Gold Loans Ticket Size ~Rs 50,000 LTV Unsecured Yield 18-22% Loss Rate < 1% o Unsecured Business Loans Ticket Size Rs 1-2 mn LTV Unsecured Yield 17-25% Loss Rate 5-8% o Loan against Property Ticket Size ~Rs 2-5 mn LTV 50-70% Yield 12-22% Loss Rate 1% India Financials Sector 13

14 Structural factor #2: Credit bureaus are well established 150 mn+ individuals' credit history captured It was only in that the Credit Information Companies (Regulation) Act was passed by parliament. Thus, for the better part of the consumer lending boom, banks could rely only on their internal history of customers (which would have been rudimentary, given the low focus on retail loans until then). Instances of multiple unsecured loans being offered to the same borrower were not uncommon. However, credit bureaus in India are now quite evolved. As per RBI data, credit bureaus in India cover ~155 mn individuals (Dec-13) with penetration of ~20% of adult population. While this is still significantly behind the other developed markets, it still is a significantly large database for banks to rely upon. Figure 29: Penetration of credit bureaus at 20% in India 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% US OECD Europe and Central Asia India Middle East and North Africa Source: RBI 80%+ hit rates for many retail lenders In our discussions with lenders, we found that hit rates of new loan applications on various credit bureaus is fairly high (80%+ in many cases). Moreover, over time we believe the awareness of individual credit scores is increasing among borrowers. Overall, we see these trends as helping the banking sector avoid the problems of the last lending cycle. India Financials Sector 14

15 Magma Fincorp HDFC Bank (credit card and PL) Bajaj Finance ICICI Bank (car loans) LTHF Indiabulls HF Kotak car loans SKS Microfinance 13 January 2015 Figure 30: Result of quick CS survey among banks and NBFCs 90% 80% 70% 60% 50% 40% 30% Of every 100 new loan applications, how many profiles find a hit on one of the credit bureaus? Source: Credit Suisse survey Monitoring post origination is probably a bigger benefit One pretty straightforward benefit of using credit bureaus is in credit underwriting at the time of loan origination: most lenders we spoke to have a minimum credit score cut-off below which they do not lend to the loan applicant. However, the credit score happens to be only one of the many factors that go into the credit underwriting decision. What is probably a bigger benefit is the active monitoring of a loan customer post disbursement, using analytics/alerts provided by the credit bureaus. Industry participant insights: Mr Mohan Jayaraman, Country Manager, Experian India Experian is one of the leading credit bureaus in India. Credit bureaus in India The regulatory framework for bureaus in India is very strong, and we have started with both positive and negative information (which makes the database more useful than only negative information collected by bureaus in many countries) mn active credit lines are on the bureaus, spread across mn individuals. This excludes 80 mn+ credit lines across 35 mn customers in specialist MFI credit bureaus. Weeding out overlaps, mn individuals' credit history should be currently captured by credit bureaus in India. Even though credit bureaus (other than CIBIL) are young in India, most of us have availed historical data from members. As a result, an average five-year credit history is available for each individual; however, only the last three years' data is the most relevant. What has changed in consumer lending from the previous cycle of 2008? Credit bureaus have become strong. Underwriting quality has improved significantly, and the quality of people in collections departments of banks/nbfcs has improved significantly. The big problem in 2008 was multiple lending/overleverage. Bureaus will help prevent that today. India Financials Sector 15

16 Growth in credit bureaus: The biggest contributors to growth in credit bureau database are the private banks. Experian receives information for 1.8 mn new loans every month, 60-65% of this coming from the private sector (banks and NBFCs). Of these, 75% would be customers already on the database, while the rest would be new individuals being introduced to the database for the first time. Most lenders contribute data to multiple bureaus it is in the interest of the lenders that other lenders are aware of their customers' indebtedness. Figure 31: India among the few countries with positive and negative credit histories Sources of information Type of information Full (Information shared by banks, retailers and NBFIs) Fragmented (e.g. information shared among banks only or retail only) Positive & negative information High predictiveness (e.g. U.S., U.K., India) Lower predictiveness (e.q. Mexico, Kuwait) Negative Information Lower predictiveness (e.q. Australia, Swaziland) Lowest predictiveness (e.q. Malaysia, Botswana) Source: IFC/RBI Management speaks: Mr Rajiv Sabharwal, ED, ICICI Bank Credit bureaus We would attribute a lot of the recent growth in the retail lending segment to the credit bureaus. For ICICI Bank, there is an overall 70% hit rate on credit bureaus for new loan applications. The use of bureaus at the time of origination is just the first (and probably smaller) benefit. The bigger benefit arises from the use of bureaus for active monitoring of the individual borrower after disbursement, through alerts, skip tracing, analytics etc. Some bureaus specialise in analytics better than others. ICICI Bank is implementing a multi-bureau strategy to choose bureaus based on their strengths on particular parameters for the task at hand. Structural factor #3: Large existing base of customers allows internal sourcing Over the past decade, the top private banks have continued to grow their retail liability franchises, and now each has significantly large customer bases themselves. We believe this provides a ready captive market with available financial history for these banks to cross-sell loan products to. India Financials Sector 16

17 Figure 32: Number of liability customers Figure 33: Growth in customer base for HDFC Bank 30 Number of liability customers (mn) 25 Liability customers ICICI HDFC bank Axis Kotak IndusInd Source: Company data, Credit Suisse research Unsecured lending is tapping into internal customers Source: Company data, Credit Suisse research In our industry discussions, we understand that even the unsecured lending happening now is largely restricted to the existing customer base of the banks. Figure 34: Unsecured loans are mostly sourced from existing customer base (personal loans + credit cards) 90% 85% 80% 75% 70% 65% 60% 55% 50% HDFC Bank ICICI Bank Kotak % of unsecured loans to existing bank customers Cyclical factor: Falling interest rates should accelerate growth In our 10 November 2014 report, Easing liquidity to aid moderation in rates, CS India banks team argued that improving liquidity and the possibility of a rate cut by the RBI could lead to lower rates in the economy. With decline in inflation and improving liquidity, we believe moderation in real life rates is already visible. Wholesale rates have already moderated bp over the past six months on easing liquidity. With loan demand coming down, banks have cut deposit rate (one-year benchmark) by bp. Further, CS' economics team expects a cut in the benchmark repo rate by 50 bp by mid The key factor will be if liquidity deficit turns to surplus and banks move from being a net borrower to RBI to being a net lender as this would result in the operating rate falling closer to reverse repo and another ~100 bp fall in market rates. In addition to the fall in loan demand, healthy BOP surplus and lower government borrowings are turning the liquidity situation benign. India Financials Sector 17

18 The key beneficiaries from such a movement in the rates environment would be strong retail asset franchisees and wholesale funded entities. Some underlying drivers are sensitive to interest rates As the charts below show, some of the underlying drivers for sectors such as mortgages and car loans are sensitive to interest rates in the economy. Figure 35: Housing sales growth is sensitive to interest rates 150% 100% 50% 0% -50% Growth in housing sales (YoY %) HDFC Home loan rate (inverse axis) RHS 8.00% 8.50% 9.00% 9.50% 10.00% 10.50% -100% 11.00% Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Figure 36: so is car sales growth 70% Growth in car sales (YoY %) 60% SBI 1yr deposit rate (inverse axis) RHS 50% 40% 30% 20% 10% 0% -10% -20% -30% Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan Source: PropEquity, company data, Credit Suisse estimates Source: SIAM, company data, Credit Suisse estimates Thus, the expected fall in rates in the economy could spur consumer demand and hence loan growth for retail lenders. Management speaks: Mr Rajiv Sabharwal, ED, ICICI Bank Outlook on retail lending Overall strategy is to grow the bank 3-4% faster than market growth. Within that, the current focus is to grow retail faster as we see best opportunities here. Retail loans are a little under 40% of total bank assets. Bank remains positive on the opportunities in retail space, and retail should continue to grow faster (20-25%) than bank average. Over the medium term, retail lending could be within 40-50% of total assets. The biggest segment remains mortgages, and the segment continues to grow fast driven by geographic expansion and strengthening of developer relationships. Growth in the auto segment is being calibrated with profitability in mind. The bank is increasing focus on CV and unsecured loans (having stayed away from both segments for a few years). India Financials Sector 18

19 Strong retail asset franchises to outperform We believe that the players with established track records across cycles and market leadership positions are best positioned to capture the expected profitable growth in consumer lending. Among banks, we like HDFC Bank (for its proven track record in retail execution, and market leadership in multiple segments), IndusInd bank (experience and leadership in vehicle financing) and Axis Bank (growing focus in retail segment). NBFCs should also benefit on the funding side, in addition to the underlying growth on the asset side. Our preference is for Shriram Transport (the market leader with a proven track record in CV finance, and at the sweetspot of a turn in the CV cycle), Bajaj Finance (strong focus on cross-selling should ensure stable asset quality despite industry leading growth) and LIC Housing Finance (a beneficiary of the expected fall in rates). We also initiate coverage on Indiabulls Housing (OUTPERFORM), SKS Microfinance (NEUTRAL) and SCUF (UNDERPERFORM). Private banks and NBFCs have a higher share in the retail segment While PSU banks have a dominant share in the overall banking system advances, NBFCs and private banks together account for more than half of the retail assets, as seen in the charts below. Figure 37: Private banks and NBFCs together have a less than 40% share of banking system total assets... (FY14) Breakdown of loan assets of Indian banking system Figure 38: while they have a nearly 60% share in the retail and small business segment (FY14) Breakdown of retail and small business loan assets NBFC 23% Pvt Bank 16% NBFC 34% Pvt Bank 24% PSU Bank 61% PSU Bank 42% Source: RBI, company data, Credit Suisse research The individual retail loan exposures of key lenders are given below. Source: RBI, company data, Credit Suisse research India Financials Sector 19

20 Figure 39: Retail exposures of key banks and NBFCs Retail Loans (Rs bn) Retail as % of total loan assets 3, % 3,000 2,500 2,000 1,500 Banks NBFC's 90% 80% 70% 60% 50% 40% 1,000 30% % 10% - 0% Falling rates: Wholesale-funded entities should benefit We analyse the impact of a falling rates environment on both the asset and liability side below, to see the potential beneficiaries: Liabilities side: NBFCs with higher bond dependence will see the benefit first It is fairly clear that wholesale-funded entities should benefit in a falling rates environment. Cost of wholesale sources of funds (bonds, borrowing from banks, etc) move quicker and sharper than retail sources of funds. However, the actual impact of falling rates on the funding cost of an entity depends on multiple factors: Mix of borrowings: Bond yields tend to react faster than rates on bank borrowings (linked to base rates). On the other hand, a fall in bond yields benefits an entity mostly on an incremental basis (since bonds are fixed rate instruments), while a fall in cost of bank borrowings are applicable on the back book too. Tenure of borrowings: The shorter the tenure of existing borrowings for an entity, the quicker the funding cost will re-price lower. Growth: An entity growing faster will add more of lower cost borrowings to its balance sheet, thus bringing down the overall blended cost of funds faster than a slow growing entity. In our analysis, Bajaj, Indiabulls and LICHF should see the earliest benefit of the fall in wholesale rates, as they are most leveraged to the bond/money market (40-70% of funding), and also shorter tenure/high growth working in favour of Bajaj. On the other hand, once the banks start reducing base rates materially, SKS and Indiabulls could see the biggest delta on cost of funds. India Financials Sector 20

21 Figure 40: Bajaj, Indiabulls and LICHF are sensitive to bond yields; they will see cost of funds benefit before others Change in blended cost of funds for every 100bps fall in bond yields Figure 41: While a fall in bank borrowings could happen with a delay after bond yield drop, SKS and Indiabulls will see most benefits from such a fall Change in blended cost of funds for every 100bps fall in bank base rates - Bajaj LIC Indiabulls SCUF STFC MMFS SKS - SKS Bajaj Indiabulls SCUF MMFS STFC LIC Figure 42: Assumptions driving the above sensitivity analysis Mix of borrowings (%) % of borrowings maturing in one year FY16 loan growth (CS) Bonds Bank Others borrowings LIC 69% 29% 2% 18% 18% MMFS 23% 58% 19% 30% 18% STFC 35% 30% 35% 36% 15% Indiabulls 38% 62% 0% 43% 20% Bajaj 41% 58% 1% 47% 29% SCUF 41% 54% 5% 26% 29% SKS 0% 100% 0% 80% 38% Note: the analysis assumes that the mix of borrowings does not change. Asset side: The mortgage segment should be most sensitive to the loan yield decline, gold/mfi the least Seeing a drop in funding costs is one thing. Whether it can be retained (to improve margins) or passed on to customers (to retain market position/grow faster) is a completely different story. One could argue that segments where the sensitivity of EMIs to lending rates is high should be least likely to hold on to the benefit of a fall in funding costs (since the market would react to a competitor cutting rates). Going by this yardstick, mortgages stand out as being the most sensitive to lending rates (EMI for a typical borrower drops 5.5% for a 100 bp drop in lending rates from current levels). This is thanks to the already low lending rate (a 100 bp cut on 11% mortgage loan is relatively large than on an 18% CV loan), and longish tenures. On the other hand, gold loan EMIs are least sensitive to lending rates (short tenures and high yields). Conclusion HFCs/LAP players such as LICHF, Indiabulls and Bajaj are likely to enjoy benefits of a fall in whole rates earlier than other companies, but this benefit could start shrinking once banks start reducing base rates (thus bringing down mortgage yields). Vehicle financiers such as SHTF and MMFS should see the benefits of a fall in wholesale rates with a lag, but should be able to retain the benefit for a longer period. India Financials Sector 21

22 Figure 43: Gold loan companies most likely to retain benefit of a fall in cost of funds; HFCs least likely 6.0% % drop in EMI for 100bps fall in lending rates 5.0% 4.0% 3.0% 2.0% Special case: regulated spread so all funding cost benefit will be passed on to customer 1.0% 0.0% Gold MFI 2W CV 4W LAP Mortgage LOW Likelihood of passing on funding cost benefit to customer HIGH Prefer leaders with a strong track record HDFC Bank, IndusInd among banks; Shriram Transport, Bajaj Finance among NBFCs We believe select banks and NBFCs are well positioned to benefit from the expected strong growth in retail lending. Our preference is for lenders with established track records in specific segments. Our preferences are given out in detail in the following tables. Our top picks among the banks are HDFC Bank and IndusInd Bank. Among NBFCs, we like Shriram Transport and Bajaj Finance. India Financials Sector 22

23 India Financials Sector 23 Figure 44: Profile of key retail lending stocks we like Banks Current Target Upside Rating Retail assets Why we like? price (Rs) price (Rs) (%) as % of total HDFC Bank Proven track record and execution; the largest retail loan book among the private lenders; market leader in 968 1,178 22% O 48% car loans, small business loans (within the private sector), credit cards and personal loans IndusInd Established track record in vehicle loans (across CV, car and two-wheeler); likely to benefit from a turn in the % O 43% CV cycle Axis % O 38% Growing focus on the retail segment ICICI Bank NBFCs % N 40% Among top three retail loan books in the industry; a sharp uptick in growth in recent years (25%+ CAGR); among top three in home loans, LAP, car loans, credit cards HDFC 1,130 1,305 16% O 71% Market leader with an established track record in home loans; likely to benefit from a fall in wholesale rates Shriram Transport 1,042 1,400 34% O 100% Market leader with an established track record in CV loans; likely to benefit from a turn in the CV cycle Bajaj Finance O 94% Top 3 player across consumer durables, personal loans, two-wheeler loans; strong focus on cross-selling 3,451 4,350 26% allows to keep credit costs low LIC Housing O 97% Top player in home loans; highly leveraged to movement in wholesale rates % Finance Indiabulls Housing O 79% Mortgage and real estate specialist, with expertise in the self-employed segment; likely to benefit from a fall % Finance in wholesale rates SKS Microfinance % N 100% The second-largest MFI in India, and the only one listed Rating key: O = Outperform; N = Neutral; U=Underperform; Figure 45: Changes to earnings/recommendations/initiations Stock Rating Target price (Rs) Change to EPS Comments Banks Old New Old New FY15 FY16 FY17 HDFC Bank O O 1,099 1, % 0.9% 2.0% Increases retail loan growth estimate with share increasing to 53% by FY17 IndusInd Bank O O % 3.3% 7.5% Higher loan growth estimate from auto demand recovery and expansion in NIMs ICICI Bank N N % 3.0% 3.8% Slight increase loan growth and NIM estimate Axis Bank O O % 2.9% 3.8% Increase loan growth estimate NBFCs Bajaj Finance NA O NA 4,350 Initiation Expect strong growth to continue, supported by aggressive cross-selling activity LIC Housing O O % 1.9% 7.5% Expectation of higher NIM expansion on the back of lower wholesale rates Indiabulls NA O NA 630 Initiation Attractively valued for strong growth and tailwind from ratings upgrade Housing finance SKS NA N NA 390 Initiation On a firm recovery path but, after the recent rally, the stock looks richly valued Microfinance SCUF NA U NA 1,570 Initiation Changes in business strategy and high capitalisation should cap returns and earnings growth near term, while the valuation is high

24 Taking a deep dive into retail In this report, we take a deep dive into the retail lending side of the banking system in India. We take a closer look at seven sectors that account for over 85% of overall retail loan assets of the Indian banking system housing, small business lending, CVs, autos, gold loans, credit cards and MFIs. Figure 46: Breakdown of retail loan assets by segment (FY14) Credit card 1% Micro-credit 3% Consumer Durables 1% Gold 5% Others 13% Housing 33% CV 7% Auto 8% Small business lending (including LAP) 29% Note: (1) In the chart above and the rest of the report, loans against property (LAP) are included in the small business lending segment and not in housing finance Source: RBI, company data, Credit Suisse estimates A brief profile of the key segments is given below, followed by detailed discussions into each segment after chapter 3 of this report. India Financials Sector 24

25 Figure 47: Top retail lending segments that account for 85% of retail assets Mortgage Auto - 4W Auto - 2W CV's Gold Business Banking MFI FY14 loan book (USD bn) FY20 loan book (USD bn) FY14-20E - CAGR 14.7% 15.7% 13.8% 11.5% 14.1% 16.1% 14.4% Key Players HDFC, LIC Hsg, SBI, ICICI, Axis, Dewan Hsg, Indiabulls RCap HDFC Bank, ICICI, SBI Kotak HDFC Bank, IndusInd, Bajaj, TVS SCUF Shriram Trans, IndusInd, Chola Magma Muthoot, Manappuram, HDFC Bk, South Indian Federal Bank HDFC Bank, ING Vysya, ICICI, SCUF, Capital First, IndusInd Kotak SKS Micro, Bandhan Ticket size Rs 2 mn to 2.5 mn Rs. 500,000 Rs. 45,000 LCV - Rs. 350,000 M&HCV - Rs. 1,650,000 Rs. 40,000 Rs. 2 mn to 100 mn Rs 10,000-12,000 Tenure years 3 years 1 years 3-4 years 3-6 months 3-10 years 1 2 years Yield % 11-14% 20-22% 12-22% 18-22% 12-22% 20-24% RoA 1.5% 2.0% 3% 2.2% 3.1% 2.7% 2.2% Loss Rates bps bps bps bps 10 bps bps 50 bps India Financials Sector 25

26 Retail mortgages: Safe and under penetrated Figure 48: Housing finance market in India Nominal GDP - 15% CAGR Mortgage Penetration - 7.7% to 9.2% of GDP 19% CAGR USD 409 bn Figure 49: Key players in the mortgage industry USD 144 bn FY14 FY20E Source: Company data, RBI, NHB, Credit Suisse estimates Source: RBI, NHB, company data, Credit Suisse estimates Figure 50: Loan characteristics of housing finance Product template Banks Large HFCs Small HFCs Players SBI, ICICI Bank, Axis, HDFC, LICHF Dewan, Indiabulls, RCAP Customer segment Salaried Salaried Self-employed Lending rate % % % Lending rate type Mostly floating Processing fees % LTV 55-65% Ticket size (Rs) Originating tenure Actual tenure Sourcing mn years 5-7 years DSAs, brokers, lenders own sales force Sizing the potential: India is 9-11 years behind other EMs in penetration The size of the housing finance market in India was ~Rs9 tn (US$150 bn) as on Mar-14. The segment has seen a 17% CAGR over the past five years. At less than 8%, India s mortgage penetration (as a percentage of GDP) is quite low compared to those of other countries, including other emerging economies in the region. A look at the past growth in other countries shows that at current penetration levels, India is 9-11 years behind other countries such as China and Thailand. Figure 51: Housing finance growth in India 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 - FY09 FY10 FY11 FY12 FY13 FY14 25% 20% 15% 10% 5% 0% Figure 52: Mortgage penetration levels in India are significantly behind other countries 120% Mortgage as a % of GDP 100% 80% 60% 40% 20% 0% Total o/s Housing Loans (Rs bn) Growth Source: Company data, RBI, NHB, Credit Suisse estimates Source: RBI, NHB, company data, Credit Suisse estimates India Financials Sector 26

27 Figure 53: India is nine years behind Thailand s mortgage penetration Thailand: Mortgage as % of GDP 12.0% 11.0% India is here 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% Figure 54: India is ten years behind China on mortgage penetration China: Mortgage as % of GDP 18.0% 16.0% 14.0% India is here 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Recent regulatory changes and a fall in interest rates could fuel demand for mortgage segment Effective tax rate reduces by ~120 bp will push up demand The tax exemption limit for mortgage interest expense increased to Rs0.2 mn from Rs0.15 mn recently. Also the maximum deduction for principal has been enhanced by Rs50,000. For a customer with a home loan of ticket size Rs25 mn, this implies a reduction in effective interest cost by ~120 bp. Figure 55: Budget has helped reduce effective interest cost by ~120 bp Particulars Loan amount (Rs) 2,500,000 2,500,000 2,500,000 2,500,000 Effective interest rate on home loan 11.80% 6.03% 7.02% 5.80% Source: Indiabulls Banks allowed to raise long-term bonds for housing finance which are exempt from CRR, SLR and PSL requirements. Further, we believe that the expected fall in wholesale rates could spur demand for home loans, as is evident from the close correlation between wholesale rates and home loan growth in the past. A detailed discussion on this is in the following chapter. Figure 56: Housing sales growth is sensitive to interest rates 150% 100% 50% Growth in housing sales (YoY %) HDFC Home loan rate (inverse axis) RHS 8.00% 8.50% 9.00% 9.50% 0% -50% 10.00% 10.50% -100% 11.00% Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Source: PropEquity, company data, Credit Suisse estimates We expect the mortgage industry in India to grow slightly faster than nominal GDP growth, leading to a US$330 bn market by India Financials Sector 27

28 Market share 13 January 2015 Figure 57: Expect mortgage industry penetration to rise over the next few years 9.5% 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% India mortgage as % of GDP Source: NHB, RBI, company data, Credit Suisse estimates HFCs gaining share The housing finance segment is catered to by both banks and specialised housing finance NBFCs. The banks have a lion s share of the loan assets (60% as of FY3/14). However, note that the share of HFCs has increased steadily from 26% to 40% over the past decade. Figure 58: HFCs have gained share over banks 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY09 FY10 FY11 FY12 FY13 FY14 Banks HFCs Banks growth (RHS) HFCs growth (RHS) 35% 30% 25% 20% 15% 10% 5% 0% Figure 59: Key players in the mortgage segment (Rs bn) 2,500 45% FY09 FY14 FY09-14 CAGR (%) 40% 2,000 35% 30% 1,500 25% 20% 1,000 15% % 5% - 0% HDFC SBI LICHF ICICI Axis Dewan Indiabulls Source: Company data, RBI, NHB, Credit Suisse research Profitability: Low risk, low return, leverage helps Source: RBI, NHB, company data, Credit Suisse estimates The competition in the housing loan segment is quite intense, with some of the lowest yields in the retail segment at %, almost as low as large corporate loan yields. The LTVs range from 60% to 70% (LTV is regulated). Most of the market is on floating rate loans. The originating tenure of housing loans are years but the actual tenure is generally 6-10 years as there is no prepayment penalty (per regulations). In light of slowing corporate loan growth, and the apparent ease of their growing mortgage book (given the large ticket sizes and long tenures), banks have focused on housing loans for growth. Current housing loan rates are very close to base rates (Figure 60). Despite low operating costs and credit losses, RoAs tend to be sub -1.5% in the segment. India Financials Sector 28

29 Figure 60: Banks home loan rates are already close to their base rates Figure 61: Credit costs for the mortgage segment have remained low sub 70 bp over the past ten years 0.80% 0.70% 0.60% 0.50% 0.40% 0.30% 0.20% 0.10% Credit Costs IOB BOB PNB Axis Bank ICICI Bank SBI 0.00% -0.10% -0.20% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Base Rate (%) Current Home Loan rate (%) LIC HDFC Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Importantly, mortgages carry the lowest risk weight among all retail loan asset classes. In addition, Tier 1 requirement for housing finance NBFCs is lower (6%) than that for the other NBFCs (7.5%, to be taken up to 10% by FY17). The lower risk weight allows for higher leverage levels in this business which allows for decent RoE despite low RoAs. Figure 62: Reasonable RoE levels primarily due to the ability to leverage higher Profitability of mortgage biz PSU bank (SBI template) PSU bank (SBI template) HFC (HDFC template) HFC (LICHF template) cumulative incremental incremental incremental Interest income / total assets 9.8% 9.8% 10.7% 10.8% Home loan lending rate assumed 10.3% 10.3% 10.3% 10.3% (monthly compounded) Interest expense / total assets 6.0% 8.2% 8.1% 8.5% Cost of deposits assumed 6.4% 8.6% 9.5% 9.6% NII / total assets 3.8% 1.6% 2.7% 2.3% Fee income / total assets 0.1% 0.1% 0.2% 0.2% Opex / total assets 2.3% 0.5% 0.3% 0.4% Credit cost / total assets 0.3% 0.3% 0.1% 0.1% Pretax profit / total assets 1.2% 0.9% 2.5% 1.9% Taxes / total assets 0.4% 0.3% 0.8% 0.7% ROA 0.8% 0.6% 1.6% 1.3% Leverage RoE 15.0% 11.1% % Notes: Fore details on the assumptions, refer our report on the Indian Mortgage Sector, 20 May India Financials Sector 29

30 Figure 63: Positioning of key players in the home loan space 18.0% 16.0% 14.0% Urban, salaried Urban, self-employed Semi-urban, Rural % % 8.0% % SBI LICHF HDFC Axis Bank Indiabulls RCAP SCUF Dewan MMFS - Yield on home loans Ticket Size (Rs mn) (RHS) HFCs: Could benefit from falling wholesale rates We note that banks home loan rates are already close to their base rates (Figure 60). So the chances of increased competition from banks due to the above factor are low. But, on the other hand, lower wholesale rates could help HFCs. Indeed, leading HFCs such as HDFC and LICHF (both AAA rated) are now far less dependent on bank borrowings than in the past. For a detailed discussion on the impact of a fall in wholesale rates, see discussion in the second chapter. Figure 64: HDFC and LICHF are relying less on bank borrowings for funding... Share of bank borrowings in funding mix 35% 30% 25% 20% 15% 10% 5% 0% Figure 65: and sourcing more from the bond market Share of bonds in funding mix 80% 70% 60% 50% 40% 30% 20% 10% 0% HDFC LICHF HDFC LICHF Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research India Financials Sector 30

31 Small business lending/lap: Funding entrepreneurs Figure 66: Growing interest in small business lending Nominal GDP % Target segment revenue growth multiple 1.3x of GDP Debt to Rev - Increase by 200 bps LTV - Unchanged 17.8% CAGR USD 346 bn Figure 67: Leading small business lenders USD 130 bn FY14 FY20E Source: RBI, company data, Credit Suisse estimates Source: RBI, company data, Credit Suisse estimates Figure 68: Loan characteristics of small business lending Cash credit/ working capital loans Long-term loans secured by business assets Key players PSU banks like SBI, PNB; Pvt Private banks (HDFC Bank, ICICI Bank, banks like ING Vysya ING Vysya); NBFCs (Bajaj, SCUF, RCAP) Customer segment Small businesses Small businesses with good track record of a few years Secured/unsecured Unsecured (sometimes secured by Secured (by plant and machinery and/or plant and property) promoter property). Detailed cash flow analysis of the underlying business usually undertaken Loans against property NBFCs (IndiaBulls, Bajaj); Private banks (HDFC Bank, Axis, IndusInd) Business owners with self-occupied residential property Secured by the above mentioned property. Cash flow checks on underlying business not so critical Lending rate 11-14% 13-16% 12-14% Lending rate type Fixed Fixed Fixed LTV NA 50-65% 40-50% Ticket size (Rs) mn 1-20mn mn Average tenure (yrs) < Sourcing DSAs DSAs, CAs DSAs, CAs Sizing the potential: GDP growth likely to pick up, expect small businesses to grow faster The micro, small and medium enterprises (MSME) of India together account for 8% of GDP, 45% of manufactured output and 40% of exports (Source: 2010 PM task force). This is largely an unorganised industry, with ~50 mn firms employing over 100 mn people in sectors as diverse as retail trade, textiles, food and beverages, hospitality, auto repairs, furniture, etc. Over time, the importance of these units has been recognised and greater focus been accorded to this segment. Even the term MSME is strictly defined by the MSME Development Act of However, penetration of formal finance into the MSME sector is considerably low. The last available formal numbers from the government (the 4 th MSME census of 2007) show that less than 13% of all MSME units in the country have access to finance/credit. Our own analysis with more recent data shows that levels of debt in small enterprises in India is significantly below that of listed small cap stocks (here we use 210 companies on BSE with sales in the range of Rs100 mn to Rs2 bn as small cap companies). Despite such low penetration levels, the small business lending segment is already as large as the housing finance segment, and is much larger than other retail segments with higher penetration levels (like CV and Auto finance), indicating that this will remain a crucial segment for the banking system for a long time. India Financials Sector 31

32 Figure 69: Low finance penetration among MSMEs (2007 MSME census) 40% 35% 30% 25% 20% 15% 10% 5% 0% % of MSME units with loans MSME finance - low penetration Debt/Sales Debt / equity Debt/Gross fixed assets Figure 70: Leverage levels at small enterprises continue to remain low even in FY14 120% 100% 80% 60% 40% 20% 0% Debt as % of sales BSE: 210 companies with revenues in the range Rs100mn to Rs2bn Total MSME segment Source: Ministry of SME, company data, Credit Suisse estimates Source: Bloomberg, RBI, Ministry of SME, company data, Credit Suisse estimates Given the close linkage of these small businesses with the economy, it is not surprising that the overall growth in this segment had slowed (the chart below shows that growth in bank loans to micro and small enterprises has slowed in recent years). Figure 71: Key industries within small business segment (FY14) Metals 2% Textiles 2% Furniture 3% Autos 4% Hotes & Restaurants 4% Others 19% Other Business 4% Other Services 6% Food & Beverage 7% Apparel 9% Source: Company data, Credit Suisse research Retail Trade 40% Figure 72: Slowdown in loans to small enterprises 60% 50% 40% 30% 20% 10% 0% Small business lending growth YoY % Small business loans (Rs bn) Source: Company data, Credit Suisse research 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 - Figure 73: Sizes/market potential of some segments within SME Segment No. units (mn)\ Industry revenues Organised (%) (US$ mn) Retail , Food processing , Restaurants , Printing/publishing , Diagnostic labs 0.1 1, Dental clinics 0.1 1,000 With GDP growth having bottomed, we expect small businesses to outpace overall GDP growth. With penetration low at ~12%, and increased presence of banks and NBFCs in rural and semi-urban centres, the organised sector should see strong loan growth from this segment. Most banks have increased their focus on the small and mid-corporates segment. While we have assumed 15% growth in nominal GDP, we believe that this segment will grow ~1.1x GDP growth, on account of an increased share of the organised India Financials Sector 32

33 sector and faster growth by these companies. We assume that the debt/revenue level for the small enterprises will grow from 38% to 40% by FY20. Each lender defines the segment differently The scope of the small business lending segment varies significantly across lenders, with the same nomenclature referring to different categories at each firm, as seen below. Figure 74: Conflicting nomenclature on business loans at various lenders Lender Nomenclature Description Typical customer Bajaj Finance Business loan Unsecured loans, ticket size sub Rs2 mn Axis Bank LAP Loans against property; average ticket size Rs23 mn Commercial Small manufacturing units; average ticket size Rs200 mn Auto component vendors Emerging Enterprises Enterprises with sales of less than US$1 mn Group LAP Loans against property; ticket size usually less than Rs25 mn HDFC Bank Business banking Secured loans of average ticket size Rs5 mn Restaurant owners, small taxi fleet operators, doctors, lawyers, etc SCUF SME Secured/unsecured loans of ticket size up to Rs1 mn Grain merchants, pharmacies, grocers, plastic recyclers etc Indiabulls LAP Loans against property; average ticket size Rs8 mn Small businesses based in cities, looking for funds to expand business Capital first SME Secured by cash flows on business and property; average ticket size Rs10 mn Traders, small time manufacturers, suppliers etc Religare SME LAP Loans against property; average ticket size Rs10 mn, five-year duration Services/manufacturing business with 3-4 years of existence SME Working capital loans Unsecured WC loans; average ticket size Rs3 mn Services/manufacturing business with 3-4 years of existence Reliance Capital LAP Loans secured against property - borrower is individual business owner; average ticket size Rs8 mn Manufacturing/services companies with up to Rs200mn revenues SME Loans secured against plant and machinery - borrower is the firm; Manufacturing/services companies average ticket size Rs10 mn with up to Rs200mn revenues ICICI Bank Business banking Loans secured by business assets; average ticket size Rs10-20 mn Small businesses in the neighbourhood of branches LAP Loans secured by residential property; average ticket size Rs8 mn; reported as part of mortgage loan book SME Loans to enterprises with revenues up to Rs3 bn; average ticket size Rs1 bn+ Kotak Bank Emerging corporate loans Loans secured by business / residential property; average ticket size Rs mn Businesses with turnover of upto Rs3bn LAP Loans secured by residential property; average ticket size Rs5 mn; reported as part of mortgage loan book Focus on self employed nonprofessional customers SME-Working capital Secured revolving loan facility given to SMEs; average ticket size Rs20-25mn SME-Business loan Unsecured term loans; average ticket size Rs1.5mn ING Vysya Business Banking/SME LAP Working capital loans, secured by business assets; average ticket size Rs22 mn Loans against property; average ticket size Rs22 mn; reported as part of home loan segment SBI MSME Loans up to Rs500 mn in ticket size; usually secured by business assets For the purpose of this report, we restrict the definition of small business loans to loans with a ticket size of less than Rs50 mn. These account for ~44% of total MSME loans as reported by RBI. Traders (steel, pharma, etc), food processing units, FMCG distributors, etc Traders (steel, pharma, etc), food processing units, FMCG distributors, etc India Financials Sector 33

34 Figure 75: We focus on small business lending of up to Rs50 mn which form ~44% of total MSME lending of Rs18 tn in the country Ticket size < Rs50mn (focus of this report) 44% Ticket size > Rs50mn 56% Source: RBI, Credit Suisse research Management speaks: Mr Mahesh Dayani, Country Head, Retail Assets, ING Vysya Bank The SME segment for ING Vysya is ~Rs220 bn in loan book (~52% of total loan book). Market structure: The SME loan segment today is ~Rs18 tn (US$300 bn) in size. The space is dominated by the PSU banks and the rural/co-operative banks. Private banks and NBFCs probably have a less than 10% share of the market. 60% of the lending happens through short-term working capital loans, and the rest through term loans. ING Vysya's business: ING Vysya has a better mix than the market as working capital loans form 90% of the loan book. ING Vysya Bank has an average ticket size of ~Rs22 mn, at yields of 12-13%. 75% of loan book is towards SME in the services sector (25% from manufacturing sector primarily food processing). Traders form ~40% of loan book (includes distributors and traders across diverse segments such as FMCG, steel, and pharma). Typical yields for ING Vysya are %. ING Vysya sources customers from the existing database/referrals and does not rely on DSAs. The operating costs and loan losses are lower in the SME segment compared to the overall bank, and the profitability higher. How are private banks different from PSU banks? PSU banks have the strength of relationship over multiple years, and immense local knowledge. But private banks score on service levels. LAP The LAP business has become popular starting India Financials Sector 34

35 RCAP SCUF Bajaj ING Vysya Indiabulls Chola PNB BOB BOI Kotak HDFC Bk L&T Fin ICICI SBI Magma HDFC IndusInd LICHF Axis 13 January 2015 PSU banks are yet to start the LAP business in a significant way, and it is primarily the private sector as of now. LAP accounts for ~13% of the SME segment for ING Vysya (and ~50% of the mortgage segment as reported). Advantages of banks over NBFCs Banks usually insist that the borrower also maintains all his business transactions through the current accounts with the same bank. This helps in better monitoring of the loan. This helps banks foresee any problems in the borrower's loan servicing capability. PSU banks dominate, but that is more from compulsion of PSL Given that lending to small businesses is an explicit sub-target within priority sector targets, it is not surprising that PSU banks dominate the small business lending space, just like they dominate the overall banking space. Figure 76: PSU banks dominate in lending to small businesses (FY14) Share of small business loans NBFCs 15% Figure 77: Some NBFCs have specialised in the small business lending space in recent years (FY14) 70% Small business loans as a % of total loans 60% 50% 40% Pvt Banks 15% 30% 20% PSU banks 70% 10% 0% Source: Company data, Credit Suisse research However, we believe the lending models of the PSU banks differ significantly from those of the private banks and NBFCs. PSU banks' lending to small businesses usually tends to be in the form of working capital loans, overdraft facilities or cash credit facilities. These lack the long-term nature of term loans that the private banks and NBFCs offer to the businesses. The perceived risky nature of these borrowers is likely the reason for PSU banks not lending on longer tenures to this segment. India Financials Sector 35

36 Industry participant insights: Branch Manager at SME branch of SBI, Central Mumbai About the branch's business The branch has a loan book of Rs4-4.5 bn. Most loans are short-term working capital lines, though the branch has started doing the LAP business in a small way. Loan size is capped at Rs500 mn per borrower, and the average ticket size for this branch is ~Rs50 mn. The branch does not have approval/sanctioning powers. All loan applications need to be sanctioned/approved by the central committee (one in Mumbai). New loan applications usually take 4-6 weeks to process. The branch uses a rating scale of 1 to 16 to rate all customers, and for applicants with poorer ratings more collateral is asked for (the poorest rating attracts 100% collateral i.e., usually the LTV is more than 100%). For ticket sizes of Rs100 mn+, the branch prefers rating by an external agency. The interest rate charged depends on the rating, and ranges from 11% to 18%. The collateral is usually inventory, receivables, property of company/promoter, etc. The branch has two relationship managers for small enterprises (ticket size less than Rs50 mn, 60 accounts) and one RM for medium enterprises (ticket size Rs50 mn+, 30 accounts). Sourcing usually happens through referrals from existing customers or from the head office. NPA is ~30% of loan portfolio, though the manager is quick to point out that overall SBI NPA level is much below this figure. Customer profile Customers are usually traders (steel, medical equipment, etc) or small manufacturers. Many exporters are also present (this branch offers forex services, too). Many textile companies are in the sub-rs50 mn category. All customers conduct their day-to-day transactions through current accounts maintained at the branch. Earlier there was no restriction on the location of the customer to whom a branch could lend to. But recent rules restrict the business with only customers from the locality of operation of the branch. Operating model: Some private banks and NBFCs have a specialised focus on small businesses. Of late, LAP has become prominent Some of the NBFCs and private banks have a significantly larger exposure to the small business segment, and have developed specialised lending models to the small business segment. These involve longer-term loans secured against: business fixed assets (to fund business expansion or purchase of new equipment), or the promoter's residential property. The longer term ensures continuity/visibility of credit for the borrower vs short-tenure lines from the PSU banks. In particular, loans against property have gained prominence in the past four to six years. Loans against property: Attracting attention NSSO data show that the largest asset by value owned by Indian households continues to be real estate related (90%+ of all assets owned). In recent quarters, one type of small India Financials Sector 36

37 business loan, loans against property (LAP), has become popular. Here, loans are extended to promoters of small businesses against the promoters' own property (usually the self-occupied residential property). These are also called home equity loans. Figure 78: Real estate accounts for over 90% of assets owned by Indian households (2013) Land 64% Building 29% Note: Data excludes holdings in Bullion as this is not captured in the survey. Source: NSSO: Financial assets 3% Others Vehicles 2% 2% A few private banks and NBFCs have been operating in the LAP market for four to five years. In fact, for some of the lenders, LAP is the dominant way of lending to small businesses. Figure 79: Private banks and NBFCs lead in the LAP business 140 LAP book (Rs Figure 80: For some players, LAP is a significant part of overall small business lending (Rs mn) 300,000 Business Banking LAP 250, , , ,000 50, HDFC Bank ICICI ING Vysya Kotak Reliance Cap IndusInd Bajaj We also notice that for a number of financiers, LAP has been the primary driver of retail loan growth in recent years. India Financials Sector 37

38 Figure 81: Some NBFCs have seen a bulk of their growth in retail loan books from the LAP segment 90.0% Share of LAP in incremental retail loan book in FY % 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Capital First IndusInd Chola Bajaj Indiabulls Axis This segment has gained a lot of attention in recent quarters from almost all lenders. The attractiveness of the sector lies in the fact that while operating costs and credit losses are believed to mirror the home loan segment, the yields are typically higher than mortgages leading to higher profitability. Thus, even mortgage players like LICHF are becoming interested in the LAP business. Figure 82: LAP yields are typically higher than in home loans, with underlying cost structure being similar 18.0% Yield on home loans Yield on LAP 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% LIC Indiabulls HDFC/HDFC Bank Axis Rcap Industry participant insights: Head of Sales, LAP segment, Mumbai region, leading private bank The person has been in the LAP market in Mumbai for over eight years. Mumbai LAP market Mumbai is one of the largest LAP markets in India, with Rs7-8 bn disbursement per month (the market is tracked mostly on a disbursement basis and not on a portfolio basis by the sales teams). HDFC Bank (along with its subsidiary HBL) is the largest player with Rs bn disbursements per month. India Financials Sector 38

39 The other important players in Mumbai are Kotak (Rs mn per month), Axis Bank, ICICI Bank, few foreign banks (Rs mn per month each). Among NBFCs, Bajaj Finance and Capital First are key players (Rs mn per month each). Customer profile Almost all borrowers are businessmen/self-employed. The profile includes manufacturers, traders, exporters, importers, steel manufacturers, and transporters % of the money raised through LAP actually gets re-invested into the real estate market. Business model Banks usually lend up to 60% LTV, while some NBFCs go higher (70-80%). The valuation of the property is usually done by a mix of internal and external valuers. The lowest of the two values (internal/external) is taken for LTV purposes. Banks usually lend at %, while NBFCs operate at %. However, recently, some NBFCs reduced their lending rates bringing themselves closer to the banks. Business is sourced either through DSAs or branch referrals. DSAs charge % of the loan amount. Since processing fees is only %, there is an immediate upfront loss if a DSA channel is used. While HDFC Bank has a large share of branch led business, the rest of the market usually has a 70% share of DSA channel. Management speaks: Shaubik Sengupta, Head of SME Lending, Reliance Capital LAP market Competition has become very aggressive over the past few months, e.g., Religare and Yes Bank in SME lending and Bajaj in LAP. HDFC Bank is the largest player in LAP. Rs400 bn of incremental disbursements ex- PSU banks. Business profile No corporate lending, only retail and SME. Focus on MSME clusters, like Pune which is an auto cluster and Hyderabad being a pharma cluster. Are a mix of from manufacturing and services sectors, being in the business for 5-10 years. Within SME, the equipment retail segment is high yielding and growing fast which could improve profitability. NPAs are at 1.5% for LAP, 2.5% for SME and 4% for CVs. Targeting 50% mortgage + LAP, 30% SME and 20% CV and others, with a full-year loan growth estimate of 10-15%. India Financials Sector 39

40 Industry participant insights: Jairam Sridharan, Head of Retail Lending, Axis Bank Business banking Until now, most of the small capital requirements were being met by friends and family, and co-operative banks. The share of organised sector was relatively small. Customers in business banking are generally restaurant owners, small fleet operators, doctors, etc. LAP 70-80% of loans are typically secured, with the exception of some smaller ticket size loans. Large ticket size LAP has been seeing significant pressure. LAP is a channel-based business, and DSAs tend to move customer lenders. Below 12% yields profitability is quite thin. Profitability: Could come under pressure in LAP In general, the profitability in small business lending is higher than the other large retail lending segment, home loans. Competition in the LAP segment is rising leading to NIM compression the returns here could be approaching those of home loans. Rising competition could either lead to compression in yields, or an increase in LTV (i.e., assumption of more risk). However, non-lap business loans (secured by the underlying cash flows, receivables, plant, machinery and the inventory that has been funded), which requires understanding of the borrower's business, are seeing comparatively benign competition (for example, pure play mortgage companies like LICHF are not focusing on this segment of business loan). Figure 83: Profitability profile in small business loans As % of assets LAP Business lending Interest income 13.0% 14.0% Interest expense 9.0% 9.0% NII 4.0% 5.0% Fee income 0.1% 0.1% Opex 0.3% 0.5% Credit losses 0.3% 0.5% Pre-tax RoA 3.6% 4.1% Tax 1.2% 1.4% Post tax RoA 2.4% 2.7% India Financials Sector 40

41 Figure 84: Market position of various lenders on LAP 18.0% 25.0 Figure 85: Market position of various lenders on smallbusiness lending 20.0% % % % 12.0% 10.0% 8.0% 6.0% LIC Bajaj Finance Axis HDFC Bank Capital First Indiabulls Religare Rcap % 14.0% 12.0% 10.0% 8.0% 6.0% HDFC Bank Axis Religare Bajaj SCUF Yield on LAP Ticket Size (Rs mn) (RHS) Yield on business loans Ticket Size (Rs mn) (RHS) Management speaks: Mr B Sriram, MD, National Banking Group, SBI Mr Sriram oversees a business unit that accounts for 45% of SBI's domestic loan assets, across SME, agriculture and retail. The discussion below focusses on the SME segment. SME segment at SBI SBI had an SME loan book of Rs1.8 tn as of Mar % of the portfolio is balance sheet funding, while the remaining 30% is what SBI calls 'risk mitigated' loans, which are primarily asset-backed loans. Loan ticket size is capped at Rs500 mn, and the average ticket size should be in the range of Rs mn. The portfolio sub-rs10 mn is ~Rs420 bn. LAP was started very recently at SBI. NPAs situation, and corrective measures SME NPAs are running at ~9.5% at SBI. Cash flows are stuck at various parts of supply chains, leading to delayed payments for SBI's SME borrowers. However, management believes that stress in the SME segment has not peaked. NPAs could start declining after manufacturing growth picks up. The recovery could take 3-4 quarters. SBI has commissioned a consultant to reposition the SME portfolio with a new strategy. Technology is being used increasingly in the operations. Earlier SME borrowers would take a loan from SBI but maintain current accounts at other branches, making it difficult to track cash flows. However, now SBI insists on having a current account with itself. Management speaks: Mr Rajiv Sabharwal, ED, ICICI Bank Small business lending ICICI Bank has two products for small businesses: SME loans and loans against property. The target segment for each is usually different from the other. In the LAP segment (housed under and managed by the mortgages team), the LTV is lower than industry average. Ticket sizes are Rs8-10 mn. Sourcing may involve DSAs. India Financials Sector 41

42 In the SME loan segment, lending is usually in the form of working capital loans. Loans are secured by hard assets such as real estate, deposits etc. Sometimes they are in the form of term loans as well. Ticket sizes are Rs20-30 mn. The evaluation of the business is far more detailed than in the case of LAP. Sourcing is usually in-house through branches (the idea is to cater to businesses in the vicinity of the branch). The yields in the two segments are similar, though LAP is facing some downward pressure due to competition (primarily from the NBFCs/HFCs). LAP vs home loans LAP yields are higher than home loans (by bp). Ticket sizes in LAP are bigger (Rs8-10 mn vs Rs3.5-4 mn in home loans). Also, disbursement in LAP happens in one shot (as against construction linked disbursement in home loans). The prepayment/churn levels in LAP are lower than in home loans, because of the absence of prepayment penalty in home loans. Thus, realised tenure in both home loans and LAP are similar. Credit costs are not very different, neither are other operating costs. Thus, profitability in LAP still remains significantly higher than home loans. India Financials Sector 42

43 CVs: Recovering from the bottom Figure 86: CV market should recover from the recent sluggish growth Volume growth - 16% CAGR ASP - 5% CAGR LTV - Unchanged USD 30 bn 12.7% CAGR USD 62 bn Figure 87: Key players in CV financing FY14 FY20E Figure 88: Loan characteristics of CV financing Product template New CVs large fleet New CVs small fleet/srto Used CVs Key players HDFC Bank, ICICI, Kotak IndusInd, Sundaram, Chola, Shriram, AU Finance Tata Motors Finance Customer segment Large fleet owners with 100+ trucks Small fleet owners with 5-10 trucks Owner-drivers with 1-4 trucks Lending rates 10-12% 14-16% 18-22% Lending rate type Usually fixed, sometime floating linked Fixed Fixed to base rate for super large fleet LTV 80-90% 80-90% 70-80% Ticket size (Rs) mn per truck mn per truck mn per truck Average tenure 3-4 years 3-4 years 3-4 years Sourcing Direct relationship with large fleet owners Dealer agents, DSAs, own sourcing Brokers, own sourcing Sizing the potential: Organised finance already accounts for 75%+ the market The CV finance segment has a clear segmentation between new and used (second-hand) CV financing. In our analysis, ~52% of the CV loans today are against new/first-hand trucks. The yields, perceived borrower risks and even lender preferences differ significantly between the two segments. Figure 89: Penetration of organised finance into a new CV market is nearly complete (Sep-2014) Share of new and used CV financing Used CV - others 20% New CV - organised 48% Used CV - organised 28% New CV - others 4% India Financials Sector 43

44 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY30 13 January 2015 In our view, penetration of organised finance in new CV purchase is near complete, with just the Top 12 lenders accounting for nearly 90% of the market. The used CV market, however, still has a large unorganised segment. We believe overall organised finance penetration into the CV market is 75%, and unlikely to go up significantly soon. Thus, growth in the loan book will mirror underlying CV industry growth. Truck penetration in India is quite low, and at least 15 years behind other emerging markets such as Indonesia, which shows the structural potential for CV sales. Figure 90: CV penetration in India lags that of other countries significantly CVs per 1000 pop Figure 91: India will take 15 years to reach current CV penetration of Indonesia, assuming steady 15% growth in sales each year 14,000, ,000, Indonesia in ,000, ,000, ,000,000 India in ,000, ,000, Annual sales (CV units) LHS CV penetration (CVs per 1000 pop) RHS Source: Road transport authorities of respective countries, SIAM, Credit Suisse estimates However, this is also a highly cyclical industry, with the cycles coinciding with economic cycles in the country. With the pick-up in CV sales, CV financiers should see strong growth in their loan books. Figure 92: MHCV sales growth appears to have bottomed 100% 12 m Moving Average M&HCV's growth Figure 93: Freight rates have been rising in recent quarters 105,000 Freight rates (Rs) for round trip 16 ton load 85,000 50% 65,000 0% -50% 45,000 Delhi-Mumbai Delhi-Kolkatta Delhi- Hyderabad Delhi-Chennai Delhi- Bangalore FY12 FY13 FY14 YTD FY15 Nov-14 Source: SIAM, Company data, Credit Suisse research With the pick-up in overall economy, we expect a pick-up in CV sales. We expect truck penetration to increase from 4.4 per 1,000 people in FY14 to 7.1 per 1,000 people in FY20E, driven by a ~14.4% and 19.9% sales CAGR in LCV and MHCV, respectively, along with a ~5% ASP CAGR. This translates into a 12.7% CAGR on the loan book. India Financials Sector 44

45 Figure 94: Expect CV penetration to go up from 4.4 per 1,000 population to 7.1 by FY CV penetration per 1000 people FY14 FY15E FY16E FY17E FY18E FY19E FY20E Players are positioned in different segments Shriram Transport Finance remains the largest truck financier in the country, with a loan book almost equal to the next three lenders combined. Some NBFCs (particularly Tata Motors Finance and Chola) have grown their CV loan books aggressively over the past four years. Figure 95: The larger lenders accounting for 40% of industry have seen a sharp slowdown in their loan book growth 80% 60% HDFC Bank ICICI IndusInd Kotak Shriram 40% 20% 0% -20% -40% FY11 FY12 FY13 FY14 Source: Company data, Credit Suisse research However, we note that overall CV loan growth for leading players has slowed considerably in recent years, mirroring the downtrend in underlying CV demand, and overall weakness in the economy. With signs of a revival in CV sales (particularly MHCV sales), we believe that growth rates for CV financiers could start improving in the coming quarters. Profitability: Used CV > SRTO > large fleet While used CV financiers get higher yields/nims vs new CV financiers, this is offset by higher credit and operating costs in this segment. The large fleet financing market, on the other hand, is the most competitive on rates and as a result enjoys lower profitability despite lower opex as well as lower credit costs. India Financials Sector 45

46 Figure 96: Profitability across segments within CV financing As % of assets New CVs large fleet New CVs small fleet/srto Used CVs Interest income 12.5% 16.0% 18.5% Borrowing costs 8.3% 9.9% 10.8% NIMs 4.2% 6.1% 7.7% Processing fees 0.5% 0.5% 0.5% Operating expenses 1.5% 2.1% 2.3% Credit costs 0.6% 1.0% 1.8% PBT 2.6% 3.5% 4.1% Tax 0.9% 1.2% 1.4% ROA 1.8% 2.3% 2.7% While Shriram focuses on the used CV segment, the large banks focus on the large fleet segment. Other NBFCs and IndusInd Bank focus on the SRTO segment. Figure 97: Market position of various lenders in the CV segment 23% 21% Large fleet Small road transport operators Used CV 19% 17% 15% 13% 11% 9% 7% 5% HDFC Bank Indusind Magma Chola RCAP Sundaram SHTF Yield on CV loans Management speaks: SV Parthasarathy, Head, Vehicle Finance, IndusInd Bank Key players in the CV financing market IndusInd has an 11% market share in new CV financing and is among the Top 2 along with HDFC Bank. The other key players are ICICI Bank, Axis Bank, and NBFCs. PSU banks are quite small in CV financing, and together have probably a less than 10% market share. HDFC Bank and ICICI Bank are strong in the large fleet segment. IndusInd focuses on the small fleet (5-20 vehicles) segment. Market cycles CV cycle usually last 4-5 years, and typically coincides with the economic cycle. Management believes that the current situation is ripe for an upturn in the CV cycle. Much of the excess truck capacity in the country has been absorbed. India Financials Sector 46

47 Impact of a recovery will be two-fold: (1) pick-up in growth here the large fleet owners will act first and hence those lenders will see the uplift earlier than small fleet lenders; and (2) improved collections. IndusInd expects growth in CV disbursements to pick up from Mar-15 quarter. Expected CV sales for FY16 are ~300, ,000 (up from 200,000 in FY14, and 100,000 in 1H FY15). Use of credit bureaus IndusInd checks for credit scores on all cases. More than 70% of new loan applications are from repeat customers, so the hit rate for IndusInd on credit bureaus is very high. Management believes that the rise of credit bureaus has worked wonders on consumer behaviour, too (for instance, NPAs in the two-wheeler segment have fallen from 4% to 2%, largely attributable to the bureau awareness). Overall, management does not see much difference in the database sizes of various bureaus, and the differentiation, if any, is on analytics and data acceptance rates. Other topics Used CV financing is ~20% of CV loan book for IndusInd, and growing fast. Management speaks: Mr Rajiv Sabharwal, ED, ICICI Bank CV loans ICICI Bank operates in the large fleet segment, where the stress has been the least. CV yields are bps above base rates Growth in recent months has been driven by replacement demand, primarily by the fleet segment, and actual expansion of fleet is yet to take place. India Financials Sector 47

48 Auto loans: Competition keeping yields/returns low Figure 98: Expect a 16% CAGR in the car loan segment Volume growth - 14% CAGR ASP - 5% CAGR USD 33 bn FY % CAGR USD 90 bn FY20E Figure 99: Key players in auto financing Source: Company data, Credit Suisse research Figure 100: Loan characteristics of auto loans Product template PSU bank Pvt banks NBFCs Two-wheeler loans Key players SBI HDFC Bank, ICICI Bank, MMFS, Magma, SCUF, Bajaj, HDFC Bank, SCUF, Kotak, Axis Bajaj Finance IndusInd Customer segment Salaried, Urban Salaried, Urban Self Employed/Rural Mass Lending rate % % 13-14% 18-20% Lending rate type Fixed Fixed Fixed Fixed Processing fees % 1.00% 1.00% 2.00% LTV 75-85% 75-95% 70% 70-80% Ticket size (Rs) mn Avg tenure (yrs) Sourcing Dealers, DSAs Dealers, DSAs Dealers, DSAs, Own sourcing Dealer's commission % Sizing the potential: Pent-up demand to drive pick-up in volumes Penetration of organised financing in car sales in India is fairly high, at 75%+. Thus, auto financing industry growth trends should theoretically largely reflect the underlying car sales trends. Car penetration in India, at 15 per 1,000 people, is significantly lower than other countries. This suggests good long-term growth potential. Dealers India Financials Sector 48

49 Figure 101: Car penetration in India is less than major markets' 600 Car penetration per 1000 people Figure 102: so is two-wheeler penetration 40 2W penetration per 100 people Source: World Bank, Credit Suisse research Source: World Bank, Credit Suisse research While car sales are less cyclical than truck sales in India, they do get impacted by the consumer sentiment. The passenger vehicle market, after four years of flat volumes, has started to show signs of increased demand. Growth has picked up over the past five months after almost three years of subdued demand. Figure 103: Demand to pick up after four years of stagnant volumes 3,500 Passenger Vehicle (Cars+UVs) 3,000 2,500 2,000 1,500 1, % 30% 25% 20% 15% 10% 5% 0% -5% -10% Figure 104: Growth over the past few months has picked up after three years of subdued demand 30% PV Volume growth (YoY %) 20% 10% 0% -10% Volume ('000) Growth (YoY %) -20% Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Source: Company data, Credit Suisse research We assume car penetration in India will rise from 15 in FY14 to 25 per 1,000 pop by FY20E, leading to a 14.5% CAGR in volume in 4Ws (and we also build in 13.5% growth in the 2W market). Assuming a ~5% ASP CAGR, stable LTVs and tenures (three years), this translates into a 17.9% CAGR for the car loan market, increasing from US$33 bn to US$90 bn. Private banks still dominate the car financing market Top three players for the passenger vehicle financing market account for over 50% of the market share. However, after that, the market is quite fragmented with almost all the banks actively present in the auto financing market. As a result, competitive intensity is higher compared to the other retail segments (probably with the exception of housing finance). Banks dominate the car loans segment with HDFC Bank, ICICI, SBI and Kotak accounting for the major share. Within rural markets, MMFS has gained prominence due to its widespread network. India Financials Sector 49

50 HDFCB SBI ICICI Kotak Axis MMFS Magma BOB PNB Canara Indus BOI Union SCUF Bajaj 13 January 2015 Industry participant insights: Mr Vyomesh Kapasi, CEO, Kotak Prime Car Finance Market structure 70-72% of cars are bought on finance in India, thus finance penetration is fairly high. The average ticket size for the market is Rs400, ,000, with 80-85% LTVs. Yields are typically in the % range. The biggest player in the car finance market is HDFC Bank, followed by SBI, Kotak and ICICI Bank, not in any particular order. The used car market is still largely unorganised, with probably 30-40% transactions involving financing of some form. Lending rates here are bp higher than in new cars. Operations More than 50% of the business comes through dealership tie-ups. Most major lenders have tie-ups with OEMS for dealership referrals. Usually, Kotak also funds the dealers' inventory The next largest source of business for Kotak is its own database of past customers. Impact of credit bureaus Repossessions in car loans are rare nowadays. This is because the delinquency levels have improved significantly over the past 4-5 years. A large contributor towards this improvement is the rise of credit bureaus. Kotak gets 80-85% hit rate on the credit bureaus for its new loan applications Further, customers are conscious about credit bureaus and there is a marked improvement in consumer behaviour in recent years. The two-wheeler segment is, however, less crowded, with HDFC Bank, IndusInd, Bajaj, TVS and SCUF accounting for ~85-90% of the total market. Figure 105: Key players in the car financing market 350 Four wheeler loan book size (Rs bn) Figure 106: Key players in the 2W financing market 40 Two-wheeler loan book size (Rs bn) Bajaj Finance HDFC Bank SCUF IndusInd Source: Company data, Credit Suisse research Profitability in car loans lower compared to other retail segments Source: Company data, Credit Suisse research PSU banks have been aggressive in the car loans segment especially on lending rates. SBI is offering car loans at the lowest rate (at ~10.5%) with most other PSU offerings in the range of % as well. Private banks have been relatively less aggressive in pricing (11-12%), but have tried to compete by offering higher LTVs. NBFCs operate in India Financials Sector 50

51 segments where either risk is higher (salaried customers) or the cost of operations are higher (rural and semi-urban) and hence charge higher yields. Given aggressive pricing in car loans, profitability is relatively low compared to other segments. Figure 107: Auto loan profitability levels lower compared to other products As % of assets Banks NBFCs 2W loans Interest income 11.5% 15.0% 20.0% Interest expense 8.2% 8.8% 8.8% NII/total assets 3.3% 6.2% 11.2% Processing fees 0.2% 0.2% 0.2% Dealer's commission 0.3% 0.5% 0.5% Opex 0.8% 2.0% 3.0% Pre-provision profit 2.5% 4.0% 7.9% Credit cost 0.8% 1.4% 3.5% Operating profit 1.7% 2.6% 4.4% ROA (%) 1.2% 1.7% 3.0% Figure 108: Market positioning of various players in the auto loan segment 30.0% 25.0% Urban Rural 2wheelers 20.0% 15.0% 10.0% 5.0% Kotak (car) SBI (car) MMFS (car) IndusInd (2W) SCUF (2W) Capitalfirst (2W) Bajaj (2W) Yield on auto loans Industry participant insights: Senior management personnel in car finance, MMFS Market structure Yields on used cars are ~500 bp higher than new cars. DSA channel is well established in the used car market. In Pune, the number of used car transactions would be similar to the number of new car sales. 70% of new cars are sold on finance, compared with 50% for used cars. HDFC and ICICI have been in the used car financing market for a while. HDFC Bank is the largest, while ICICI has become aggressive in the used car space. HDFC would offer lower interest rates. Operations Use of CIBIL in most cases, with an 80% hit rate. Percentage of rejections has gone up from less than 10% to 20% now. Have ~32% market share within M&M car sales, HDFC and Chola have ~5-6% share. NPAs had gone up in the past 3-4 months, during the festive season. India Financials Sector 51

52 Gold loans: Growth should follow regulatory clarity Figure 109: Loan growth at 10.6% over the next six years, to lag the retail sector % of gold pledged with banks - 5% to 8% LTV - Up from 50 to 60% USD 61 bn Figure 110: Apart from a couple of NBFCs, the market is dominated by banks 50 16% CAGR USD 25 bn FY14 FY20E Figure 111: Loan characteristics of gold loans Product template Banks NBFCs Key players South Indian Bank, Federal Bank Muthoot, Manappuram, SCUF Customer segment Mass segment with gold jewellery available to pledge Mass segment with gold jewellery available to pledge Lending rates 12-15% 18-22% Lending rate type Fixed Fixed LTV 60% 70% Ticket size (Rs) 80, ,000 40,000 Average tenure 3-6 months 3-6 months Sourcing Branch walk-ins Branch walk-ins Sizing the potential: Likely to lag the retail loan market Estimates from RBI state that there is 18,000-19,000 tonnes of gold in India, 65% of which is in rural India. Gold is typically seen as an important savings instrument that is liquid and can be converted into cash instantly to meet any urgent needs. While there are no formal statistics, our industry discussions indicate only ~1,000 tonnes of gold is with lenders in terms of collaterals for loans. Customers are generally of walk-in type. The end-use of ~40% of the loans is towards small and micro businesses, while ~30-35% is used towards agri-related businesses. While 5-10% is towards small fleet operators, the balance 15% is towards personal expenses (hospital expenses, school fees, etc). Companies are now starting to lend towards the purchase of consumer durable items as well. While the traditional pawn broking business (where the customer just sells the jewellery with no guarantee of getting it back intact at a later date) has been in existence for ages, the focus of this section of the report is on the practice of borrowing against gold as a collateral, where the borrower is sure of recovering the original asset intact upon the completion of the loan. Estimates from RBI suggest that the formal gold loan market is ~US$25 bn in size. The gold loan market has seen some slowdown on account of intervention by the RBI on NBFCs, and volatility in gold prices. The top five players saw their loan book shrink 16% YoY in FY14 (after witnessing a 57% CAGR over the preceding three years). India Financials Sector 52

53 Figure 112: Growth in gold loans has slowed considerably in recent years 300 Muthoot Manappuram South Indian HDFC Bank Federal Bank Rs bn FY09 FY10 FY11 FY12 FY13 FY14 Source: Company data, Credit Suisse research However, we expect growth to resume slowly on the back of stability in gold prices, and RBI's comfort with the current state of the sector (evident in the raise in LTV limit to 75% from 60% in Jan-14). With current estimates of ~19,000 tonnes of gold in India, we build in a 4% CAGR, assuming 800-1,000 tonnes of gold imported each year (i.e., the current annual run-rate) and price of gold remaining flat. We build the quantum of gold on pledge to go from 5% to 8% by FY20, along with a gradual increase in LTV to ~60% (from 50% currently). This leads to a ~16% CAGR in growth for the gold loan industry. Figure 113: We expect 7.5% of all gold in India to be pledged with banks by FY20 (from 5% currently) 27,000 25,000 Unpledged Gold (MT) Gold pledged with banks/nbfcs (MT) 23,000 21,000 19,000 17,000 15,000 FY14 FY15E FY16E FY17E FY18E FY19E FY20E Geographic diversification could drive growth Over the longer term, growth could be driven by a geographic diversification: south India still accounts for a significant share of the gold loan business, as seen from loan concentration of the gold loan NBFCs in this region. As per RBI, south India accounted for 80-85% of the gold loans market in India in India Financials Sector 53

54 Figure 114: Muthoot and Manappuram have the majority of their loans in the south (Sep- 2014) East 6% West 14% North 14% South 66% Source: Company data, Credit Suisse research The gold loan market is dominated by banks, who command a 71% share. However, individual banks are actually smaller players in the market compared to the specialist NBFCs. The largest gold loan portfolios are with specialist gold loan NBFCs Muthoot and Manappuram respectively have a 15% and 6% share in the formal market. Industry participant insights: Mr Oommen Mammen, CFO, Muthoot Fincorp Market structure ~18,000 tonnes of gold in India, of which ~1,000 tonnes is pledged. The organised NBFC market size is ~Rs400 bn, while the banks command ~Rs1,000 bn. The unorganised market could be 2-3x the organised market. Banks do agri gold loans to fulfil the PSL requirements. Loans are taken for various end-uses (small businesses: 40%, agri: 35%, auto and tractor: 10% and others [hospital or school fees]: 15%) Operations NBFCs could give a gold loan in 5-10 mins compared to slower processing times for banks. Small value and large number of loans make the business difficult for banks. Operating model: Low credit loss but high opex The yield on gold loans is relatively high for a secured loan business, at 16-22% with LTV varying from 65% to 75% on value of gold; higher LTVs typically command higher yields. While the tenure of these loans varies from a few days to longer-term loans of up to a year, the average tenure generally ranges from three to six months. NBFCs normally do not charge any processing fees on loans, while some banks do. The operating costs in this business tend to be high, due to the following factors: The ticket sizes are usually small and the volumes high. The nature of the business requires a wide reach in terms of physical branches; Muthoot has the fifth largest branch network across all banks and NBFCs. India Financials Sector 54

55 Figure 115: Muthoot has the largest branch network among NBFCs, comparable to some large PSU banks 18,000 No. of branches 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - Source: Company data, Credit Suisse research Requirement for staff to be highly skilled in gold jewellery valuation. Credit losses are generally low in the business (the NBFCs we studied have seen loss rates in the range of 0-10 bp over the past few years). The sentimental value attached to the specific pieces of jewellery pledged, as well as the sub-75% LTV, ensure low loss rates. Gold loan companies saw pressure on profitability, with the fall in gold prices Sharp drop in gold loan prices With the sharp increase in gold prices, in 2Q12 and 3Q12, gold loan companies had lent aggressively, with loan-to-value ratios touching ~90%. In 4Q13, there was a sharp decline in gold prices (-16% from January to April). The decline in gold prices led to the value of collateral not covering the loan value, resulting in an increased number of customers not servicing their loans. The increase in default led to auctioning of the gold held by the gold loan companies, and with the decline in gold prices, this led to a loss on the sale of these gold assets. RBI tightens norms for gold loan companies In Mar-12, RBI came out with several regulations for the sector. One of which was limiting the LTV to 60%, and a frequent and more transparent method of valuing the gold. This limit was subsequently raised to 75% in Jan-14. Sustainable RoA of 3% On a sustainable basis, this sector could have a RoA in the range of % (while banks could enjoy lower funding costs vs NBFCs, we also believe this is largely negated by the lower yields that banks traditionally charge in the segment). India Financials Sector 55

56 Figure 116: Gold loans profitability As % of assets Banks NBFCs Interest income 15.0% 20.0% Interest expense 8.2% 9.9% NIM 6.8% 10.1% Opex 3.0% 5.0% Credit losses 0.1% 0.1% Pre-tax RoA 3.7% 5.0% Tax 1.2% 1.7% Post tax RoA 2.5% 3.4% Figure 117: Positioning of various lenders on gold loans 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% South Indian Bank SCUF Muthoot Manappuram Yield on gold loans Ticket size (Rs) RHS India Financials Sector 56

57 Bandhan SKS Spandana Janalakshmi Share Ujjivan Equitas Satin Asmitha Muthoot GFSPL 13 January 2015 Microfinance: Banking the unbanked Figure 118: Loan growth of over 14.4% in the next six years No. of customer - 9% CAGR Addressible segment penetration - 45% to 70% Loan per customer - 8% CAGR USD 12 bn 18.1% CAGR USD 32 bn Figure 119: SKS is the only listed MFI at the moment; Bandhan recently got a banking licence 70 GLP - FY14 (Rs bn) FY14 SHG MFI FY20E Figure 120: Operating profile of the MFI industry Key players Customer segment Secured/unsecured Microfinance NBFC-MFIs like Bandhan, SKS Rural self-employed women Unsecured Lending rate 20-24% Lending rate type LTV Fixed Ticket size (Rs) 10,000-12,000 Avg tenure (yrs) 1-2 Sourcing Sizing the potential: Less than half the market has been touched NA Group referrals Banking penetration in India continues to be low, and in particular, the rural poor are largely excluded from formal banking services (leave alone formal credit access). It is this gap that the microfinance institutions and self-help groups try to fill. Figure 121: Banking penetration still low 80% 70% 60% 50% 40% 30% 20% 10% % of households availing banking services 0% Rural Urban Total Source: Company data, Credit Suisse research Specialist Micro Finance Institutions (MFIs) and the bank-led self-help groups (SHGs) model together cater to around 85 mn borrowers (after taking into account overlaps), with India Financials Sector 57

58 an average loan ticket size of ~Rs8,400. Thus, the micro-credit industry has an ~US$11.8 bn loan book, with a 60% share held by banks and the rest with NBFC-MFIs. Figure 122: Micro credit customers in India (mn) 120 SHGs MFIs Figure 123: Size of microcredit industry (Rs mn) 800,000 SHGs MFIs 700, , , , , , ,000 - Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Source: State of sector report, MFIN, RBI, Credit Suisse research Source: State of sector report, MFIN, RBI, Credit Suisse research While the industry has stabilised post the AP MFI crisis and started growing again, we believe penetration levels are still low. Of the total 247 mn households in the country, 52% or around 128 mn have an annual income of under Rs90,000. The average household size in India is 4.9 people. Further breaking it up, women per household is 2.4. Limiting the target microfinance borrowers to only adult women, in these low income (less than Rs90,000 annual income) households, translates into a potential client base of 182 mn, given the national average of 1.4 adult women per household. This number will increase as more girls reach the age of 18 and are eligible as earning members. After the AP crisis in 2011, microfinance has again reached the pre-crisis levels at ~100 mn households. With SHGs having a client base of mn and MFIs reaching 34 mn and an estimated 19 mn overlap between the two, it implies an untapped market size of about 100 mn (55% of the total potential clients). Figure 124: Less than 50% of the addressable market has been tapped by the micro-credit industry Figure 125: Estimated market potential for the MFI industry across various agencies Estimated microfinance credit (in USD bn) Vijay Mahajan (Basix Chairman) CS estimate Intellicap (based on regional demand) EDA rural report Intellicap (by population segment) The microfinance industry loan book was ~US$11.6 bn in 2014 (60% of this with the SHGs). The total potential size of the microfinance market is estimated at US$40-50 bn by various industry studies (Figure 125). Based on our customer potential of 182 mn, at the current average loan size of Rs 8,400 per customer, the estimated market size potential is US$25 bn. But we note that the average loan size has seen a CAGR of 14% over the past two years. Assuming a Rs12,000 average loan size (not too aggressive, in our view, and well below the Rs15,000 limit for one-year loans) the market potential comes to US$36 bn. India Financials Sector 58

59 60% of the total outstanding is still with SHGs, but the share of MFIs is inching up quickly. The share of MFIs in incremental micro-credit post-ap crisis is 50%+ and we expect this trend to continue. Industry has recovered from the AP crisis In our view, the MFI industry (especially in the large southern markets such as the erstwhile Andhra Pradesh) had manifested many of the ills of the unsecured retail lending businesses like MFI: Multiple lending to the same borrower. Over-leverage of borrowers beyond their true repayment capacity. In addition, the AP government documents and various industry reports suggested that other practices like high interest rates, aggressive collection practices, poaching of clients from the state-supported SHGs had become common. However, post the crisis, many of these issues have been effectively addressed, largely due to firm and clear rules set by RBI on various parameters. Figure 126: Multiple issues that culminated in the AP MFI crisis have now been addressed or rectified Issue What has changed post AP-crisis Confusion on regulatory authority RBI the sole regulator, not the state governments Multiple lending to same individual RBI set a limit of maximum two lenders to each borrower. MFIs mandated to become members of credit bureaus to monitor adherence to this rule Over-indebtedness RBI set a limit on maximum indebtedness of borrower at Rs50,000. MFIs mandated to become members of credit bureaus to monitor adherence to this rule Loans in excess of Rs15,000 should have a tenure not less than 24 months High interest rates RBI set a margin cap of 12% over borrowing costs (later reduced to 10% for large MFIs); yield cap of 26% on individual loans (later the cap was revoked). Priority sector status Bank lending to NBFC-MFIs continue to remain PSL compliant. Geographical concentration Source: RBI, Company data, Credit Suisse research RBI has mandated MFI boards to set internal exposure limits to specific states/geographies to avoid concentration risk Figure 127: Other important change post AP MFI crisis Other changes Before AP-crisis Post AP-crisis Asset classification Similar to other NBFCs: 180 days overdue New MFI specific rules: NPA on 90 day overdue Std asset provisioning Transparency/fair practices Source: RBI, company data, Credit Suisse estimates Similar to other NBFCs: 0.25% standard asset provisioning, NPA provisioning: 6-18M: 10%; 18-30M: 20%; 30-54M: 30%; 54M+ 50% Complex contract structures with multiple revenue streams to lender We believe post a three-year consolidation phase, the MFI industry has started growing again. We believe the following facts indicate that the industry has recovered from the crisis and on the way to meeting the growth targets we have projected: New MFI specific rules: standard asset provisioning 1% of loan portfolio, NPA provisioning: 90 days overdue, 50%; 180 days overdue, 100%. No penalty on delayed payments Only three price components: interest rate, loan processing fee (capped at 1%) and insurance premium (on cost basis without any margin) All borrowers to be provided loan cards with all contract details in local languages India Financials Sector 59

60 Figure 128: Average loan ticket size has starting going up again post AP crisis Avg Loan size per client (Rs) 12,000 10,000 8,000 6,000 4,000 2,000 Figure 129: Loan portfolios of MFIs have surpassed their pre-ap crisis levels 70 FY10 FY SKS Spandana Share Micro Bandhan Asmitha Source: MFIN, company data, Credit Suisse estimates Figure 130: Geographic concentration was high pre-ap crisis (mid-2010) Maharashtra 5% MP 3% Bihar 2% Chhattisgarh 2% Source: Company data, Credit Suisse research Figure 131: Industry is now fairly diversified across multiple states (2014) MP 6% Assam 5% Orissa 5% West Bengal 17% Uttar Pradesh 7% Orissa 8% Andhra Pradesh 32% Bihar 7% Uttar Pradesh 8% Tamil Nadu & Puducherry 17% Tamil Nadu & Puducherry 11% West Bengal 11% Karnataka 19% Maharashtra 10% Karnataka 11% Andhra Pradesh 14% Source: Company data, Credit Suisse research Awareness of credit bureaus on the rise Source: Company data, Credit Suisse research One important positive development post the AP MFI crisis is the emergence of credit bureaus, and their usage in the daily functioning of MFIs. From our discussions with MFI/CB managements, we understand that over 35 mn individuals figure in the MFI database of credit bureaus (like Equifax), and a 90%+ hit rate is usually seen when new loan requests are queried. It helps that RBI has mandated all MFIs to become members of such bureaus. The acceptance of credit bureaus is seen not only among the MFIs, but more importantly, even among the customers. In our field visits we picked up several cases of customers being denied loans by various MFIs because their profile on the credit bureaus had problems (most frequently due to the borrower already having loans with two MFIs, less often due to past overdues or having reached the maximum permissible borrowing limit). As a result, the awareness of credit bureaus is growing even among the customers which bodes well for the industry as a whole. India Financials Sector 60

61 But SHGs pose risk to the industry We believe the post-ap RBI regulatory actions more or less take care of risks arising from within the MFI industry. However, the SHG model still remains outside the purview of these regulations. The SHGs are not required to share their borrower information with credit bureaus, nor do the multiple-borrowing/maximum indebtedness limits apply to them. On the ground, the bank leading the SHG may rarely have full details of the members who are part of the SHG (and hence are borrowers) the intermediary NGO is often the only entity the banks have knowledge of. It is thus possible that the intentions of the RBI to prevent over-indebtedness of the borrowers could be nullified by the SHGs. Indeed, from our industry discussions, we understand that the NPA levels in some of the SHG ecosystems could be as high as 10%. MFIs such as SKS Microfinance believe that while this risk is theoretically real, in practice the opportunity is so large and the activity of SHGs so infrequent that it hardly poses any meaningful risk. Industry participant insights: Mr Mohan Jayaraman, Country Head, Experian India Experian is one of the leading credit bureaus in India. The discussion here is specific to MFI databases. A more detailed discussion on takeaways from our meeting with Mr Jayaraman is in the next chapter under the discussion on credit bureaus. Risk from SHGs: MFIs strictly adhere to the RBI norms of not more than two loans per individual, and mandatory membership of credit bureaus. But this is not true of SHGs. The lead banks are aware of the names of individuals in each group, but not the actual amount lent to each individual (this is managed by the NGO/SHG involved). The Aditya Puri committee has recommended that banks arrange for capturing SHG data for reporting to credit bureaus in a reasonable period of time. Profitability hinges on the ability to sell down Under the new RBI rules, as we have seen earlier, there is a 10% spread cap for MFIs over their borrowing rate. Now the MFI business model is heavy on operating costs, due to the low-ticket/high volume/short-tenure nature of the product as well as the people intensive operations (as seen below from the low AUM per employee for SKS). Of course, this model allows the companies to keep credit costs low (including the fact that borrowers meet company officials face to face every week). India Financials Sector 61

62 Figure 132: MFI business model is people intensive, as seen from the low AUM per employee for SKS below 35 AUM per employee (mn) SHTF MMFS SCUF SKS Given that even large MFIs like SKS run on 10% opex/assets, it is clear that the underlying profitability of this business is now fairly weak. Companies can hope to enhance the profitability, however, by Trying non-mfi revenue streams (like insurance broking, financing small ticket assets like mobile phones etc); Selling down the portfolio through assignment/securitisation transactions. In our analysis, at the current scale of leading MFIs, it is imperative that they are able to sell down their portfolios significantly, as seen below. It is possible, however, that over time and with scale, the companies get some operating leverage allowing the underlying profitability of the business to improve. Figure 133: Profitability of MFIs now depends on the ability to sell down loans outside balance sheet As % of gross loan portfolio MFI with off-book = 0% MFI with off-book = 40% Interest income 22.5% 22.5% Interest income 10.7% 10.9% NIM 11.8% 11.6% Other income 2.0% 2.0% Opex 10.0% 10.0% Credit losses 0.5% 0.5% Pre-tax RoA 3.3% 3.1% Tax 1.1% 1.0% Post tax RoA 2.2% 2.1% Leverage 6 10 RoE 13.2% 20.7% Note: SKS makes higher profits than indicated above because of low taxes and higher fee income; Structural triggers to watch out for RBI action: It is unlikely that RBI will tighten rules on MFIs any further. Changes, if any, are more likely to be on relaxing existing rules. In particular, if RBI increases the maximum loan limit of Rs15,000 (for one-year loan ticket size) this could help the industry grow faster. Any relaxation of the maximum spread (currently 10%) could help profitability significantly. SHG behaviour: SHGs operate in the same market as MFIs, and are largely unregulated. We see them as the biggest risk to the MFI industry. Any rise in delinquencies here (or even rapid growth in this segment) would be detrimental to the MFIs. India Financials Sector 62

63 Credit cards Figure 134: Credit card spends to see a 28% CAGR Retail payments growth % CAGR Share of non-cash to 40% (32%) Share of Credit cards to 1.5% (1.1%) USD 111bn Figure 135: Private and foreign banks dominate the market 6 Outstanding Credit cards (mn) FY14 5 Total outstanding cards - 19mn % CAGR USD 26bn FY14 FY20E 0 HDFCB ICICI SBI Citibank Axis Stanchart Figure 136: Loan characteristics and market potential of credit cards Credit cards market in India Players Customer segment HDFC Bank, ICICI, SBI, Citibank and Axis Salaried, Self-employed(mostly bank's internal customer) Lending rate 22-26% Lending rate type Key sources of revenue Membership fees (Rs bn) Avg fees No of cards Estimated fee income pool Fixed 2, Interest income (Rs bn) Avg rate Avg size of industry loans outstanding Estimated interest income 24.0% Interchange fees (Rs bn) Avg fees Retail payments through credit cards (avg) Estimated fee income pool 1.5% 1, Total revenue pool (Rs bn) 119 Sizing the potential: Share of non-cash payments to rise significantly Consumer payments in India primarily continue to be in cash despite a sharp increase in share of non-cash payments over the past ten years. The share of non-cash payments in total consumer payments has gone up to 32% from very low levels ten years ago, but still has a long way to go to catch up with more mature markets. The increase has been primarily driven by an increase in electronic and cards payments. The share of cheque payment still remains disproportionately large in consumer payments (~60%) and would continue to go down. The share of card payments, especially credit cards, in non-cash consumer payments remains very low (~1.1%) even compared to other emerging markets. We expect total retail payments to grow broadly in line with nominal GDP growth at a 14.8% CAGR until The share of non-cash payments is likely to go up ~40% from currently at 32%. This will be primarily driven by an increase in the share of electronic and card payments, with the share of credit cards in non-cash payments going up to ~1.5%. The size of opportunities for the credit cards market is tremendous and we estimate the pace of growth in credit cards to only accelerate from here (a 28% CAGR until 2020 vs a 26% CAGR for the past five years) as banks try to capitalise on the ~US$111 bn consumer payments market by India Financials Sector 63

64 Figure 137: Share of non-cash payments to move closer to mature markets levels Share of non-cash payments in total consumer payments (%) Figure 138: Cheques still dominate as a mode for consumer non-cash payments 160 Retail payments (Rs trn) France UK US Singapore Brazil Malaysia SA India Indonesia Russia 0 FY10 FY11 FY12 FY13 FY14 Paper Clearing Electronic Clearing Card Payments Source: Company data, Credit Suisse research Credit cards penetration remains low Source: Company data, Credit Suisse research India has total outstanding credit cards of ~19 mn. Credit card penetration remains low in India at just ~2% vs the global average of ~15%. However, penetration in the high income group is relatively high; compared to that mid income to low income group penetration is extremely low at ~2%. Figure 139: Credit card penetration low compared to global standards Cards penetration in India (%) World High Income Upper Middle Income Middle Income India - overall Lower Middle Income Low Income Source: Company data, Credit Suisse research Sharp increase in transaction volumes Post the retail asset quality cycle of FY08-10, banks have been cautious in expanding their un-secured consumer loan portfolio. The number of credit cards during the cycle declines sharply and has not really grown over the past five years. Some of it is also on account of banks continuously weeding out non-operative cards. Credit card volumes in contrast have been growing at a robust pace (a 26% CAGR over FY10-14) and likely to maintain the robust pace on the back of a shift from cash and check payments to credit cards and electronic mode of payments. India Financials Sector 64

65 Figure 140: A 26% CAGR in credit card transaction value even with the number of cards being flat 30 1,800 Credit Card Transactions 1, , FY09 FY10 FY11 FY12 FY13 FY14 Value (Rs bn) (RHS) Number of Credit cards (mn) 1,200 1, Source: Company data, Credit Suisse research HDFC Bank remains the market leader in terms of outstanding cards by far followed by ICICI, SBI, Citi and Axis Bank. Private banks account for ~55% of the market share with foreign banks (25%) and PSU banks (20%) accounting for the rest. Figure 141: HDFC Bank is the market leader by far 6 Outstanding Credit cards (mn) FY14 Figure 142: Private and foreign banks dominate the market Credit cards mkt share (FY14, %) 5 4 HDFCB 27% ICICI 16% HDFCB ICICI SBI Citibank Axis Stanchart Source: Company data, Credit Suisse research Othe r Pvt 5% Other PSUs 5% Other Foreign 6% Stanchart 6% Axis 7% Citibank 13% Source: Company data, Credit Suisse research SBI 15% Management speaks: Parag Rao, Head of Card Payments, HDFC Bank Market structure and Outlook There are mn credit cards outstanding in the industry, but individual customers could be between 12 and 15 mn. HDFC bank is market leader with ~30% share of spends. HDFC Bank looks at the cards segment as a product to engage the customer and complete the basket of offering (rather than focusing on a pure transaction driven / revenue driven business model). The challenge in the credit card market is to be the preferred card in the customers wallet. Management expects growth in the next three years to be higher than the last three years. India Financials Sector 65

66 Operations In the current cycle, the main driver of growth for the larger banks should be from internal liability customers. For HDFC bank, ~80% of credit cards are given to existing customers. The cost of acquisition of an existing bank account customer is half of sourcing an outside customer. Online spends account for 37% of credit card spends, up from 27% a year ago, compared to debit cards which is at 22% compared with 15%. Bank get a 90%+ hit rate on CIBIL, for larger cities and towns. Industry participant insights: Jairam Sridharan, Head of Retail Lending, Axis Bank Credit cards Axis is now No. 3 in terms of commercial cards. There has not been an increase in the number of cards, but there has been a healthy growth in card spends. The profitability of the credit card industry is low, after accounting for expenses and rewards. Rising contribution to fee income We look at the three revenue sources for the credit cards business separately, i.e. subscription fees, interest income and interchange fees and try to estimate the size of the revenue pool. As shown in Figure 136, we estimate the revenue pool for credit cards to be at ~Rs120 bn, likely to grow at a very healthy pace. An increase in the scale and check on opex are the two key determinants of profitability for credit cards. Transactions on SBI Cards have more than doubled over the past two years resulting in improvement in profitability as well. SBI Cards with a card base of ~2.8 mn generates pretax profits of ~Rs4,800 mn. IndusInd Bank, with a card base of ~250,000, generates fee income of ~Rs450 mn (Rs35-40 mn per month), similar to SBI. HDFCB and ICICI, with a larger card base and better card spends, would likely have better profitability on their cards. Credit cards are going to be a meaningful fee income contributor for the banks with the segment poised for a long period of high growth. Figure 143: Rise in transaction volumes driving profitability for SBI Cards 200 Credit Card Transactions ,500 3,000 2,500 2, ,500 1, FY11 FY12 FY13 FY14 SBI cards profits (Rs mn) Transactions (Rs bn) 0 Source: Company data, Credit Suisse research India Financials Sector 66

67 Personal loans: Fast growing; though caution remains Personal loans has been another fast growing segment at a 25% CAGR over the past two years on a low base, with total outstanding personal loans at ~US$33 bn. Banks, however, continue to remain cautious on extending small ticket personal loans for consumption purposes. While the arrival of CIBIL has resulted in increased discipline among consumers, the risks still remain high for the segment. We expect the share of personal loans in total loans to go up from current low levels, but to remain in single digits for most banks. HDFC Bank is the market leader in the segment with the share in loan book at ~7%. Figure 144: High growth in personal loan book on a low base 250 Personal Loans 160% % % % 0 HDFCB Axis Kotak ICICI Rs bn CAGR (FY12-14) (%) 0% Source: Company data, Credit Suisse research Management speaks: Mr Rajiv Sabharwal, ED, ICICI Bank Unsecured loans Close to 75% of the personal loans would be to existing customers of the bank. However, penetration is still low leaving enough opportunity to grow within customer base. Bank is innovating new products (like easy EMIs, where disbursement takes place without fresh credit evaluation for existing customers). On credit cards (3.5mn customers), Bank gets a reasonable mix of both fee and interest income. India Financials Sector 67

68 Asia Pacific / India Bajaj Finance Ltd Rating OUTPERFORM* Price (12 Jan 15, Rs) 3, Target price (Rs) 4,350.00¹ Upside/downside (%) 26.0 Mkt cap (Rs mn) 173,076 (US$ 2,785) Number of shares (mn) Free float (%) week price range 3, ,460.2 ADTO - 6M (US$ mn) 1.3 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Research Analysts Sunil Tirumalai [email protected] Kush Shah [email protected] Chunky Shah [email protected] (BJFN.BO / BAF IN) INITIATION Cross selling to sustain growth and asset quality We initiate coverage on Bajaj Finance with an OUTPERFORM rating and a target price of Rs4,350 (26% upside). Leader in multiple segments: Bajaj Finance has a well-diversified loan book of US$4.7 bn, spread across consumer and small business segments. The company is amongst the top players in multiple segments such as consumer durables, two-wheelers, personal loans and loans to self-employed borrowers. The company has demonstrated its ability to incubate and grow new businesses with good help coming from its cross selling ability. Cross selling expert. The key differentiator in Bajaj's retail lending strategy is its intense focus on cross-selling and upselling products to existing customers. We believe the consumer durables segment (12% of loan book) primarily functions as a source of new customers (company acquired 3.4 mn customers in FY14 alone). The 6-9 month tenure of this segment gives sufficient time to study the credit behaviour of new customers on small ticket loans in order to be able to cross-sell other products later. Currently, 40-50% of new disbursements are to existing customers, and we expect this to continue to go up. Expect strong growth and asset quality to sustain. The important fallout of its cross-sell strategy is that Bajaj's credit costs are lower than other retail lending peers (last three year credit costs of 1.3%). We expect credit costs to remain stable and loan growth to sustain at 30%+ levels in coming years. Share price performance Price (LHS) Rebased Rel (RHS) Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Valuation. Bajaj's valuations at 14.5x/2.7x FY16E P/E/P/B appear rich, but we believe the company's strong execution track record and stable earnings outlook justify such a premium. Our 12M TP of Rs4,350 is based on 14x P/E multiple on 24M EPS of Rs311. Key risks: (1) sharp rise in competition in small business lending segments, leading to drop in margins; and (2) drop in asset quality arising from risks to economic growth. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 13, , , ,532.7 Pre -tax profit (Rs mn) 10, , , ,084.6 Net attributable profit (Rs mn) 7, , , ,214.8 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) , ,587.9 P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 68

69 Bajaj Finance Ltd BJFN.BO / BAF IN Price (12 Jan 15): Rs3,451.35, Rating: OUTPERFORM, Target Price: Rs4,350.00, Analyst: Sunil Tirumalai Target price scenario Scenario TP %Up/Dwn Assumptions Upside Central case 4, Downside Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 37,886 50,649 65,546 83,669 Interest expense 15,732 22,766 29,700 36,545 Net interest income 22,153 27,883 35,846 47,125 Fee and commission income Trading income Insurance income (& premiums) Other income 2,429 2,785 4,170 5,354 Total non-interest income 2,429 2,785 4,170 5,354 Total income 24,582 30,668 40,017 52,478 Personal expense 3,408 Other expenses 8,103 13,854 17,642 21,945 Total expenses 11,511 13,854 17,642 21,945 Pre-provision profit 13,071 16,813 22,375 30,533 Loan loss provisions 2,578 2,976 4,826 5,470 Operating profit 10,492 13,837 17,549 25,063 Associates/JV Other non-operating inc./(exp.) ,022 Pre-tax profit 10,912 14,442 18,350 26,085 Taxes 3,722 4,913 6,240 8,870 Net profit before minorities 7,190 9,529 12,111 17,215 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 7,190 9,529 12,111 17,215 Analyst adjustments Net profit (Credit Suisse) 7,190 9,529 12,111 17,215 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 233, , , ,060 Risk provisions Net customer loans 233, , , ,060 Interbank Loans Investment & Securities Cash & cash equivalents 7,768 10,650 15,953 13,013 Fixed Assets Intangibles Other assets 4,429 6,246 8,221 10,407 Total assets 246, , , ,480 Liabilities Interbank deposits Customer deposits Total deposits Other liabilities 206, , , ,308 Total liabilities 206, , , ,308 Shareholders' equity 39,909 48,390 66,289 82,172 Minority interests Preferred stock Total liabilities & equity 246, , , ,480 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth NIM (%) Credit costs (before reversal Credit costs of provisions) (after reversal of Asset provisions) yields Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rs) BVPS (Rs) ,281 1,588 Tangible BVPS (Rs) ,281 1,588 DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates. 12MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 69

70 Diversified consumer and small business loan book Bajaj Finance has a well-diversified loan book with a mix of consumer lending and small business (self-employed) lending segments. Other than the two-wheeler/three-wheeler business (where the company acts as captive financier for the group company, Bajaj Auto), in all segments the company focuses on affluent customers. Figure 145: Bajaj Finance's US$4.7 bn loan book split Construction equip. finance 1% Home Loans 9% SME cross sell 4% Loan against securities 4% Infrastructure lending 2% Commercial lending Small business lending Auto vendor financing 4% Consumer lending 2W & 3W finance 12% Consumer durable finance 12% Lifestyle finance 1% Personal loans 12% Loan against property 28% Source: Company data, Credit Suisse research Home loans 2% Business loans 9% Figure 146: Customer profile across segments Segment AUM Customer profile Ticket size Realised (%) tenure % Rs Months IRR (back book) Loan against property 28% Affluent small business owners 22,500, % Consumer durable finance 12% Mass Affluent 28, % 2W & 3W finance 12% Mass 45, % Personal loans 12% Mass Affluent 500, % Home loans 11% 15% salaried customers, 85% self employed 7,500, % Business loans 9% Small business owners. Unsecured loans 1,800, % Loan against securities 4% Affluent 15,000, % SME cross sell 4% Affluent small business owners 5,500, % Commercial lending 3% Auto component vendors 200,000, % Lifestyle finance 1% Mass Affluent. Furniture and high end smartphone buyers 35, % Rural lending 0% Rural affluent self-employed customers 36, % Infrastructure lending 2% This business is being run down - Construction equip. finance 1% This business is being run down - Leading position in multiple segments In spite of having a well-diversified loan book, Bajaj Finance occupies a market leading position in many of its segments of operation. It is amongst the largest financiers in consumer durables, two-wheelers and unsecured personal loans. It is also amongst the largest NBFCs lending to small businesses in India. India Financials Sector 70

71 Figure 147: Bajaj Finance has amongst the largest loan books towards small businesses amongst NBFCs 160,000 Size of self employed book (Rs mn) 140, , ,000 80,000 60,000 40,000 20,000 - Indiabulls Bajaj Reliance Cap SCUF Religare Capital First LIC Housing Figure 148: Bajaj Finance is the dominant consumer durables financier with more than 15% market share Indian consumer durables financing market (loan book Rs bn) FY11 FY12 FY13 FY14 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Indian banking sector Bajaj Finance Bajaj market share (RHS) Source: Company data, Credit Suisse research Figure 149: Bajaj has the largest unsecured personal loan portfolio amongst NBFCs, and large enough to be comparable to leading private banks (FY14) HDFC Bank Unsecured personal loan book (Rs bn) Axis Bank ICICI Bank Kotak Bajaj Finance BoI Union Bank Source: RBI, CCI, Company data, Credit Suisse estimates Figure 150: Bajaj is also amongst the largest two-wheeler financiers in the country. However, note that Bajaj is the only captive financier in this chart below (FY14) Two-wheeler loan book size (Rs bn) Bajaj Finance HDFC Bank SCUF IndusInd Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Largest NBFC in terms of disbursements, but quick repayment cycle keeps overall AUM small Bajaj Finance disbursed over Rs220 bn in loans in FY14 placing it amongst the larger originators of retail loans amongst Indian NBFCs. The only reason this does not translate into a higher loan book is because of rapid run-down due to the short tenures. Figure 151: Bajaj Finance is amongst the largest NBFCs in terms of disbursements ,000 FY14 retail disbursements (Rs mn) 300, , , , ,000 50,000 - SHTF LICHF Bajaj finance MMFS SCUF Indiabulls Source: Company data, Credit Suisse research Figure 152: but this does not translate into a large AUM because of short loan tenures 1,000 FY14 AUM (Rs bn) LICHF SHTF Indiabulls MMFS Bajaj finance SCUF Source: Company data, Credit Suisse research India Financials Sector 71

72 Widespread customer touchpoints With over 13,500 customer touchpoints across the country, Bajaj Finance has amongst the largest physical touchpoints in the financial space. Figure 153: Bajaj Finance has large number of customer touchpoints across businesses Segment Customer touchpoints Consumer Electronics 6,000 Lifestyle Finance 2,000 2W - Dealer / ASCs 2,800 SME 1,300 Rural Consumer Durable 1,500 Total 13,600 Source: Company data, Credit Suisse research It is thus not surprising that in FY14 alone, the company acquired 3.4mn clients across its businesses. This is more than the number of customers that other leading NBFCs have serviced in their lifetimes! Figure 154: Number of customers serviced (mn) Bajaj (FY14 customer acquisitions) MMFS (current live customers) Magma (cumulative customers serviced) SHTF (current live customers) Source: Company data, Credit Suisse research Consumer lending: Focus on quick turnaround is the differentiator Bajaj Finance is easily the largest consumer durables financier in the country, and is amongst the largest two-wheeler and personal loans lender as seen above. The company is also creating a new market in lifestyle goods financing (high-end watches, furniture, digital products, etc). We believe one of the key strengths that Bajaj has built over time is a quick turnaround time unmatched by most other retail financiers. Thus, other than purchases on credit cards of banks, there are very few other competitors that Bajaj sees in the consumer durables business. A number of factors help Bajaj in maintaining leading turnaround times: Ready database of over 6mn + customers who have transacted with Bajaj in the past. Note that 50%+ of Bajaj Finance's disbursements in the consumer businesses are to repeat customers. Innovative Existing Member Identification (EMI) cards that act as quick verification tools. Customers with EMI cards can just present their cards at the stores; the agent at the store uses the card to retrieve all information about the customer (including behaviour on past loans from Bajaj). India Financials Sector 72

73 Figure 155: Bajaj Finance's EMI card Source: Credit Suisse Subvention agreements with manufacturers: With long standing relationships with key consumer durable manufacturers, Bajaj gets interest subvention from the manufacturers, and passes on these costs to customers. Thus, the 'zero interest' schemes of Bajaj Finance appear quite competitive in the market place as against other financing options for the customer (including bank credit cards). The manufacturers see the subvention as a cost of promotions in return for higher volumes of sales. Figure 156: Bajaj offers attractive payment terms at a Mumbai electronics retail store Source: Credit Suisse Importantly, we note that Bajaj Finance is clearly moving up the value chain in terms of the goods being financed. This is seen in the steady increase in average ticket size of loans for the company in the consumer durables segment (in spite of prevalent pricing deflation in many of the products such as electronics). India Financials Sector 73

74 Figure 157: Bajaj Finance has been moving up the value chain in consumer durables financing 33,000 Bajaj Finance consumer durable loan ticket sizes (Rs) 31,000 29,000 27,000 25,000 23,000 21,000 19,000 17,000 15,000 FY12 FY13 FY14 1H FY15 According to our discussion, Bajaj Finance's management explained that the company is focusing on only mid-to-higher end retail stores in order to tap into the right quality of footfalls. Aggressive accounting on subventions We believe it is important to highlight one aspect of aggressive accounting by the company in the consumer durables segment. Bajaj Finance recognises subvention from manufacturers fully as income at the time of disbursement which sort of acts as upfronting of interest income. In our discussions, we understand from the company that it usually gets ~8% subvention from the manufacturers. Given the short tenures of consumer durable loans, the overall overstatement of the NII/PBT due to this upfronting of interest income works out to 2%/5% respectively. Management speaks: Devang Mody, Head of Consumer Loans, Bajaj Finance Consumer durables Bajaj approaches this business as a source for acquiring new customers (the standalone profitability is not great, but this is a good scouting ground for prospective customers for other segments). In fact, 80%+ of the internal profits for this business come from cross-selling other products. The business is challenging because of low-ticket/high volume operations and that is the competitive moat for Bajaj. Opex is the biggest cost item (bigger than interest cost). Bajaj also has an average three minute turnaround time for this business. Thanks to this business, Bajaj claims to be the largest user of credit bureaus in the country. Most of the in-store staff are outsourced (on an entity housed in parent company), with their pay largely variable and linked to sales. In many stores, Bajaj staff actively sell products alongside the store sales people. The proposition to OEMs is that giving subventions to Bajaj and selling through Bajaj is a better/more effective form of advertising/promotion than actual ad spends. Personal loans Since the personal loans are primarily given to existing customers, the cost of acquisition is lower. Also, Bajaj's internal customer loss rates are 40-70% lower than open market loss rates. Hence the profitability in the personal loan segment is fairly high for Bajaj India Financials Sector 74

75 Small business lending: Pioneer with leading position Bajaj Finance is one of the earliest NBFC entrants into the self-employed lending space having started in Today, it is one of the leading financiers to self-employed borrowers across multiple segments. Figure 158: Bajaj Finance has amongst the largest loan books amongst NBFCs towards self-employed customers 160, ,000 Size of self employed book (Rs mn) 120, ,000 80,000 60,000 40,000 20,000 - Indiabulls Bajaj Reliance Cap SCUF Religare Capital First LIC Housing Source: Company data, Credit Suisse research Bajaj Finance is a sizeable player in the LAP segment, as well as in the loans against securities segment. Figure 159: Key players in LAP 140,000 LAP Book (Rs mn) 120, ,000 80,000 Figure 160: Kay players in loans against shares 25,000 LAS book (Rs mn) 20,000 15,000 60,000 40,000 20,000 10,000 5, Religare IIFL Bajaj Fin Source: Company data, Credit Suisse research Heavy thrust on cross-selling Source: Company data, Credit Suisse research One of the unique features of Bajaj Finance's business model is the thrust towards leveraging existing customer relationships to grow business. Bajaj tries to cross-sell other products to its existing customers across segments with a focus that is seldom seen in other companies (not just financial companies). In fact, many products have been launched/designed in such a way that they focus primarily on mining existing customer relationships: Moreover, the company sees one of its largest segments consumer durables as a source of acquiring new customers and upselling other loan products to them after a fair amount of seasoning. India Financials Sector 75

76 Figure 161: Many of Bajaj Finance's products are designed keeping cross-selling in mind Product name Description Personal loans SME cross-sell Credit ratings Lifestyle finance Existing Membership Card Consumer durables customers with 6+ months track record and good credit bureau score are approached for unsecured personal loans. Currently 6% of consumer durables customer database has been penetrated with personal loans Self-employed customer who start as LAP customers, after good track record of six months, are approached for other loans for their business requirements Bajaj Finance approaches small business owners in their data base with CRISIL ratings service. This is a fee income stream for Bajaj where it acts as a distributor for CRISIL Consumer durable customers who also intend to buy high-end furniture, watches, digital products etc. This is not a revenue generating product, but one that is designed help Bajaj cross-sell services easily. The EMI card acts as a quick verification tool to quickly pull-out details of existing customers so that new loans can be processed in minutes without hassles of another round of documentation. Currently, nearly 40% of the company's loan disbursements in a year are towards repeat customers (i.e., customers who already have an existing or past relationship with the company). Figure 162: Nearly 42% of Bajaj's loan disbursements in a year go to repeat customers 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Share of disbursement between repeat and new customers Consumer Lending Small business lending Overall company Repeat customer % New customer % helps keep credit costs low Bajaj Finance has amongst the lowest NPA levels and credit costs of retail focused NBFCs. Figure 163: Bajaj Finance has low NPA levels 7.0% Gross NPA - Sep-14 (%) 6.0% Figure 164: and enjoys lower credit costs versus peers 3.0% Credit Cost - FY14 (%) 2.5% 5.0% 2.0% 4.0% 1.5% 3.0% 2.0% 1.0% 0.0% LICHF IndiabullsBajaj finance Chola SCUF SHTF MMFS 1.0% 0.5% 0.0% Sundaram Finance Bajaj Finance Magma Chola MMFS SHTF SCUF We believe the low credit costs at Bajaj Finance stem out of two important factors: Repeat customer focus: As a large portion of Bajaj Finance's business is with tried and tested customers, the delinquency levels tend to be lower. India Financials Sector 76

77 Biz. Loan LAP LAS SME Cons. Durable Home loans PL Lifestyle Rural Infra Commercial CE 2W/3W 13 January 2015 Shorter tenure loan book: With multiple short tenure loan segments, the overall loan book of Bajaj Finance has a realised tenure of just 11 months. We believe this helps to keep credit costs low for the company. Share of less-risky businesses should grow As part of a strategy to reduce the 'beta' in the business (in the words of management), Bajaj Finance is trying to grow the less-risky businesses such as LAP and home loans faster. This is already visible, as these lower-yielding, stickier (i.e., longer tenure) loan segments are growing in share within Bajaj's loan book. Figure 165: Growing share of lower-yielding, more sticky loan segments could lead to a decline in NIMs for Bajaj Finance going forward (100) (200) (300) 30% 25% 20% 15% 10% 5% 0% Change in AUM share (bps, Sep-14 over Sep-13) Avg yields This should lead to fall in yields and credit costs We expect this shift in portfolio for Bajaj to lead to a decline in yields for Bajaj Finance going forward. At the same time, this could lead to a fall in credit costs as less risky assets grow their share in the loan book. However, Bajaj Finance also has a fairly large funding exposure to money market products (NCDs and CPs) thanks to the backing of the parent company. The expected fall in wholesale rates should thus help Bajaj absorb the decline in yields due to mix leading to stable NIM. Figure 166: Funding mix for Bajaj Finance should benefit from falling wholesale rates (Sep-2014) Banks 53% NCDs 29% Fixed Deposits 2% Tier II debt 4% CPs 12% India Financials Sector 77

78 Figure 167: We expect stable NIM and credit costs for Bajaj Finance FY12 FY13 FY14 FY15E FY16E FY17E NIM 12.1% 11.2% 10.7% 9.9% 9.6% 9.8% One factor that could help cushion the fall in NIM (and also RoE) is the growing share of off-book loans. Management expects to take off-book ratio from current 5% of AUM to 13-14% over three years primarily driven by sell downs in home loans. In our models, we have off-book ratio going up to 9% by FY17 Management speaks: Rajiv Jain, CEO, Bajaj Finance Overall business outlook Aim is to sustain 20-25% growth over the next years. However, there will be some rebalancing of the portfolio (consumer:sme:commercial going from 40:53:7 to 35:45:20 over the next few years). LAP/SME Bajaj continues to focus on LAP even though the returns here are lower than the company's traditional consumer businesses, due to the stability that comes with this business. Bajaj is a top-4 player in the LAP market, and the management believes the market is currently in consolidation mode. However, the opportunity in the SME/LAP space remains large, and probably not even captured properly in data. Overall, the real estate stock in India is under-leveraged, feels management. Bajaj Finance sees rural India as a big opportunity. The company intends to launch SME lending in rural segment from next year, and also expand geographically from Maharashtra to Gujarat and Karnataka states. Two-wheeler business Management believes that captive financing is the most sustainable and profitable mode of auto financing globally. Bajaj Finance own close integration with Bajaj Auto makes this a profitable business for the company. Cross-sell focus On a 24 month lag basis, Bajaj has sold 2.7 products per customer in consumer segment, and 3.3 in SME segment. Management feels these numbers can go up to 5x/15x respectively (being the cross sell ratios of global peers like Wells Fargo). Out of 3.5mn consumer durable customers, 90% have an EMI card, 50% buy another consumer durable in the same year, 11% buy insurance through Bajaj and 6% take a personal loan. 90 DPD NPA transition Bajaj Finance is comfortable positioned on NPA, with 90% provision coverage ratio on 180 DPD. The high coverage gives room to cushion the impact from 90 DPD transition (by reducing coverage). India Financials Sector 78

79 Conservative provisioning should help cushion 90DPD transition Overall, we note that due to accelerated provisioning in recent years (with an eye on the expected transition to 90DPD NPA recognition), Bajaj Finance's provision coverage ratio is the highest amongst retail NBFC peers. Further, the company with 45 bp standard asset provisioning and is already well above RBI's Mar-18 target of 40 bp. Figure 168: Bajaj has the highest provisioning levels among peer group of retail NBFCs 100% Coverage Ratio (%) 80% 60% Figure 169: and also already at 45 bp standard asset provisioning 0.50% Std asset provision (%) 0.45% 0.40% 0.35% 40% 0.30% 20% 0.25% 0% Bajaj STFC SCUF MMFS Magma L&T Fin 0.20% SCUF L&T Fin SHTF Magma Sundaram MMFS Bajaj Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research We believe this high provisioning can help cushion the impact of a transition to 90DPD for the company. Figure 170: We expect underlying asset quality to remain stable. Current high provision coverage will provide cushion for 90DPD transition Figure 171: Falling coverage can lead to stable credit costs 2.0% 1.5% 1.0% 0.5% 0.0% FY13 FY14 FY15 FY16 FY17 85% 80% 75% 70% 65% 60% 55% 50% 45% 40% 1.20% 1.10% 1.00% 0.90% 0.80% 0.70% 0.60% Credit costs Provision coverage (RHS) GNPA (underlying on 180 DPD) 0.50% GNPA (new regulations) 0.40% FY13 FY14 FY15 FY16 FY17 Thus, we believe the impact from the 90 DPD NPA recognition transition should be easily absorbed by Bajaj Finance. Opex leverage should continue Given Bajaj's smaller size and characteristics of business model (i.e., shorter tenure loans), the company sees a higher level of opex compared to other retail NBFCs. India Financials Sector 79

80 Figure 172: Bajaj's scale and business model result in higher opex 6.0% Opex / Avg AUM (%) 5.0% 4.0% 3.0% 2.0% 1.0% Figure 173: even on cost to Income metric 70.0% Cost to Income (%) 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% SHTF MMFS Magma SCUF Bajaj 0.0% SHTF MMFS SCUF Bajaj Magma Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research However, given the expected fast growth in Bajaj Finance's size (30% loan book CAGR in three years) and the growing share of longer tenure loans (like LAP and home loans), we believe the opex ratios should continue to decline for the company. Figure 174: Expect opex leverage in coming years 7.0% 6.5% Opex/Avg AUM (%) Cost to Income (%) (RHS) 48% 47% 46% 6.0% 45% 5.5% 44% 43% 5.0% 42% 4.5% 41% 40% 4.0% FY12 FY13 FY14 FY15E FY16E FY17E 39% Leading to sustained 20%+ RoE We expect the RoA to remain stable at ~3.4% with downward pressure from lower yielding loan segments to be offset by lower credit costs, better operating leverage and higher off-book ratio. While we expect leverage to stay at ~6.3x levels, greater off-book ratio could help improve leverage and RoE further. India Financials Sector 80

81 Figure 175: Bajaj Finance Dupont tree FY12 FY13 FY14 FY15E FY16E FY17E Interest income / total assets 19.3% 19.1% 18.2% 18.0% 17.5% 17.4% Interest expense / total assets 7.2% 7.9% 7.6% 8.1% 8.0% 7.6% NII / total assets 12.1% 11.2% 10.7% 9.9% 9.6% 9.8% Fee income / total assets 1.6% 1.1% 1.2% 1.0% 1.1% 1.1% Other income / total assets 0.1% 0.1% 0.2% 0.2% 0.2% 0.2% Opex / total assets 6.5% 5.6% 5.5% 4.9% 4.7% 4.6% Credit cost / total assets 1.5% 1.2% 1.2% 1.1% 1.3% 1.1% Pretax profit / total assets 5.8% 5.7% 5.2% 5.1% 4.9% 5.4% Taxes / total assets 1.9% 1.8% 1.8% 1.7% 1.7% 1.8% ROA 3.9% 3.9% 3.5% 3.4% 3.2% 3.6% Avg leverage RoE 24.0% 21.9% 19.5% 21.6% 21.1% 23.2% Capital raising likely in 12 months Given the projected growth rates and RoE trajectory for the company, we believe the Tier 1 ratio for Bajaj Finance will fall below 14.5% some time in early FY3/16 at which point we expect the company to raise capital. Figure 176: Expect Bajaj Finance to raise capital in FY16 20% 19% Tier-I Ratio (%) 18% 17% 16% 15% 14% 13% 12% 11% 10% FY12 FY13 FY14 FY15E FY16E FY17E Initiate with an OUTPERFORM rating Bajaj Finance has a short trading history, of less than four years. Thus, current valuations after the recent financials rally are significantly above historical levels for the company. However, given its ROE and growth profile, we believe the company is reasonably valued versus peers. India Financials Sector 81

82 Figure 177: Bajaj Finance is trading above its valuation range of short-listed history (1yr fwd P/E) mth fwd PE Mean Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Figure 178: Bajaj Finance is trading above its valuation range of short-listed history (1yr fwd P/B) mth fwd PB Mean Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Source: IBES, Credit Suisse estimates Source: IBES, Credit Suisse estimates We value Bajaj Finance at 14x P/E multiple, applied on our 24-month forward EPS of Rs311, leading to 12-month forward target price of Rs4,350. We initiate coverage on Bajaj Finance with an OUTPERFORM rating. Figure 179: Bajaj Finance Reasonably priced for strong earnings growth P/B RoE P/E EPS growth 2yr CAGR Stock FY15 FY16 FY15 FY16 FY15 FY16 FY15 FY16 FY17 (FY16-17) Bajaj Finance % 21.1% % 22.2% 42.1% 32.2% CS NBFC Universe Avg % 20.5% % 30.8% 27.5% 29.1% Key risks Sharp rise in competition in loans against property and small business lending segments Bajaj Finance is one of the earliest NBFC entrants into the self-employed lending space having started in Today, it is one of the leading financiers to selfemployed borrowers across multiple segments. In last 3-4 years, competition has entered into the small business lending segment and has pushed yields downwards. Incremental competition in these segments can impact Bajaj's profitability Drop in asset quality arising from risks to economic growth Bajaj Finance has amongst the lowest NPA levels and credit costs of retail focused NBFCs. If the economy does not grow at a desired pace, this could have an impact on the asset quality for Bajaj Finance. India Financials Sector 82

83 Asia Pacific / India Indiabulls Housing Finance Ltd Rating OUTPERFORM* Price (12 Jan 15, Rs) Target price (Rs) ¹ Upside/downside (%) 26.5 Mkt cap (Rs mn) 176,966 (US$ 2,847 mn) Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 7.2 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Share price performance Price (LHS) Research Analysts Sunil Tirumalai [email protected] Kush Shah [email protected] Chunky Shah [email protected] Rebased Rel (RHS) 0 Jul-13 Nov-13 Mar-14 Jul-14 Nov The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) (INBF.BO / IHFL IN) INITIATION Breaking into the top league We initiate coverage on Indiabulls with an OUTPERFORM rating and Rs630 target price (27% upside). Mortgage and real estate specialist. Indiabulls has a US$5.8 bn loan book covering individual home loans, loans against property (to small businessmen) and real estate loans (underconstruction projects and lease rental discounting). The company's differentiator is in its expertise in the self-employed segment (37% of loan book) which many banks consider risky. Ratings upgrade to help cushion rising competition. While the mortgage sector in general is attracting the attention of banks, we believe the risks to margins are fairly low due to most leading banks already lending close to the base rate on home loans. However, this is not true of the LAP segment where the cost structures are believed to be similar to mortgages but yields are at least 250 bp higher. Indiabulls is vulnerable here (LAP accounts for 31% of NII, in our view). However, the recent ratings upgrade awarded to the company (with two agencies rating it AAA) could help the company cushion the margin pressure through lower funding costs. Further, the rating upgrade could help the company become more competitive against other leading HFCs such as HDFC and LICHF. Expect sector-leading ROEs to expand. Indiabulls is already among the most profitable mortgage players with an RoE of ~25%. Continued strong growth (18%+ three-year CAGR) over current low leverage levels (15% Tier 1) should help the company deliver improvements to RoE to ~28% by FY17E (note that the RoE mentioned here is adjusted lower for the premium on redemption of zero coupon bonds that it charges to reserves). High dividend yield. At 6%, Indiabulls stock offers one of the highest dividend yields in the Indian market (let alone the financial sector). We find valuations quite undemanding at 8.6x/2.3x FY16 adjusted P/E / P/B, for its superior ROE and growth profile. Key risks to our TP: (1) Sharp rise in competitive pressures in LAP segment, (2) slowdown in the housing market. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 19, , , ,141.4 Pre -tax profit (Rs mn) 19, , , ,141.4 Net attributable profit (Rs mn) 15, , , ,270.0 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 83

84 Indiabulls Housing Finance Ltd INBF.BO / IHFL IN Price (12 Jan 15): Rs497.85, Rating: OUTPERFORM, Target Price: Rs630.00, Analyst: Sunil Tirumalai Target price scenario Scenario TP %Up/Dwn Assumptions Upside Central Case Downside Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 53,144 58,089 68,504 80,455 Interest expense 32,824 38,361 44,438 52,001 Net interest income 20,320 19,728 24,066 28,453 Fee and commission income Trading income Insurance income (& premiums) Other income 3,061 8,226 9,036 10,694 Total non-interest income 3,408 3,009 3,879 4,591 Total income 23,728 22,737 27,945 33,044 Personal expense 2,637 Other expenses 1,470 5,830 7,027 8,006 Total expenses 4,107 5,830 7,027 8,006 Pre-provision profit 19,274 22,124 26,075 31,141 Loan loss provisions Operating profit 19,274 22,124 26,075 31,141 Associates/JV Other non-operating inc./(exp.) Pre-tax profit 19,274 22,124 26,075 31,141 Taxes 4,133 4,610 5,381 6,871 Net profit before minorities 15,142 17,514 20,694 24,270 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 15,185 17,514 20,694 24,270 Analyst adjustments Net profit (Credit Suisse) 15,185 17,514 20,694 24,270 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 355, , , ,507 Risk provisions 5,016 6,579 7,919 9,309 Net customer loans 350, , , ,197 Interbank Loans Investment & Securities Cash & cash equivalents 73,414 88, , ,723 Fixed Assets Intangibles 6.5 Other assets 14,970 17,634 20,790 24,687 Total assets 439, , , ,607 Liabilities Interbank deposits Customer deposits Total deposits Other liabilities 382, , , ,487 Total liabilities 382, , , ,487 Shareholders' equity 57,070 66,113 76,356 86,101 Minority interests Preferred stock Total liabilities & equity 439, , , ,607 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth NIM (%) Credit costs (before reversal Credit costs of provisions) (after reversal of Asset provisions) yields Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense (1.5) Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates MF P/E multiple 0 Jan-14 May-14 Aug-14 Dec Jan-14 May-14 Aug-14 Dec-14 Source: IBES 12MF P/B multiple India Financials Sector 84

85 Housing and real estate financier Indiabulls Housing Finance has a loan book of US$5.8 bn and specialises in lending to the home loan and real estate segment. In the retail businesses (home loans and LAP), the company focuses on the affluent segment, as Figure 146 shows. Figure 180: Indiabulls loan book breakdown (Sep-2014) CV 5% Large loans 21% Breakdown of $5.8bn loan book Home loans 48% LAP 26% Figure 181: Indiabulls: Profile of various businesses Segment Share of Customer profile Ticket size Contracte Realised IRR (back loan book d tenure tenure book) (FY14) % months months % Home Loans Loan against property Commercial Credit Commercial Vehicles 48.4% Affluent customers, who buy homes of Rs3.5mn+ in value for their own usage. 80% salaried customers + 20% selfemployed customers Rs2.4 mn (Avg. LTV 70% on origination) % Owners of small and mid-sized businesses. Having selfoccupied Rs6.8 mn residential property of value Rs10mn+ (Avg. LTV 49%) 21.0% Top real estate developers. Construction finance (5- Rs 3bn %) is only for residential buildings. Lease rental discounting (15%) on operational commercial projects 5.0% Large fleet owners. This business is being run down with no incremental disbursements happening Figure 182: Indiabulls is the sixth-largest housing financier in India 2,500,000 Housing loans - 2Q15 (Rs mn) 2,000,000 1,500,000 1,000, ,000 - Figure 183: Indiabulls also has the third-largest LAP book in the country 140 LAP book (Rs India Financials Sector 85

86 Strong balance sheet: Recent rating upgrade Indiabulls is among the least-leveraged housing finance companies. Figure 184: Indiabulls has the highest capitalisation among HFCs Figure 185: and the lowest leverage level 30.0% FY14 - Tier I (%) 14.0 FY14 - Leverage (x) 25.0% % % % % % Repco Indiabulls Gruh LIC Housing HDFC Dewan - LIC Housing Dewan Gruh HDFC Indiabulls Repco Indiabulls also consistently retains high liquidity on its balance sheet. Figure 186: Indiabulls retains high liquidity vs peers 18% % of cash and liquid investments 16% 14% 12% 10% 8% 6% 4% 2% 0% Indiabulls HDFC LIC Housing Dewan Gruh Repco Figure 187: Indiabulls has retained high level of liquidity over time 20% % of cash and liquid investments 18% 16% 14% 12% 10% FY11 FY12 FY13 FY14 Given its strong balance sheet, Indiabulls recently enjoyed a rating upgrade by major credit rating agencies. Figure 188: Recent changes to Indiabulls' credit ratings Old rating Revised rating Date of rating change CRISIL AA AA+ 1-Aug-14 ICRA AA AA+ 25-Jun-14 CARE AA+ AAA 22-Aug-14 Brickworks AA+ AAA 7-Aug-14 Source: Company data India Financials Sector 86

87 Figure 189: Indiabulls is among the top private sector NBFCs in terms of credit rating CRISIL CARE HDFC AAA AAA LIC Housing AAA AAA Indiabulls AA+ AAA MMFS AA+ AA+ Bajaj Finance AA+ NA Shriram Transport AA AA+ Magma N/A AA+ Dewan N/A AA+ Gruh N/A AA+ Source: Company data Home loan: Affluent customer focus In the home loan segment, Indiabulls focuses on the higher end segment with probably the highest concentration of affluent/rich among specialised housing finance companies: Figure 190: Indiabulls operates in the affluent home loan segment Avg. ticket size of home loans (Rs mn) Indiabulls HDFC LICHF Dewan Housing MMFS housing We see two important consequences of this focus on the higher end segment, one positive and the other negative: Fewer customers = better branch productivity In our estimate, Indiabulls' US$2.8 bn home loan book has only ~130,000 live customer accounts (in contrast to ~1 mn customers that we believe account for LICHF's individual home loan book). We thus believe that each branch/employee of Indiabulls can be more productive from an assets under management (AUM) perspective. High prepayment rate Being in the more affluent segment, Indiabulls also faces much quicker/more frequent prepayments of its home loans. We believe that Indiabulls home loans on average have a duration of a little more than four years (50 months) versus the six plus years of other financiers. As a result, Indiabulls' home loan book growth is more volatile and sensitive to disbursement growth rates compared to other HFCs. India Financials Sector 87

88 Better spreads than LICHF on home loans On a consolidated basis, Indiabulls makes net interest margins (NIM) similar to HDFC and better than LICHF. In our analysis, even the standalone home loans business of Indiabulls makes better NIMs than LICHF. Figure 191: Indiabulls makes better spreads than LICHF on home loans Indiabulls LICHF HDFC Indiabulls Home loan Yield 12.5% 10.9% 11.4% 11.3% Cost of borrowing 10.3% 9.6% 9.1% 9.8% Spread 2.3% 1.2% 2.3% 1.5% Note: Indiabulls' borrowing costs include the notional interest on zero coupon bonds charged to the balance sheet directly by the company. Figure 192: Indiabulls' home loan NIMs are superior to LICHF's As a % of loan assets Indiabulls LICHF HDFC Indiabulls Home loan Interest income 12.5% 10.8% 11.4% 11.3% Interest expense 8.9% 8.5% 7.9% 8.5% NII 3.6% 2.3% 3.5% 2.8% Fee income 0.5% 0.2% 0.3% Other income 2.2% 0.2% 0.0% Opex 1.0% 0.4% 0.3% Credit cost 0.9% 0.0% 0.0% Pre-tax profit 4.4% 2.2% 3.4% Taxes 1.1% 0.6% 0.9% RoA 3.3% 1.6% 2.5% Avg. leverage RoE 24.5% 18.8% 19.0% Note: Indiabulls' borrowing costs include the notional interest on zero coupon bonds charged to the balance sheet directly by the company. We believe that the superior spreads of Indiabulls' home loans business is because of the following factors: Focus on higher yielding segment: As can be seen from the table above, Indiabulls operates in higher yielding loan segments versus LICHF. In particular, LICHF's focus on the "safe" government employee segment versus Indiabulls' focus on the private sector could be a reason for the difference. Higher sell down ratio keeps funding costs low: Indiabulls' book borrowing costs are 40-50bp higher than for LICHF. However, the blended funding costs for Indiabulls are similar to those of LICHF due to the active sell-down of loans by Indiabulls. Indiabulls actively sells down its home loans (primarily through the Pass through certificate (PTC) route) while LICHF does not. The benefit here is not so much on leverage, but on access to cheaper funds than would have otherwise been possible for Indiabulls on its own balance sheet. Currently, ~14% of Indiabulls' consolidated loan book is sold down. Given the sell-down mostly happens in the home loans and LAP segment only, we believe that nearly 20% of home loans are off-book for Indiabulls on which the company makes a spread of bp (against ~130bp spread on onbook loans) Reliance on short term funds: A study of Indiabulls' borrowing profile shows a higher reliance on shorter term funds compared to LICHF which could help in borrowing costs. Note that the following charts are based on consolidated borrowing numbers. India Financials Sector 88

89 Figure 193: Indiabulls shows a higher reliance on shorter term money... Current maturirty of long term debt 15% Short term borrowings 22% Temporary overdrafts 3% Long term borrowings 48% Figure 194: compared to LICHF Current maturirty of long term debt 13% Short term borrowings 4% Off-book funding 0% Temporary overdrafts 2% Off-book funding 12% LAP: Among the pioneers in loans to the 'risky' selfemployed segment Indiabulls is one of first NBFCs to build a business around lending to self-employed customers (back in 2005 along with Citi). Today, Indiabulls has among the largest loan books towards self-employed individuals/small and medium businesses. Nearly three quarters of these loans for Indiabulls are in the LAP category (the rest being home loans). Traditionally, banks have stayed away from this segment: the cash flows of the customer are more volatile than for a salaried customer, and in many cases the reported profitability could be quite different from the true profitability of the business Figure 195: Indiabulls has one of the largest loan books to self-employed borrowers among NBFCs 160, , ,000 Size of self employed book (Rs mn) Long term borrowings 81% 100,000 80,000 60,000 40,000 20,000 - Indiabulls Reliance Cap SCUF Bajaj Religare Capital First LIC Housing We believe that a significant differentiator for Indiabulls in the individual loan business is the specialisation in the self-employed segment. Across home loans and LAP, selfemployed customers account for 37% of the company's total loan book. India Financials Sector 89

90 Figure 196: Indiabulls' loan book split by customer profile Real estate developers 22% Salaried individuals 41% Self employed individuals 37% Note: excludes CV segment which is being run down Indiabulls has developed significant capabilities in the self-employed category. The company has 25 Master Service Centres (MSCs) which are responsible for credit decisions on self-employed loan applications. Management explained that these centres have credit experts who use an internally developed framework for credit decisions. The framework incorporates industry benchmarks on profitability, volatility and cyclicality across multiple customer segments. Overall, management explained that the acceptance ratio for self-employed loan applications is 35% (versus 65% for salaried applications). The same MSCs take care of self-employed loan applications across home loans and LAP. Management speaks: Sachin Chaudhry, Head of mortgage/lap segment, Indiabulls Market structure In some situations, the lender to the construction company has the upper hand in disbursing retail loans to home buyers. 98% ECS penetration for EMI repayments. Does not see significant balance transfers in mortgages. Operations Approval rate for self-employed loans is 35%, while for salaried it is 65%. Rejection is largely due to CIBIL. LAP is largely self-employed. For SMEs, 60% of the funds can be tracked directly and used for paying down term loans. The balance of 40% is used for other expenses, such as office space enhancement, etc. Home loan NPAs between %, while for LAP it is %. Builder loans: Big ticket loans with top developers Indiabulls lends to the top real estate developers in the country and for projects in the premium segment, i.e., more expensive than what the typical Indiabulls' home loan customer would buy. In other words, the builder loan segment is not used to generate downstream home loan business for the company, but is quite independent. Some 75% of the business is in the form of lease rental discounting, with cash flows from the tenant (a corporate) flowing directly to Indiabulls. India Financials Sector 90

91 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep January 2015 The loans are chunky in size at ~Rs3 bn ticket size, reasonably large given the size of the company each loan on an average is 0.7-1% of consolidated loan book and ~5% of net worth. One of the large well known loan accounts Palais Royale project in Worli Mumbai is ~Rs6 bn in exposure (~10% of net worth) is facing legal issues. Guidance of 20-25% loan growth requires sharp uptick in disbursements Loan growth has been slowing with flat disbursements and high rate of run down Indiabulls disbursements have stayed largely flat for the last few years. This coupled with high re-/pre-payment rate has ensured a sharp slowdown in loan growth rates. Figure 197: Disbursements have come down annually 160, , , , , , ,000 Disbursement (Rs mn) FY12 FY13 FY14 Guidance of 20-25% loan growth Figure 198: leading to drop in AUM growth 500, , , , , , , , ,000 50,000 - AUM (Rs mn) AUM growth (%) Indiabulls management guides to 20-25% loan growth for the next few years. In our analysis, for the company to end FY15 on 20% loan growth, disbursements should pick up 35%+ YoY for the rest of the year. Management explains that with growth being expected to be faster in the home loan segment and slow in the builder loans segment, the rate of loan book run down could slow thus helping achieve the 20% growth figure on smaller disbursement numbers than what our analysis above shows. In our projections, we model loan growth rising to 18% for FY15, and to 20% by FY17. Rising competition could impact profitability where it matters the most There is no doubt that competition in the mortgage and LAP segments is rising especially as banks are facing slow credit off-take in corporate segment and the mortgage segment has historically been the best performing on asset quality. However, we believe that the impact on HFCs could be marginal, given that home loan yields are already low (and close to bank base rates in many cases). However, the situation in LAP is different, with many NBFCs operating at high yields despite low LTVs. 70% 60% 50% 40% 30% 20% 10% 0% India Financials Sector 91

92 Figure 199: LAP loan yields and LTVs across NBFCs Yields Reliance Capital 16% 70% Bajaj Fin 17-19% 50% SCUF 19-20% 75% Religare 15-16% 50% Indiabulls 13-14% 50% Capital First 13-14% 60% Herein lies the risk for Indiabulls. While the LAP business contributes only 22% to overall AUM (including liquidity), the business is the largest contributor to NII/profits for Indiabulls, as can be seen below. The high yields in this segment, along with aggressive sell down (22% of loan book) at high spreads means the NIM in this segment for Indiabulls is in excess of 600 bp. Figure 200: AUM breakdown CV 4% Home loans 41% LTV Figure 201: NII breakdown Cash and Cash and investments CV investments 15% 9% 5% Home loans 26% Large loans 18% Large loans 29% LAP 22% LAP 31% Figure 202: NIM across segments for Indiabulls 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Home loans LAP Large loans CV Cash and investments Indiabulls NIM breakdown across segments Blended Expect competition to take away most of the cost benefits of rating upgrade According to our discussions with management, we understand that the company has started seeing funding cost benefit of 30 bp in the bond market ever since the rating upgrades took place (bonds account for 32% of funding currently). Further 20 bp cost benefit is expected over the next six months. With rising share of bonds, this could lead to bp improvement in funding costs for the company in the near term. In our view, much of this funding cost benefit could get taken away by pricing pressure in the LAP segment (which is the largest contributor to NII as we have seen above). Overall, we expect NIM (including cash and investments) to stay flat going forward. India Financials Sector 92

93 Figure 203: Expect funding cost benefit of rating upgrade to be offset by shrinking margins in LAP to lead to flat NIM 9.0% NIM (%) 8.0% 7.0% 6.0% 5.0% FY12 FY13 FY14 FY15E FY16E FY17E Management speaks: Gagan Banga, CEO, Indiabulls Market structure LAP market is like a pyramid, as interest cost reduces, the size of the market increases significantly, with credit quality improving and opex reduces. PSU's account for 75% of loans and 85% of SME lending. The private lenders have only now begun to take share from the PSU banks. The top ten cities account for ~70% of loans. US$2.5-3 bn of disbursements are done each month by the industry on LAP. While the contracted tenure is between 7-10 years, the actual tenure would be 2-3 years. Operations While the pressure on pricing in LAP is rising, Indiabulls' recent rating upgrade should help offset any of the NIM pressures. Operating cost leverage could continue to play out Indiabulls has significant operating leverage in past years, with opex/assets falling from 3% of assets in pre-2011 to 1.1% in FY14. Even now the company's cost levels are significantly higher than other HFCs of larger size. We expect Indiabulls to continue to enjoy operating cost leverage albeit at a slower pace than in the past due to slowing growth. India Financials Sector 93

94 Figure 204: Indiabulls has higher opex intensity due to smaller scale 1.2% FY14 - Cost to AUM (%) 1.0% 0.8% 0.6% 0.4% 0.2% Figure 205: Expect slower opex gains going forward 3.5% Cost to AUM (%) Cost to Income (%) (RHS) 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 35% 30% 25% 20% 15% 10% 5% 0.0% Indiabulls LIC Housing HDFC 0.0% FY11 FY12 FY13 FY14 FY15E FY16E FY17E 0% What we don't like: Some aggressive accounting policies Bypassing P&L and direct adjustment to reserves for certain costs For zero coupon bond redemption premium and debenture issue expenses, Indiabulls takes the costs directly to reserves, thus overstating profits. As the table below shows, over the last three years, Indiabulls' profits would have been 13-20% lower than reported if the costs had been expensed as normal P&L costs (and RoE lower by upto 500 bp). Figure 206: Indiabulls adjusts a few costs to reserves which overstates profits Rs mn FY12 FY13 FY14 Reported PAT 10,786 12,584 15,642 Reported RoE 22.8% 25.0% 28.7% Zero coupon bonds (Premium on Redemption) 1,248 1,818 1,841 Debenture issue expenses Total direct adjustment to reserves [A] 1,493 2,501 2,017 [A] as % of PAT 13.8% 19.9% 12.9% Adjusted RoE 19.7% 20.0% 25.0% In all our analysis in this report (and for our target price), we include these costs as P&L costs for Indiabulls. High dividend yield and undemanding valuations Indiabulls housing has paid out an average of 50%+ of its profits as dividend in recent years and intends to continue the practice. This places Indiabulls' stock as the highest dividend earning NBFC stock. In fact, Indiabulls is amongst the top dividend earners in BSE-500. India Financials Sector 94

95 Figure 207: Highest dividend yield amongst financial stocks 7.0% FY14 - Dividend Yield (%) 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Figure 208: and among the top five within the BSE % FY14 - Dividend Yield (%) 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Coal India Piramal Enterprises Clariant Chemicals NMDC Indiabulls Hsg Hexaware Technologies Source: Company data, Bloomberg Source: Company data, Bloomberg At 8.6x/2.3x adj P/E/P/B, the Indiabulls stock is trading at a significant discount to peers. We believe continued strong growth, stable NIMs and returns and consistent dividend support should help the stock rerate. We initiate coverage on Indiabulls with an OUTPERFORM rating and Rs630 target price. Our TP is based on 10x forward P/E multiple applied on our 24M forward EPS of Rs63. Figure 209: Indiabulls' 12M forward P/E mth fwd PE Mean 1 + SD 1 - SD Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Source: IBES, Credit Suisse research Figure 210: Indiabulls' 12M forward P/B mth fwd PB Mean 1 + SD 1 - SD Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Source: IBES, Credit Suisse research Figure 211: Indiabulls Attractively priced for high RoE and decent growth P/B RoE P/E EPS growth 2yr CAGR Stock FY15 FY16 FY15 FY16 FY15 FY16 FY15 FY16 FY17 (FY16-17) Indiabulls Finance % 29.4% % 18.5% 20.4% 19.5% CS NBFC Universe Avg % 20.6% % 30.8% 27.0% 28.9% India Financials Sector 95

96 Risks to OUTPERFORM call Risks to our Rs630 target price include Sharp rise in competitive pressures in LAP segment, which is a key contributor to profitability at Indiabulls There is no doubt that competition in the mortgage and LAP segments is rising especially as banks are facing slow credit off-take in corporate segment and the mortgage segment has historically been the best performing on asset quality. However, we believe that the impact on HFCs could be marginal, given that home loan yields are already low (and close to bank base rates in many cases). However, the situation in LAP is different, with many NBFCs operating at high yields despite low LTVs. Herein lies the risk for Indiabulls. While the LAP business contributes only 22% to overall AUM (including liquidity), the business is the largest contributor to NII/profits for Indiabulls. The high yields in this segment, along with aggressive sell down (22% of loan book) at high spreads means the NIM in this segment for Indiabulls is in excess of 600 bp. Slowdown in housing market in India Any slowdown in the housing market in India, would lead to a slowdown in growth for Indiabulls, and could directly impact growth leading to decline in profitability Competitive forces While we expect no further increase in competitive aggression from banks, banks could sacrifice profitability and turn more aggressive on pricing. This could impact Indiabulls' market position. India Financials Sector 96

97 Asia Pacific / India SKS Microfinance Ltd. Rating NEUTRAL* [V] Price (12 Jan 15, Rs) Target price (Rs) ¹ Upside/downside (%) Mkt cap (Rs mn) 55,662.2 (US$ 895.6) Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 12.5 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). Research Analysts Sunil Tirumalai [email protected] Kush Shah [email protected] Chunky Shah [email protected] (SKSM.BO / SKSM IN) INITIATION Recovering nicely, but priced in Firmly on the path of recovery. We initiate coverage on SKS Microfinance with a NEUTRAL rating and Rs390 target price (12% downside). SKS' recent performance gives comfort that the company is firmly on the path of recovery after the 2010 Andhra Pradesh (AP) crisis. In our field visits, we came across a number of process improvements aimed at strengthening the business. Large market opportunity: We believe less than half of the potential US$35 bn market opportunity in microfinance has been tapped so far in India. A large part of the near-term growth could come riding on existing branch infrastructure, and longer-term growth could come from geographic expansion. Could upside be getting capped? SKS' operations are already at the peak levels projected by management earlier (1,000+ borrowers per officer) implying further productivity improvements could be slow. Moreover, under the current regulatory cap of 10% spread, MFIs (who run with 10% opex costs) profitability increasingly depends on being able to sell down loans aggressively, or find new/fee income revenue streams. Further, we believe the risks from the self-help group segment (larger than MFI, and mostly unregulated) is less understood by the markets. Valuation. While SKS looks richly valued at 4.3x/23x FY16E P/B/P/E respectively, we believe the strong underlying growth should support valuations. We find the stock reasonably priced and hence initiate coverage with NEUTRAL. Upside risks: (1) stronger-than-expected growth, and (2) relaxation in regulations either on ticket sizes, spreads or multiple lending. Downside risks: (1) political risks like AP, (2) systemic risks from the Self- Help Group system. Share price performance Price (LHS) Rebased Rel (RHS) 0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) , ,182.9 Pre -tax profit (Rs mn) , , ,066.4 Net attributable profit (Rs mn) , , ,212.4 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a EPS growth (%) n.m P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 97

98 SKS Microfinance Ltd. SKSM.BO / SKSM IN Price (12 Jan 15): Rs441.45, Rating: NEUTRAL [V], Target Price: Rs390.00, Analyst: Sunil Tirumalai Target price scenario Scenario TP %Up/Dwn Assumptions Upside Central case (11.65) Downside Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 4,490 5,775 7,914 10,861 Interest expense 2,142 2,455 3,321 4,643 Net interest income 2,348 3,321 4,592 6,218 Fee and commission income Trading income Insurance income (& premiums) Other income Total non-interest income Total income 2,348 3,321 4,592 6,218 Personal expense 1,656 2,162 2,823 3,669 Other expenses ,089 1,324 Total expenses 2,462 3,140 3,912 4,993 Pre-provision profit ,371 2,183 Loan loss provisions (45.5) (26.7) (1.9) Operating profit ,398 2,185 Associates/JV Other non-operating inc./(exp.) 623 1,073 1,467 1,882 Pre-tax profit 701 1,801 2,865 4,066 Taxes Net profit before minorities 701 1,801 2,326 3,212 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 701 1,800 2,326 3,212 Analyst adjustments Net profit (Credit Suisse) 701 1,800 2,326 3,212 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 17,210 23,600 31,561 43,778 Risk provisions Net customer loans 17,210 23,600 31,561 43,778 Interbank Loans Investment & Securities Cash & cash equivalents 6,710 13,194 16,845 21,669 Fixed Assets Intangibles Other assets 1,045 1,382 1,893 2,583 Total assets 24,965 38,176 50,300 68,030 Liabilities Interbank deposits Customer deposits Total deposits Other liabilities 20,372 27,806 37,603 52,121 Total liabilities 20,372 27,806 37,603 52,121 Shareholders' equity 4,592 10,371 12,697 15,909 Minority interests Preferred stock Total liabilities & equity 24,965 38,176 50,300 68,030 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense (6.2) Pre-provision profit (121) Net profit (124) Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 98

99 SKS Microfinance Firmly on the path of recovery While SKS did go through three years of impact from the AP MFI crisis, recent performance shows that the company is firmly on the path to recovery. The company has started growing its loan book again, and that is reflecting in operating leverage and improved returns. Figure 212: SKS has recovered substantially from the AP crisis Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Just before AP 1Y later 2Y later 3Y later 4Y later crisis Disbursements LTM Rs mn 98,400 39,970 23,550 38,870 58,320 Collection efficiency LTM (%) 96.85% 96.70% 99.88% 99.85% Gross loan portfolio Rs mn 54,340 26,350 17,170 23,480 30,430 Of which: Non-AP Rs mn 38,038 16,350 13,720 20,290 30,430 Opex ratio LTM % of avg GLP 16.7% 11.9% 20.6% 11.3% 9.9% GNPA % 0.20% 2.50% 0.80% 0.20% 0.10% Credit costs LTM (%) 1.36% 21.75% 50.16% 0.73% -0.12% RoA LTM (%) 9.1% -20.2% -60.4% 1.2% 5.4% Source: Company data, Credit Suisse research High collection efficiency maintained All through the post-ap crisis period, while SKS' loan book has shrunk, the company maintained its collection efficiency at average 95%+ levels. We believe this gives comfort on the viability of the MFI business model in India. Figure 213: High collection efficiency maintained all through AP crisis 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 - Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Loan portfolio (Rs mn) Collection efficiency % 101% 100% 99% 98% 97% 96% 95% 94% 93% 92% Source: Company data, Credit Suisse research Recoveries on AP portfolio can give upside SKS has completely provided for the AP portfolio. However, the company's efforts on recovering the residual portfolio continues. In our discussions with management, we understand that incremental disbursements are being made only to customers who repay past dues (with the continuous availability of credit being an attraction for the customer to return to SKS). Overall, the company has managed to recover over Rs722 mn in the last 12 months which works out to nearly 30% of the outstanding AP portfolio of a year ago. India Financials Sector 99

100 Figure 214: Cumulatively, 28% of the AP portfolio has been recovered in the last 12 months Recoveries from AP (Rs mn) Q14 2Q14 3Q14 4Q14 1Q15 Source: Company data, Credit Suisse research Recoveries from AP (Rs mn) Revamped branch operations: Processes > people While SKS has traditionally focussed on strong processes, our visit to SKS' branch/centre operations in rural Maharashtra showed that various processes have been tightened up further by the firm in the aftermath of the AP crisis. Some of the important processes that we found interesting from our branch visits are summarised in Figure 216. We believe a strong process-oriented culture has the following advantages: Natural screening of customers: Given the water-tight procedures and group borrowing nature of business, customer acquisition is not a critical function. In fact, we believe that in business models such as that of SKS', it is important for management to focus on the processes being followed and credit/collections will fall in place automatically. Prevention of lending malpractice: Since the same procedure is followed in all centres, the responsibility of a centre manager / loan officer is greatly reduced (only to the extent of collections and record keeping). In fact, collection targets are not even on the performance scorecards of loan officers (RBI mandated). Important to note that the customers themselves are part of the procedural culture of the company. In this situation, it becomes easy for the company to relocate loan officers regularly so that familiarity with customers does not take place. This could help control malpractices such as bribery for loan approvals, evergreening, coercive collections. Figure 215: SKS centre meeting in rural Maharashtra Source: Credit Suisse India Financials Sector 100

101 Figure 216: Strong process culture at SKS Subject Process description New village entry Formal survey is conducted focusing on factors such as political stability, availability of all-weather roads, law and order situation and population density Once a village is selected, a public meeting is called in consultation with the village head to explain the business model and benefits of micro-finance If some women show interest in becoming members, then a smaller group meeting is called for where the processes and rules are explained in greater detail New customer acquisition New customers are taken in only upon referral from existing members in the respective centres (except in case of new village entry, when the following procedures apply to entire group) A detailed know-your-customer (KYC) document is filled up by the loan officer Next a housing survey is conducted, with points awarded across various parameters: size of the house, condition of the house, roof type, whether made of bricks or mud, whether electricity/water etc are available, assets owned including vehicles and cattle A customer is a accepted only if they turn out to be 'poorer' than a certain threshold (i.e., the score on the above scorecard should be less than 15) The entire process is then cross-verified by the loan officer's superior (the branch manager) Then the customer's profile is checked against the Credit Bureau for possible conflicts (New, post AP-crisis) The new member undergoes a three-day training Once the new member becomes part of a group, disbursements are made to her only after she has spent a few months in the group Group formation A group of five members is formed based on mutual consent among the members Care is taken so that blood relations are not in the same group Distance between the houses of any two members of a group should not be more than 300 m The group elects a group leader Group meetings Group meetings happen once a week at a predetermined time Meetings take place at a common, public place (change after AP-crisis) All group meetings in all centres follow a set procedure The meetings usually last ~10mins, unless there are some disbursements to be made The group leaders/centre leader collects the weekly collections from all the groups in the centre, and notes the same in a register The centre manager's (loan officer) task is to check the accuracy of the collections and sign off. Given the joint liability nature of the business, the centre manager is seldom bothered about the individual members not being able to pay the weekly dues Disbursements Applications for fresh disbursements from members will have to be approved first by the other group members by mutual consent This step acts as an important check in terms of the customer's repaying capacity and behaviour The application is then taken through the usual loan approval process (including CB verification) and the disbursement is made the following week The disbursement is made only in the presence of all the members of the group The entire group's buy-in is essential because the group bears the risk of default in the JLG model Cash management At end of the day, the loan officer/centre manager deposits the cash in the branch and documents all collections Branch manager then verifies the record and prepares a branch level collections report. A team of independent auditors conducts surprise but frequent visits to branches to ensure the documentation and cash management are upto the mark Loan records All borrowers are given a loan passbook, which has all details like loan amount, IRR etc. (New, post AP-crisis) Weekly payment receipts are noted down in the passbook by the loan officer during every week's centre meeting Customer grievance Toll-free phone numbers in local languages for borrowers to place complaints (New, post AP-crisis) redressal End usage verification On a random sample basis, the branch managers visit the borrower's premises to confirm if the disbursed loan amount has been used for the end use as declared Recruitment Formal recruitment drives are announced and applications invited Candidates are screened through written examinations, interviews, on-the-job probation etc Postings are done in nearby villages but not in the same village as the residence of the employee Staff rotation Every six months, the centres/villages assigned to loan officers is changed, so that there is no familiarity between loan officer and members India Financials Sector 101

102 Management speaks: Regional manager, SKS, West Maharashtra Region Changes post AP-MFI crisis Credit Bureau checks are now mandatory. Also, earlier meetings used to take place at one of the borrowers' home. Now we have to conduct meetings at a common public place. In general, visits to customers' home are discouraged. A lot of practices in group meetings have come in primarily to improve transparency of the processes. Business growth/competition In southern states and Maharashtra, the penetration of microfinance is high. For example in Maharashtra, almost all addressable areas must have at least one MFI functioning (at least eight leading MFIs are present in Maharashtra). If one MFI enters a village of 300 households, within five years all potential customers can be covered. SKS tries to differentiate itself by giving doorstep disbursement (versus branch disbursement at other MFIs). However, penetration of MFIs in north India is very low. We have difficulty in explaining the business model to people, and flexibility on women being able to work is also low Staffing issues SKS prefers candidates with 12 th grade or higher qualification (though minimum qualification is tenth grade). Company faces high attrition in regions such as Pune where other employment opportunities are available. However, attrition is low in the Vidarbha region of Maharashtra. A loan officer usually earns Rs7,400-7,500 per month on fixed basis, and including incentives the income could go up to Rs12,000. The incentives depend on the number of loans managed, number of new customers brought in, helping in training/growth of junior officers, etc. Loan officers are assigned villages for six months, post which a new allocation is made. This rotation prevents breeding of familiarity between the officers and customers. Underwriting responsibility is fairly low for the employee, since the group lending dynamics mostly take care of this to a large part. Thus, the skills required for the job are also low. Typical end-use of money Money is lent only for setting up new business or for existing business purpose. Typical businesses include tailoring, fishery, grocery stores, beautician, cattle/poultry purchase, etc. Initially, a maximum of Rs12,000 loan is given to a borrower, and this could be topped up after 20 weeks in consultation with group members. Few of the group members CS met with felt that the loan amount is increasingly insufficient for business purposes (e.g., one buffalo costs Rs30,000). Management guidance of 40% loan growth SKS' loan book bottomed a full two years after the AP crisis, and is only now showing significant growth rates. Going forward, management is guiding to 40% loan growth in non-ap portfolio for the next few years. India Financials Sector 102

103 Figure 217: SKS has started growing fast again, after sluggish growth for nearly three years after the AP crisis 40,000 AUM (Rs mn) Disbursements (Rs mn) 35,000 30,000 25,000 20,000 15,000 10,000 5,000 - Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Source: Company data, Credit Suisse research High opex: Imperative to grow fast and sell down loans At 10% of assets, operating costs are clearly the biggest cost items for MFIs (after finance costs). This becomes more relevant in the current regime of 10% spread cap imposed by RBI on MFIs. From a profitability perspective, this means that MFI's like SKS need to ensure two things over the next few years to keep their profitability respectable: Keep growth rates high, so that opex leverage plays out quickly, and Strive to sell down as much of their loans as possible in order to leverage better. Figure 218: Expect strong growth to help SKS benefit from opex leverage 12.0% Opex/GLP Opex/NII 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% FY13 FY14 FY15E FY16E FY17E 210% 190% 170% 150% 130% 110% 90% 70% Figure 219: SKS could continue to sell down a large part of its AUM, to enjoy higher leverage Off-book as % of total AUM 70% 60% 50% 40% 30% 20% 10% 0% FY12 FY13 FY14 FY15E FY16E FY17E Separately, MFI's could boost their non-interest fee income by leveraging their on-theground presence. SKS has been building non-interest revenue streams around insurance broking. India Financials Sector 103

104 Figure 220: Expect fee income to remain a key contributor to profitability Total non-interest income as % of AUM 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E Tax benefits over next few years Due to the AP crisis, SKS suffered substantial losses in FY12/13. As it turned back to profits, SKS used these losses to offset the profits generated and hence it was liable to pay tax only at MAT ( Minimum Alternative Tax ) rate. But under MAT, there is a provision to deduct write-offs (note that tax benefit is not eligible on provisions, but only on writeoffs) from eligible profits. Hence, tax rate for SKS is zero till the time entire AP portfolio was written-off. Note that this portfolio was already completely provided for and hence there was no further hit on reported P&L. Going forward from FY16, SKS will be chargeable at MAT rate (currently at 21%) for the next 8-10 years (till the time entire losses and MAT credit are used against profits) SKS will thus continue to be taxed at a lower rate for the next 8-10 years. Using a WACC of 13%, the NPV of future benefits on tax over the next few years comes to Rs38. In our view, this should be added to the current book value for comparable valuations Figure 221: Book value adjustment for deferred tax benefit Rs mn FY14 FY15 FY16 FY17 DTA as on March ,580 Profit before tax 1,800 2,865 4,066 % YoY 59.1% 42.0% Full tax rate 33.0% 33.0% 33.0% Tax rate % 21.0% Taxes paid DTA used ,342 DTA unutilised 4,986 4,041 2,699 MAT credit created MAT unutilised ,393 MAT used Tax savings Disc factor PV WACC 13% FY15 FY16 FY17 NPV BPS on reported basis (Rs) BPS adjusted for tax benefit (Rs) India Financials Sector 104

105 However, while SKS is expected to report high RoA of ~5% for FY15, we expect the posttax returns to fall next year as the company starts paying taxes at the MAT rate again. Overall, we expect RoE to settle at 22.5% by FY17 (and 16% on the book adjusted as explained above). Figure 222: SKS Dupont (on GLP) FY12 FY13 FY14 FY15E FY16E FY17E Interest income / gross loans 12.1% 10.5% 14.5% 13.4% 12.8% 12.7% Securitisation Income / gross loans 1.2% 2.8% 2.1% 2.5% 2.8% 2.8% Interest expense / gross loans 6.8% 6.8% 7.9% 6.7% 6.6% 6.6% NII / gross loans 6.5% 6.4% 8.6% 9.1% 9.1% 8.9% Other income / gross loans 2.7% 3.5% 3.5% 4.3% 4.3% 4.1% Opex / gross loans 14.3% 12.5% 9.1% 8.6% 7.7% 7.1% Credit cost / gross loans 39.7% 11.6% 0.5% -0.1% -0.1% 0.0% Pretax profit / gross loans -44.7% -14.1% 2.6% 4.9% 5.7% 5.8% Taxes / gross loans 1.2% 0.0% 0.0% 0.0% 1.1% 1.2% ROA -46.0% -14.1% 2.6% 4.9% 4.6% 4.6% Avg leverage RoE % -72.0% 16.5% 24.1% 20.2% 22.5% RoE on adjusted book 17.4% 14.0% 16.7% Small bank licence: Too early to get excited Small finance bank license The RBI has recently released final guidelines for small finance bank licences, with an objective of furthering financial inclusion by providing small savings vehicles and small ticket credit to unbanked sections. Key features: A small bank will be allowed to provide basic banking services including accepting deposits, and lending to unbanked populations/enterprises. All prudential norms including CRR/SLR maintenance will be applicable to small banks (without any forbearance). 75% of loans should be towards priority sectors (40% should stick to the sub-sector targets, the rest can be allocated as per the bank's competitive advantages). At least 50% of loan portfolio should constitute loans of ticket size less than Rs2.5mn. Tier 1 capital required is at least 7.5% of RWAs. Theoretically SKS is a decent fit SKS manages to satisfy most of the eligibility criteria based on its current MFI business. Nearly all of its loan portfolio is priority sector compliant (with some minor tweaks even the sub-sector targets for 40% can be taken care of). The largest ticket size today is Rs25,000, and the company comfortably crosses the 25% threshold for branches in unbanked areas. The company also claims 58% of portfolio is in east, central areas (which RBI has laid special emphasis on). But shareholding hurdle to be crossed One major criteria that SKS does not qualify for, however, is on the ownership structure. RBI requires that: Promoters own at least 26% stake, and Resident Indians should own more than half of the promoter stake. India Financials Sector 105

106 As can be seen from the chart below, SKS fails to satisfy both these criteria. To fix the problem, SKS could bring in new investors as promoters (with a five year lock-in), with ~17% dilution (and ensuring at least 77% of the new investors are resident Indians). Figure 223: SKS shareholding needs significant overhaul for eligibility SKS shareholding pattern - Sep-2014 Promoter - domestic 3% Promoter - foreign 6% Non-promoter foreign 58% Non-promoter domestic 33% Source: Company data Does it still make sense? We believe the biggest benefit that SKS could hope for from converting to a bank will be immunity from political risks (of the kind witnessed in AP in 2010). However, once the MFI bill gets passed by parliament, regulatory clarity should emerge anyways (the question of whether the bill gets passed before the conversion to bank happens in 18 months is a smaller issue, in our view). Our views on the other financial benefits are below: Funding cost benefit may not materialise SKS' cost of borrowing today is at ~ %, and in our discussions management believes conversion to a bank will allow access to lower cost deposits, and this is seen as a significant benefit. However, we believe the flow through of funding cost benefit could be insignificant. Firstly, as per RBI's clarifications, the loans to SKS will lose PSL status for its lenders when it converts to a bank (it will no longer be an NBFC MFI to enjoy PSL benefit for balance sheet funding). This could actually lead to an increase in cost of funds since the bulk of funding in the initial years will continue to be from bank sources. Secondly, we believe the actual cost of raising deposits in SKS' model including the operating costs of running weekly small ticket deposit inflows of the kind management envisages will be higher than the headline number (SKS' current opex runs at 10% of assets). No leverage upside One other potential reason for an NBFC to convert to a bank is to enjoy the higher leverage allowed for banks. However, RBI's guidelines show that the Tier 1/total CAR requirement for small banks is 7.5%/15% (same as what SKS is currently subject to, and higher than that of larger banks at 6%/9%). In other words, adjusting for the additional CRR/SLR assets, there is no other leverage benefit that SKS will incrementally derive by converting to a bank. India Financials Sector 106

107 Overall, we believe the upside from potential conversion to a bank for SKS is quite limited. Valuations appear rich SKS Microfinance has outperformed the banks index by over 80% in the last 12 months. Currently, the stock trades at 3.1x FY16 P/B even adjusted for the deferred tax benefits discussed above. Figure 224: Four-year stock performance vs Bank index 200 BSE Bank Index SKS Micro Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Source: CS Rave, company data, Credit Suisse estimates Figure 225: 12M stock performance vs Index 300 BSE Bank Index SKS Micro Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 We initiate coverage on SKS with a NEUTRAL rating and target price of Rs390. Our 12M forward target price is based on 2.4x forward P/B multiple on 24M forward book value (adjusted for deferred tax benefit). The 2.4x target multiple is based on Gordon growth model with 23% steady state RoE, 5% terminal growth and 13% cost of equity. Figure 226: SKS Microfinance appears richly valued P/B (x) RoE (%) P/E (x) EPS growth (%) 2yr CAGR Stock FY15 FY16 FY15 FY16 FY15 FY16 FY15 FY16 FY17 (FY16-17) SKS Micro % 14.0% % 29.2% 38.1% 33.6% CS NBFC Universe Avg % 20.6% % 30.8% 27.0% 28.9% India Financials Sector 107

108 Asia Pacific / India Shriram City Union Finance Ltd Rating UNDERPERFORM* Price (12 Jan 15, Rs) 1, Target price (Rs) 1,570.00¹ Upside/downside (%) Mkt cap (Rs mn) 130,697 (US$ 2,103 mn) Number of shares (mn) Free float (%) week price range 2, ADTO - 6M (US$ mn) 0.87 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Research Analysts Sunil Tirumalai [email protected] Kush Shah [email protected] Chunky Shah [email protected] (SHCU.BO / SCUF IN) INITIATION Pangs of change We initiate coverage on Shriram City Union (SCUF) with an UNDERPERFORM rating and Rs1,570 target price (21% downside). Specialist small business lender. SCUF specialises in lending to small businessmen, with almost all loan products designed keeping self-employed customers in mind (even segments such as gold loans, consumer durables etc are designed for self-employed customers). Over the last couple of years, the company's growth rates have cooled with reduced aggression across business lines (lower disbursements in gold loans and reduced tenures in SME loans). Restarting the growth engine. SCUF's management is now again getting back into a growth mode, with increased focus on gold segment and increased tenures in SME. We believe these could help loan growth pick up to 23-25% in the next two years. However, given the expected change in mix (rising share of gold loans), NIM could shrink ~30 bp in two years. With 80% provision coverage, the company has sufficient room to cushion impact of transition to 90-day NPA. However, with high capital levels (Tier 1 of 25%), we expect RoE to remain below 20% even after three years. Catalysts. As the company starts growing its gold loan book again, we expect NIMs to start falling (reversing the trend of previous two years). Valuation. At 17x/2.65x FY16 P/E/P/B, SCUF is expensively valued for subpar returns and earnings growth, compared to other retail NBFC peers. Our Rs1,570 target price is based on 12x P/E on 24M forward EPS (implying 1.9x P/B). Risks: (1) sharp rise in growth across gold loans and SME segments, leading to higher than expected earnings, (2) benign competitive environment leading to expansion of margins in a falling interest rate environment. Share price performance Price (LHS) Rebased Rel (RHS) Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 11, , , ,771.0 Pre -tax profit (Rs mn) 7, , , ,602.0 Net attributable profit (Rs mn) 5, , , ,058.8 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 108

109 Shriram City Union Finance Ltd SHCU.BO / SCUF IN Price (12 Jan 15): Rs1,983.10, Rating: UNDERPERFORM, Target Price: Rs1,570.00, Analyst: Sunil Tirumalai Target price scenario Scenario TP %Up/Dwn Assumptions Upside Central case 1, (20.83) Downside Key earnings drivers 3/14A 3/15E 3/16E 3/17E Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 32,129 36,263 43,301 51,340 Interest expense 13,509 14,395 17,680 21,599 Net interest income 18,619 21,868 25,621 29,741 Fee and commission income Trading income Insurance income (& premiums) Other income Total non-interest income Total income 18,619 21,868 25,621 29,741 Personal expense 2,708 Other expenses 4,775 9,347 10,604 11,913 Total expenses 7,482 9,347 10,604 11,913 Pre-provision profit 11,847 13,262 15,798 18,771 Loan loss provisions 3,856 4,340 4,476 5,169 Operating profit 7,991 8,922 11,321 13,602 Associates/JV Other non-operating inc./(exp.) Pre-tax profit 7,991 8,922 11,321 13,602 Taxes 2,602 2,971 3,781 4,543 Net profit before minorities 5,389 5,952 7,540 9,059 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 5,389 5,952 7,540 9,059 Analyst adjustments Net profit (Credit Suisse) 5,389 5,952 7,540 9,059 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 131, , , ,965 Risk provisions Net customer loans 128, , , ,509 Interbank Loans Investment & Securities Cash & cash equivalents 29,463 44,295 53,521 64,774 Fixed Assets Intangibles Other assets 4,481 5,565 6,735 8,133 Total assets 162, , , ,416 Liabilities Interbank deposits Customer deposits Total deposits Other liabilities 131, , , ,545 Total liabilities 131, , , ,545 Shareholders' equity 29,998 42,913 49,276 56,929 Minority interests Preferred stock Total liabilities & equity 162, , , ,416 Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates. 12MF P/E multiple MF P/B multiple Source: IBES India Financials Sector 109

110 A focused small-business financier Shriram City Union Finance (SCUF) is a retail-focused NBFC with around US$2.5 bn consolidated loan book. In general, the company specialises in lending to self-employed borrowers who could be perceived riskier than salaried customer by banks. The largest segment for the company is lending to small enterprises where the company usually takes the property of the promoter as collateral. This has also been the fastest growing segments for SCUF, accounting for ~94% of consolidated loan book increase over the last 12 months Figure 227: SCUF has a US$2.6 bn loan book as of Sep-2014 Personal Loans 3% Home loans 1% Auto Loans 9% Gold loans 18% SME 51% 2 wheelers 18% Source: Company data, Credit Suisse research Figure 228: Profile of various businesses Loan segment Customer profile Ticket size (Rs) Yields LTV Tenure Last 3-yr loan book CAGR SME Small business owners. 65% are traders. 600,000 22% 60-70% 30 months 51% Usually residential property of promoter is taken as collateral Two-wheelers Self-employed 40, % 60-70% 24 months 40% Gold loans Usually self-employed borrowers 80, , % <60% 12 months 0% Auto Loans Self-employed borrowers looking to buy 200, % 24 months -13% used cars, and used CVs (10yrs + age) Personal Loans Existing customers cross sell 26-27% -14% Consumer Small businesses 26-27% -4% Durables Home loans Self employed 1,000, % 50-55% 15 yrs New business Key strengths Wide reach through branch network and feet on street SCUF has amongst the widest network of branches across leading retail NBFCs. The army of field staff is a differentiator in its focus area of the unorganised self-employed market, in our view India Financials Sector 110

111 Figure 229: Comparison of branch network size of retail NBFCs (FY14) 1,200 1, Figure 230: Comparison of employee count of retail NBFCs (FY14) 24,000 20,000 16,000 12,000 8,000 4,000 - SCUF MMFS SHTF Magma Bajaj - SCUF SHTF MMFS Magma Bajaj No. of branches No. of employees Source: Company data, Credit Suisse research Riding on legacy of Shriram Chits Source: Company data, Credit Suisse research The Shriram Group started chit fund business around 40 years ago in south India, and currently has 360 chit fund branches (primarily in Andhra Pradesh, Telengana, Tamil Nadu and Karnataka). Shriram Chits has a cumulative database of over 3.5 mn customers across these key states. They are usually small businessmen or self-employed people This is a ready pool of customers for SCUF to tap into. SCUF uses Shriram Chits as a channel partner to source customers. Currently, nearly 80% of SCUF customers come from a chit fund background, and SCUF's penetration into the chit fund base is less than 15%. SCUF management believes this can go up to 40%. However, given that the overall chit fund base as of today is only ~Rs40 bn (versus SCUF's loan book of Rs160 bn), we believe the capacity of the chit fund entity to supply decent-sized customer accounts could remain muted. Multiple product offerings to self-employed category Almost all products of the company are tailored to cater to the self-employed borrower category. Moreover, we see multiple instances of the company trying to cross-sell its products to the self-employed category. The company tries to convert gold loan customers with a good track record into SME customers by extending larger ticket loans against property, etc. SCUF extends unsecured personal loans to existing customers with a good track record. The company extends loans to small businesses to fund purchase of consumer durables items to their employees (this is the major portion of the consumer durables loans). Amongst the best capitalised NBFCs After the recent capital infusion by the Piramal group, SCUF is amongst the best capitalised NBFCs today, with 24% tier 1 ratio. We believe this gives sufficient comfort on capital requirement for the company for the next few years. India Financials Sector 111

112 Figure 231: After recent capital infusion, SCUF has amongst the best capitalisation levels in the industry 30.0% 1Q15 - Tier I (%) 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% SCUF SHTF MMFS Bajaj Magma Source: Company data, Credit Suisse research Fully in-house sourcing model SCUF follows a fully in-house sourcing model across all its businesses. No brokers/dsa (direct selling agents) or CAs (chartered accountants) are used to source customers. In fact, in FY13, the company absorbed many employees of the chit fund business who were helping in new customer referrals. We believe this in-house sourcing model will help keep a check on credit losses. Increasing loan tenures key to loan growth recovery Growth has slowed down sharply over the last few quarters From 50%+ loan growth levels seen in 2012, SCUF's growth rates have slowed sharply with the company growing only 3% YoY in the Sep-14 quarter. Figure 232: SCUF loan growth has slowed in recent years 180 AUM (Rs bn) AUM growth (YoY) 80% % % % 40% 30% 20% 10% 0% 20-10% - Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Source: Company data, Credit Suisse research pulled down by gold loans A large part of the slowdown in growth is due to shrinkage of the gold loan portfolio as the company went slow in a market with regulatory uncertainty and gold price volatility. However, even in non-gold segments, loan growth has slowed considerably. -20% India Financials Sector 112

113 Figure 233: The company went slow on gold loans affecting overall loan growth rates Figure 234: even in the non-gold loan segment, the company has gone slow 180, , , , ,000 80,000 60,000 40,000 20,000 - Segment wise AUM (Rs mn) Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 40% YoY loan growth 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 SME 2 wheelers Gold loans Auto Loans Personal Loans Gold loans Non-gold loans Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Shorter loan tenures in other segments have not helped either Importantly, while disbursement level has stayed flat, the company reduced the tenures in the SME segment (from 36 months to sub 12 months) as it perceived a build-up in risk/competition. The resultant increase in repayment rates has contributed to slowdown in loan growth. Figure 235: Despite disbursements remaining steady, AUM has been declining AUM (Rs bn) Disbursements (Rs mn) Repayment Rate (%) (RHS) 35% 30% 25% 20% Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 15% 10% 5% 0% Source: Company data, Credit Suisse research Increasing loan tenures key to loan growth In our models, we build a combination of pick up in disbursements and an increase in loan tenures to help company get back to 20%+ growth levels over the next couple of years. Figure 236: Combination of disbursement growth and longer tenure loans to help growth recover FY13 FY14 FY15E FY16E FY17E AUM (Rs mn) 158, , , , ,544 AUM YoY growth (%) 18% -7% 23% 26% 22% Disbursements (Rs mn) 174, , , , ,180 Disbursements YoY growth (%) 29% -11% 19% 20% 20% Repayments (Rs mn) 150, , , , ,231 Repayment Rate 112% 105% 102% 95% 93% Implied Tenure (Months) India Financials Sector 113

114 Yield expansion could reverse in the coming years SCUF has enjoyed around 300 bp NIM expansion over the last two years primarily driven by falling share of gold loans in the portfolio. As seen earlier, gold loan is the lowest yielding segment for SCUF. Figure 237: NIMs have improved with share of gold loans declining 14.0% NIM (%) Share of gold loans in AUM (%) 13.5% 13.0% 12.5% 12.0% 11.5% 11.0% 10.5% 45% 40% 35% 30% 25% 20% 15% 10.0% Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Source: Company data, Credit Suisse research Going forward, with gold loans expected to contribute to growth, yields could reduce again. However, we build a rather benign 30 bp decline in NIM over the next two years for SCUF. Figure 238: CS forecast for NIM building small decline in NIM to account for growth in gold loan portfolio 26% 25% 24% 23% Yields (%) NIM (%) 10% 14% 13% 12% 22% 21% 20% 19% 18% FY11 FY12 FY13 FY14 FY15E FY16E FY17E 11% 10% 9% 8% Industry participant insights: SCUF's branch manager in Western Maharashtra This is in one of the larger cities in Maharashtra state Gold loans This is the biggest product in the branch, and is offered by all branches in this city Ticket sizes in gold loans are usually in the Rs80,000-90,000 range. Loans are structured on bullet payments, and for two tenure options: 6 months (2% per month rate) and 12 months (1.6% per month). The branch usually prefers customers who live in their own houses (as against people living in rented homes). The branch gets a lot of jewellers as customers. They give their inventory as security. The branch has an appraiser in the office from 10am-6pm. The company's marketing push on gold loans has increased in the last six months, and growth has picked up (monthly disbursements are up 2x). India Financials Sector 114

115 Competition is from NBFCs primarily, and is mostly on rates and LTVs. Two-wheeler loans This is the second largest segment for the branch. Branch manager claims SCUF is the largest two-wheeler financier in the city (SCUF finances both two- and threewheelers). The branch funds upto 85% of the vehicle cost. Two-wheeler loan book is growing at 18-20% YoY. High opex base: Should see leverage when growth revives Slowing growth and growing share of opex heavy businesses such as two-wheelers lead to rising opex intensity over the last couple of years for SCUF. Figure 239: Slowing growth and rising opex in recent years 80% 70% 60% 50% 40% 30% 20% 10% 0% -10% -20% 6% 6% 5% 5% 4% 4% 3% 3% 2% AUM YoY growth (%) Opex as a % of Avg AUM (RHS) Source: Company data Compared to other NBFCs, we see that SCUF has a higher opex intensity in line with its business model and smaller scale. Figure 240: Comparison of opex efficiency across retail NBFCs 600, , , , , ,000 - SHTF MMFS Bajaj Magma SCUF 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Figure 241: Expect opex leverage with scale 80% 60% 40% 20% 0% AUM YoY growth (%) Opex as a % of Avg AUM (RHS) FY14 AUM Opex as a % of Avg AUM -20% 3.0% FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% Source: Company data, Credit Suisse research India Financials Sector 115

116 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep January 2015 Asset quality: Expect to stabilise High write-off policy Slow growth in recent quarters has accentuated the asset quality problem for SCUF leading to sharp rise in P&L credit costs. SCUF's management prefers to write-off loans which already have high provisions, in order to avail tax benefits and lighten up the balance sheet. We see that SCUF's write-off run rate is higher than peer group of retail NBFCs. Figure 242: SCUF credit costs are on the rise in recent quarters 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% Figure 243: SCUF follows a high write-off policy 2.5% Write-off's as a % of average AUM FY12 FY13 FY14 2.0% 1.5% 1.0% 0.5% GNPA % Credit costs (% of AUM) 0.0% SCUF SHTF MMFS Bajaj Magma Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research Recent RBI regulations could keep credit costs high In our models, we build an improvement in asset quality, with GNPA (on 180DPD) falling to 2.4% by FY17 (from current 3% levels). However, the expected change to 90 DPD NPA reporting could prevent the reported NPA numbers from changing much from current levels. While we expect the company to offset the impact by reducing coverage ratio (to 60% from 80% currently), higher standard asset provisioning would still result in credit costs staying 2%+ for the company in coming years. Figure 244: Expect underlying asset quality to show improvement Provision coverage Gross NPA (underlying 180 dpd) Gross NPA (new RBI regulations) 3.3% 90% 3.1% 80% 2.9% 2.7% 70% 2.5% 60% 2.3% 2.1% 50% 1.9% 40% 1.7% 1.5% 30% FY13 FY14 FY15E FY16E FY17E Figure 245: Credit costs to remain at 2%+ level 3.0% 2.5% Write-off's as a % of AUM (%) PnL credit cost as a % of AUM (%) 2.0% 1.5% 1.0% 0.5% 0.0% FY11 FY12 FY13 FY14 FY15E FY16E FY17E India Financials Sector 116

117 RoE could stay sub-20% for three years Recent capital infusion leaves company highly capitalised As seen earlier, SCUF has amongst the highest capitalisation levels across retail NBFCs. This high capitalisation levels could keep RoE lower than 20% for the company, despite expected increase in RoA. Figure 246: Low leverage could keep RoE lower than 20% for the next couple of years FY14 FY15E FY16E FY17E Interest income / total assets 19.5% 19.1% 18.3% 18.0% Interest expense / total assets 8.2% 7.6% 7.5% 7.6% NII / total assets 11.3% 11.5% 10.8% 10.4% Other income / total assets 0.4% 0.4% 0.3% 0.3% Opex / total assets 4.5% 4.9% 4.5% 4.2% Credit cost / total assets 2.3% 2.3% 1.9% 1.8% Pretax profit / total assets 4.8% 4.7% 4.8% 4.8% Taxes / total assets 1.6% 1.6% 1.6% 1.6% ROA 3.2% 3.1% 3.2% 3.2% Avg leverage RoE 20.3% 16.2% 16.2% 17.0% Risk of geographic concentration Over 70% of SCUF's business comes from the south Indian states of Andhra Pradesh, Tamil Nadu and Karnataka. While the company has been trying to expand in other parts of India aggressively, dependence on South India remains high and could lead to geographic concentration risks. Figure 247: Geographic spread of SCUF's branch network (FY14) State wise branch distribution Uttar Pradesh 3% Others 15% Karnataka 7% Andhra Pradesh 34% Maharashtra 10% Tamil Nadu 31% Source: Company data, Credit Suisse research Expensive valuations for sub-par returns At 2.7x FY16E P/B for sub-20% returns, we believe SCUF is richly valued in comparison to its peers. India Financials Sector 117

118 Figure 248: Trading well above its historical mean on P/E mth fwd PE Mean 1 + SD 1 - SD Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Figure 249: and P/B valuations mth fwd PB Mean 1 + SD 1 - SD Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: IBES, Credit Suisse estimates Source: IBES, Credit Suisse estimates We initiate coverage on SCUF with an UNDERPERFORM rating and Rs1,570 target price. Our target price is based on 12x P/E multiple on our 24M forward EPS. Figure 250: Valuation P/B (x) RoE (%) P/E (x) EPS growth (%) 2-yr CAGR Stock FY15 FY16 FY15 FY16 FY15 FY16 FY15 FY16 FY17 (FY16-17) SCUF % 16.2% % 26.7% 20.3% 23.5% CS NBFC universe avg % 20.5% % 30.8% 27.5% 29.1% Management speaks: Subhashri Shriram, CFO, SCUF Overall outlook Expect overall loan growth to pick up to 20%+ levels in the coming quarters. While opex will not go up, cost-to-income may not fall below 32% either (company continues to invest into people). This will help consume capital and RoE will inch up to 20% levels over the next couple of years. Gold loan segment Gold loan segment is getting into positive growth after two years. SCUF is not the most competitive player (either on pricing or on LTV). But the company intends to play out the full cycle, and the next big upcycle is expected in The longer-tem goal is to migrate gold loan customers into SME loan customers. SME segment Typical customer profile for SCUF are fairly run businesses with a few employees. Usually, these businesses do not have any professionals helping them (i.e., no accountants etc), but end-to-end managed by the promoter months ago, SCUF took the decision to reduce ticket size (and hence tenure) in the segment. However, the tenure is now back to three years and the concerns on risk are lower. This should help growth rates in the coming quarters. India Financials Sector 118

119 Other segments Overall auto loan segment is likely to grow at healthy (20%+ levels). Geographic concentration Two-thirds of the portfolio is concentrated in Tamil Nadu and Andhra Pradesh (undivided). SCUF does not see this as a risk, and in fact, would like to take advantage of the 30-year experience of working in these states. These states happen to have the best teams of the company. However, other regions are growing faster and hence that could bring down the share of these states over the longer term. Risks Sharp rise in growth across gold loans and SME segments could lead to higherthan-expected earnings From 50%+ loan growth levels seen in 2012, SCUF's growth rates have slowed sharply with the company growing only 3% YoY in Sep-14 quarter mainly pulled down by gold loans as it went slow in a market with regulatory uncertainty and gold price volatility. In the SME segment, SCUF reduced tenures in the SME segment (from 36 months to sub 12 months) as it perceived a build-up in risk/competition. The resultant increase in repayment rates has contributed to a slowdown in loan growth. In our models, we build a combination of pick up in disbursements and an increase in loan tenures to help the company get back to 20%+ growth levels over the next couple of years. A sharp rise in growth in the gold and SME segments could help the company grow faster, leading to higher profitability Benign competitive environment leading to expansion of margins in a falling interest rate environment. India Financials Sector 119

120 Asia Pacific / India Regional Banks Axis Bank Limited Rating OUTPERFORM* Price (12 Jan 15, Rs) Target price (Rs) (from ) ¹ Upside/downside (%) 18.2 Mkt cap (Rs mn) 1,185,397 (US$19,073 mn) Number of shares (mn) 2, Free float (%) week price range ADTO - 6M (US$ mn) 28.7 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Share price performance Price (LHS) Research Analysts Ashish Gupta [email protected] Prashant Kumar [email protected] Rebased Rel (RHS) 0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 09/01/15 On 09/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) (AXBK.BO / AXSB IN) INCREASE TARGET PRICE Transitioning to a leading retail financier Share of high yielding retail segments to go up. Axis Bank has maintained strong growth in its retail portfolio over the past few years with share of retail (ex-agri) increasing to 32% as of 1H15 from ~19.5% for FY11. The growth so far has been primarily driven by secured mortgage and auto segment constituting ~84% of retail (ex-agri) portfolio. Retail loan growth is likely to remain strong at ~25% CAGR; however, incrementally would be driven by an increasing share of high yielding portfolio (non-mortgage, auto). Mortgage would continue to be the core portfolio with the bank currently among top five market players. However, incrementally the focus would be more on high yielding segments like business banking, personal loans and gold loans to drive growth. The bank has recently launched business banking and sees meaningful opportunities for PSL lending. Within auto, focus would be more on commercial vehicles (CVs) with their share increasing to 30-40% of auto book from current ~15%. Focus on branches and customers for sourcing. The bank sources a third of its retail loans from branches and two-thirds from existing customers. Credit cards are 100% internally sourced and personal loans are 70-80% internally sourced. The bank starts to look for cross sell opportunities after 6-9 months of liability relationship with the customer. The bank has mostly focused on its internal customers and rollout of products to new centres to drive retail loan growth. The number of branches offering retail products increased from ~850 in FY12 to 1,716 in FY14 and 2,215 in 1H15. The bank is now increasing its focus on self-employed segment as a growth opportunity by offering more customised products and services. Well positioned on capital and liquidity. The bank has witnessed an equally impressive improvement in its liability franchise, which is now at par with the best in the sector, with retail share in deposits now at ~80% (CASA+ retail TD). The bank is comfortable on liquidity and having raised capital recently (Tier I ~12.5%) is well positioned to capitalise on recovery in growth. We maintain OUTPERFORM with a new TP of Rs593 (from Rs567). Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 111, , , ,361.6 Pre -tax profit (Rs mn) 93, , , ,859.6 Net attributable profit (Rs mn) 62, , , ,785.9 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates India Financials Sector 120

121 Axis Bank Limited AXBK.BO / AXSB IN Price (12 Jan 15): Rs501.55, Rating: OUTPERFORM, Target Price: Rs593.00, Analyst: Ashish Gupta Target price scenario Scenario TP %Up/Dwn Assumptions Upside Significant improvement in liquidity with fall in interest rate resulting in improved margins and reduced asset quality stress Central case At 2.5x book value, 10% premium to historic avg multiple Downside (1) significant slowdown in lending in high interest rate environment; (2) huge deterioration in asset quality 6.41 environment and (3) sharp rise in wholesale deposit rates. Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 306, , , ,262 Interest expense 186, , , ,605 Net interest income 119, , , ,657 Fee and commission income 53,938 60,410 70,680 84,816 Trading income Insurance income (& premiums) Other income 16,839 14,689 17,967 20,201 Total non-interest income 55,600 63,832 75,685 89,920 Total income 175, , , ,577 Personal expense 26,013 30,082 33,732 38,887 Other expenses 52,994 60,943 71,304 83,425 Total expenses 79,008 91, , ,313 Pre-provision profit 111, , , ,362 Loan loss provisions 21,070 21,841 24,174 29,461 Operating profit 90, , , ,901 Associates/JV Other non-operating inc./(exp.) 3,276 5,834 5,417 5,959 Pre-tax profit 93, , , ,860 Taxes 31,314 36,377 44,279 54,074 Net profit before minorities 62,177 73,856 89, ,786 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 62,177 73,856 89, ,786 Analyst adjustments Net profit (Credit Suisse) 62,177 73,856 89, ,786 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 2,334,856 2,748,152 3,311,030 4,031,286 Risk provisions 21,218 26,666 29,065 35,056 Net customer loans 2,300,668 2,705,809 3,263,060 3,973,210 Interbank Loans 111,974 90, , ,660 Investment & Securities 1,135,484 1,324,757 1,582,925 1,922,379 Cash & cash equivalents 170, , , ,508 Fixed Assets 24,102 26,768 30,520 35,024 Intangibles Other assets 89, , , ,378 Total assets 3,832,449 4,469,626 5,364,692 6,499,159 Liabilities Interbank deposits Customer deposits 2,809,446 3,287,051 3,977,332 4,852,345 Total deposits 2,809,446 3,287,051 3,977,332 4,852,345 Other liabilities 640, , ,544 1,044,261 Total liabilities 3,450,244 4,027,622 4,849,876 5,896,606 Shareholders' equity 382, , , ,553 Minority interests Preferred stock Total liabilities & equity 3,832,449 4,469,626 5,364,692 6,499,159 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth Net interest margin Fee growth Cost-inc ratio P&L provision (% of loans) Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) 2,352 2,356 2,356 2,356 EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates. 12MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 121

122 Figure 251: Share of retail loans to go upto 44% by FY17E Agri 15% Personal & CC 9% Consumer loan break-up (%) (1H15) Others 6% Housing 53% Share of retail loans - 38% Figure 252: driven by increasing share of non-housing loans Personal & CC 12% Agri 13% Gold Loans 3% Consumer loan break-up (%) (FY17) Others 7% Housing 45% Share of retail loans - 44% Auto 9% LAP 8% Auto 10% LAP 10% Figure 253: Roll out of products to new branches has been a key growth driver Branches with Consumer loan products Branches yet to offer consumer loan products 3,000 2,500 2, ,500 1, FY10 FY12 FY14 1H15 India Financials Sector 122

123 Asia Pacific / India Regional Banks HDFC Bank Rating OUTPERFORM* Price (12 Jan 15, Rs) Target price (Rs) (from 1,099.00) 1,178.00¹ Upside/downside (%) 21.7 Mkt cap (Rs mn) 2,340,292 (US$37,656 mn) Number of shares (mn) 2, Free float (%) week price range ADTO - 6M (US$ mn) 28.2 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Share price performance Price (LHS) Research Analysts Ashish Gupta [email protected] Prashant Kumar [email protected] Rebased Rel (RHS) 400 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 09/01/15 On 09/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) (HDBK.BO / HDFCB IN) INCREASE TARGET PRICE In a class of its own FOCUS LIST STOCK Retail loan growth has bottomed. HDFC bank has cemented its position as the largest non-mortgage retail financier through consistent growth across the business cycles. Retail loan growth has again picked up in 2Q (17% YoY) after bottoming out at 14% in 1Q as CV loan book expanded for the first time in several quarters and key segments of auto, personal, credit cards, business banking showed healthy demand. Disbursement growth in some of its key segments like auto, CVs have started to pick-up on huge pent-up demand building in consumer discretionary segment. With pick-up in retail demand, we expect the share of retail loans to reach back to ~53% by FY17 (from current 48%). Expansion in non-urban markets to help sustain growth momentum. The bank used the consumer lending business sweet spot over the past few years to accelerate its franchise investments and build up floating reserves. Having aggressively expanded its network footprint (up 80% in three years), the bank is better positioned vs peers to capture a recovery in retail demand especially from non-urban geographies. Even now, almost a third of its ~3,400 branches are loss-making, with the benefit of improving operating leverage to continue to accrue. Well placed to extend market share gains. The bank has a superior retail franchise compared to its peers on the back of a strong distribution network, a full suite of retail products, large captive customer base of ~28 mn, and strong origination and appraisal skills. The bank with its strong liquidity position (CASA ~43%) and no asset quality overhang is well placed to for an economic recovery and further extend market share gains. With the pick-up in retail growth and market share gains in corporate, HDFC bank loan growth and profitability continue to be superior to industry. At 18x earnings, the bank is trading below its historical average valuation. With an earnings CAGR of 24% for FY14-17E and ROEs of 20%+, we maintain HDFC Bank as one of our top picks. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 142, , , ,849.0 Pre -tax profit (Rs mn) 127, , , ,230.5 Net attributable profit (Rs mn) 84, , , ,413.3 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 123

124 HDFC Bank HDBK.BO / HDFCB IN Price (12 Jan 15): Rs968.10, Rating: OUTPERFORM, Target Price: Rs1,178.00, Analyst: Ashish Gupta Target price scenario Scenario TP %Up/Dwn Assumptions Upside 1, Sustainable higher RoEs as normalised retail credit cost remain below normalised cost for extended periods Central case 1, Valued at 19x earnings, 10% discount to hist avg Downside Reversal in asset environment, significant increase in 1.49 competition, high stock valuations and significant slowdown in consumer lending. Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 411, , , ,194 Interest expense 226, , , ,942 Net interest income 184, , , ,253 Fee and commission income 78,092 83, , ,280 Trading income Insurance income (& premiums) Other income Total non-interest income 78,092 83, , ,280 Total income 262, , , ,532 Personal expense 41,790 46,750 54,886 67,242 Other expenses 78,632 91, , ,442 Total expenses 120, , , ,683 Pre-provision profit 142, , , ,849 Loan loss provisions 15,880 20,270 26,268 33,618 Operating profit 126, , , ,230 Associates/JV Other non-operating inc./(exp.) 1,039 2,500 2,000 2,000 Pre-tax profit 127, , , ,230 Taxes 42,937 52,186 65,558 81,817 Net profit before minorities 84, , , ,413 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 84, , , ,413 Analyst adjustments Net profit (Credit Suisse) 84, , , ,413 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 3,051,695 3,759,271 4,666,181 5,797,155 Risk provisions Net customer loans 3,030,003 3,733,939 4,634,343 5,755,967 Interbank Loans 142, , , ,477 Investment & Securities 1,209,511 1,496,558 1,841,906 2,289,780 Cash & cash equivalents 253, , , ,585 Fixed Assets 29,399 34,178 40,055 46,854 Intangibles Other assets 251, , , ,992 Total assets 4,915,995 6,016,875 7,444,783 9,222,656 Liabilities Interbank deposits Customer deposits 3,673,375 4,554,985 5,693,731 7,117,164 Total deposits 3,673,375 4,554,985 5,693,731 7,117,164 Other liabilities 807, ,964 1,134,962 1,364,239 Total liabilities 4,481,209 5,501,949 6,828,693 8,481,402 Shareholders' equity 434, , , ,254 Minority interests Preferred stock Total liabilities & equity 4,915,995 6,016,875 7,444,783 9,222,656 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth (%) Fee income growth (%) Cost income ratio (%) Loan loss provisions (%) Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) 2,358 2,358 2,358 2,358 EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 124

125 Asia Pacific / India Regional Banks ICICI Bank Rating NEUTRAL* Price (12 Jan 15, Rs) Target price (Rs) (from ) ¹ Upside/downside (%) 4.8 Mkt cap (Rs mn) 2,006,656 (US$32,287 mn) Number of shares (mn) 5, Free float (%) week price range ADTO - 6M (US$ mn) 64.2 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Share price performance Research Analysts Ashish Gupta [email protected] Prashant Kumar [email protected] Price (LHS) Rebased Rel (RHS) Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 09/01/15 On 09/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) (ICBK.BO / ICICIBC IN) INCREASE TARGET PRICE A strong comeback Large captive customer base provides opportunities for cross-sell. ICICI has gone through consolidation in its retail portfolio during FY08-11 after deterioration in asset quality. The share of unsecured portfolio dropped from 20% of retail to ~9% over the three years. Retail growth only started picking up towards FY14 and accelerated to 25% YoY (as of 1H15). We expect retail growth to remain strong driving share of retail to ~45% by FY17E (from ~40% currently). With ~27 mn customers, management believes that the potential for cross sell hasn't been fully leveraged and there is potential for market share gains by (a) expanding geographical reach, (b) increasing activities at branches, (c) improving turnaround time. Gaining market share through improved distribution reach. The bank is focusing on increased role of branches. It is currently sourcing ~35% of its mortgage from branches (~25% earlier) and targets reaching 40%. It doubled its auto disbursement volumes primarily by expanding geographical reach for distribution. For unsecured loans, ~75% of its business is from existing customers. Focus remains on secured products. Mortgage and auto continue to be the core of the retail portfolio (~75% of total). Unsecured products have the potential to grow from the existing customer base; however, the share in retail is likely to remain below ~10% (7% as of now). Credit cost for most retail products continues to remain below budgeted levels resulting in healthy profitability despite pressure on pricing. ICICI Bank is also increasing focus on the self-employed segment especially on business banking and CVs. Leveraging technology to tap rural opportunities. Management mentioned that rural operations are profitable as high opex is offset by liability business. The bank is using technological initiatives such as SMS banking, tab banking, cashless payment systems to reduce the cost of operations in rural areas and recently launched "digital village" initiative in Gujarat. It is the second largest player in mobile banking by transaction value. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 165, , , ,762.7 Pre -tax profit (Rs mn) 139, , , ,411.6 Net attributable profit (Rs mn) 98, , , ,588.1 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 125

126 ICICI Bank ICBK.BO / ICICIBC IN Price (12 Jan 15): Rs346.45, Rating: NEUTRAL, Target Price: Rs363.00, Analyst: Ashish Gupta Target price scenario Scenario TP %Up/Dwn Assumptions Upside Reduction in interest rate with improvement in macro conditions resulting in reduced stress on asset quality of corporate book Central case Based on sum of the parts, valuing the core bank at x adjusted book value. Downside (1) Significant slowdown in lending in high interest rate (26.93) environment, (2) substantial deterioration in asset quality and (3) slower international growth Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 441, , , ,148 Interest expense 277, , , ,465 Net interest income 164, , , ,683 Fee and commission income 83,669 94, , ,877 Trading income Insurance income (& premiums) Other income 20,610 22,843 25,870 28,419 Total non-interest income 104, , , ,296 Total income 269, , , ,979 Personal expense 42,202 48,835 56,832 65,463 Other expenses 60,887 68,193 79,786 91,754 Total expenses 103, , , ,217 Pre-provision profit 165, , , ,763 Loan loss provisions 26,264 32,945 33,077 38,351 Operating profit 139, , , ,412 Associates/JV Other non-operating inc./(exp.) Pre-tax profit 139, , , ,412 Taxes 41,577 45,939 55,936 68,823 Net profit before minorities 98, , , ,588 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 98, , , ,588 Analyst adjustments Net profit (Credit Suisse) 98, , , ,588 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 3,459,105 4,043,922 4,781,427 5,721,457 Risk provisions Net customer loans 3,387,026 3,960,026 4,686,877 5,611,441 Interbank Loans 363, , , ,030 Investment & Securities 1,645,182 1,923,509 2,262,973 2,705,792 Cash & cash equivalents 51,869 60,551 71,336 85,408 Fixed Assets 46,781 54,277 63,568 75,615 Intangibles Other assets 452, , , ,192 Total assets 5,946,416 6,899,235 8,080,139 9,611,479 Liabilities Interbank deposits Customer deposits 3,319,137 3,966,368 4,759,642 5,806,763 Total deposits 3,319,137 3,966,368 4,759,642 5,806,763 Other liabilities 1,858,300 2,083,823 2,374,737 2,742,259 Total liabilities 5,177,436 6,050,191 7,134,379 8,549,022 Shareholders' equity 732, , ,914 1,025,611 Minority interests Preferred stock 36,846 36,846 36,846 36,846 Total liabilities & equity 5,946,350 6,899,235 8,080,139 9,611,479 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth Net interest margin Fee growth Cost-inc ratio P&L provision (% of loans) Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) 5,775 5,775 5,775 5,775 EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 126

127 Asia Pacific / India Regional Banks IndusInd Bank Rating OUTPERFORM* Price (12 Jan 15, Rs) Target price (Rs) (from ) ¹ Upside/downside (%) 13.8 Mkt cap (Rs mn) 439,856 (US$7,077 mn) Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 9.5 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Share price performance Research Analysts Ashish Gupta [email protected] Prashant Kumar [email protected] Price (LHS) Rebased Rel (RHS) Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) (INBK.BO / IIB IN) INCREASE TARGET PRICE Growth to pick up Key beneficiary of CV cycle recovery. IndusInd merged with Ashok Leyland Finance in 2004 to become a leading commercial vehicle financier. Its CV portfolio grew at a strong pace to reach ~24% of loan book before the bank running down the CV portfolio to ~16% as signs of stress become visible. With the CV cycle recovery gaining more traction, IndusInd would be again a key beneficiary of the recovery. Retail loan growth has started to look up as vehicle finance disbursements have again started outpacing re-payments and strong traction from non-auto retail (LAP). Management continues to guide towards a stronger 2H, as it expects a revival in the key auto (CV) segment to come through in the 2H. Cost pressure is still there but is likely to go down on account of improvement in freight rates and recent fall in crude prices yet to be fully reflected in diesel prices. In case of opening up of the mining sector, there could be significant pick-up in tippers/truck segment. We expect the share of retail loans to move back up to ~50% by FY17E from 43% currently. Continue to build-on its niche capabilities. The bank's focus is on being the leading market player in its focus segments and geographies. It is among the top five players in CV lending and now No.1 in 2W financing. In SME segments also, the bank has been focussing on small and micro businesses to drive growth. Its MFI portfolio of ~Rs6 bn is through partnerships with SHGs and business correspondents. Supply chain financing has been growing well with it focusing on flow business. It has been focusing on leveraging corporate relationships to rope in vendors, dealers and presence across the supply chain. Increasing retail share to aid NIM expansion. The bank continues to invest in a franchise build-up which is aiding healthy CASA growth. CASA benefit has not been visible so far, offset by a shift in loan mix towards corporate. If the expected recovery in the retail segment (especially CVs) comes through, it will drive strong NIM expansion, with the bank being a big beneficiary of wholesale rate moderation as well. We retain OUTPERFORM but raise TP to Rs946. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 25, , , ,995.3 Pre -tax profit (Rs mn) 21, , , ,555.4 Net attributable profit (Rs mn) 14, , , ,385.5 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 127

128 IndusInd Bank INBK.BO / IIB IN Price (12 Jan 15): Rs831.40, Rating: OUTPERFORM, Target Price: Rs946.00, Analyst: Ashish Gupta Target price scenario Scenario TP %Up/Dwn Assumptions Upside 1, Easing of liquidity with reduction in interest rate. Central case At 18x earnings, 10% discount to long term hist avg for HDFC Bank Downside Prolonged downturn in the commercial vehicle industry (8.97) resulting in higher delinquencies and credit cost. Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 82, , , ,263 Interest expense 53,628 64,988 79,021 94,939 Net interest income 28,907 35,688 46,436 59,324 Fee and commission income 18,387 22,968 27,574 33,088 Trading income ,000 Insurance income (& premiums) Other income Total non-interest income 18,905 23,768 28,374 34,088 Total income 47,812 59,456 74,810 93,412 Personal expense Other expenses 21,853 27,566 34,108 41,417 Total expenses 21,853 27,566 34,108 41,417 Pre-provision profit 25,960 31,890 40,701 51,995 Loan loss provisions 4,676 4,528 5,651 6,440 Operating profit 21,283 27,362 35,051 45,555 Associates/JV Other non-operating inc./(exp.) Pre-tax profit 21,283 27,362 35,051 45,555 Taxes 7,203 9,111 11,672 15,170 Net profit before minorities 14,080 18,250 23,379 30,385 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 14,080 18,250 23,379 30,385 Analyst adjustments Net profit (Credit Suisse) 14,080 18,250 23,379 30,385 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 557, , ,035 1,083,044 Risk provisions Net customer loans 551, , ,087 1,069,774 Interbank Loans Investment & Securities Cash & cash equivalents 67,694 76,823 88, ,463 Fixed Assets Intangibles Other assets 247, , , ,541 Total assets 866,287 1,070,777 1,328,262 1,659,778 Liabilities Interbank deposits Customer deposits 605, , ,099 1,205,356 Total deposits 605, , ,099 1,205,356 Other liabilities 174, , , ,668 Total liabilities 779, ,255 1,207,358 1,514,024 Shareholders' equity 86, , , ,754 Minority interests Preferred stock Total liabilities & equity 866,287 1,070,777 1,328,262 1,659,778 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth Net interest margin Fee income growth Cost income ratio Credit cost (%) Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 128

129 Asia Pacific / India Regional Banks Yes Bank Ltd Rating OUTPERFORM* [V] Price (12 Jan 15, Rs) Target price (Rs) ¹ Upside/downside (%) 10.9 Mkt cap (Rs mn) 324,583 (US$5,223 mn) Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 30.1 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). Research Analysts Ashish Gupta [email protected] Prashant Kumar [email protected] (YESB.BO / YES IN) COMPANY UPDATE Starting from scratch Foundation in place for growth to take off. The bank has been building its liability franchise at an accelerated pace expanding its branch network to ~580 branches (from 214 as of FY11) and would continue to grow its branch network at ~20% each year. Especially post de-regulation of savings deposit rate, the bank has been adding savings customers at k per quarter. Management believes it has now reached the critical size in terms of branches & customers and has enough experience with the customers to start offering credit products. Liability franchise has reached the critical mass to start driving lending business. De-centralised business model with focus on branches. Management has tried to develop a more de-centralised model by delegation and empowering leadership. Branches would be the key business driver for nonwholesale businesses. Instead of function centric business model, they are more inclined towards a branch centric model with performance of the sales team based not only on acquisition of customers but their retention and performance. This ensures the focus on quality accounts and keeps sub-par accounts from entering into the system. Share of branch banking in total loans to reach 30% by FY17E. Management is targeting share of branch banking loans to reach 30% by FY17E from 17% currently. While the SME segment would continue to be the largest business (~18% vs current 8%), consumer loan would grow at a faster pace on a very small base (to reach ~10% of loans vs current 2%). Following its de-centralised approach, Yes Bank has increased the number of credit hubs to ten from two earlier. Increasing granularity of the business would reduce some of the concerns around being too wholesale focused and would reduce volatility across the business cycles. Share price performance Price (LHS) Rebased Rel (RHS) 200 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 09/01/15 On 09/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov Op profit (Rs mn) 24, , , ,210.5 Pre -tax profit (Rs mn) 23, , , ,795.2 Net attributable profit (Rs mn) 16, , , ,437.7 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 129

130 Yes Bank Ltd YESB.BO / YES IN Price (12 Jan 15): Rs777.90, Rating: OUTPERFORM [V], Target Price: Rs863.00, Analyst: Ashish Gupta Target price scenario Scenario TP %Up/Dwn Assumptions Upside 1, (1) sharp cut in the interest rates, (2) significant pickup in economic growth & (3) higher-than-expected margins Central case At 13x forward earnings, in-line with long term historical trading multiple Downside Slowdown in growth, significant deterioration in asset (9.36) quality Valuation 3/14A 3/15E 3/16E 3/17E EPS growth (%) P/E (x) P/B (x) P/TB (x) Dividend yield (%) Income statement (Rs mn) 3/14A 3/15E 3/16E 3/17E Interest income 99, , , ,570 Interest expense 72,651 80,160 93, ,084 Net interest income 27,163 33,632 42,149 52,486 Fee and commission income 14,438 18,021 22,370 27,895 Trading income Insurance income (& premiums) Other income Total non-interest income 14,438 18,021 22,370 27,895 Total income 41,601 51,653 64,519 80,382 Personal expense 7,844 9,502 11,552 14,184 Other expenses 9,655 12,551 15,563 18,987 Total expenses 17,499 22,054 27,116 33,171 Pre-provision profit 24,102 29,599 37,404 47,211 Loan loss provisions 3,617 3,080 4,327 5,615 Operating profit 20,485 26,519 33,077 41,595 Associates/JV Other non-operating inc./(exp.) 2,778 2,000 2,200 2,200 Pre-tax profit 23,263 28,519 35,277 43,795 Taxes 7,085 8,556 10,759 13,358 Net profit before minorities 16,178 19,964 24,517 30,438 Minority interests Preferred dividends Exceptionals/extraordinaries Reported net profit 16,178 19,964 24,517 30,438 Analyst adjustments Net profit (Credit Suisse) 16,178 19,964 24,517 30,438 Balance sheet (Rs mn) 3/14A 3/15E 3/16E 3/17E Assets Gross customer loans 557, , ,077 1,067,640 Risk provisions Net customer loans 556, , ,987 1,062,052 Interbank Loans 13,501 15,455 18,806 23,222 Investment & Securities Cash & cash equivalents 45,416 48,626 59,629 74,284 Fixed Assets 2,935 3,583 4,499 5,728 Intangibles Other assets 471, , , ,059 Total assets 1,090,158 1,283,232 1,555,619 1,914,344 Liabilities Interbank deposits Customer deposits 741, ,756 1,089,695 1,383,913 Total deposits 741, ,756 1,089,695 1,383,913 Other liabilities 277, , , ,681 Total liabilities 1,018,940 1,166,436 1,419,306 1,752,594 Shareholders' equity 71, , , ,750 Minority interests Preferred stock Total liabilities & equity 1,090,158 1,283,232 1,555,619 1,914,344 Key earnings drivers 3/14A 3/15E 3/16E 3/17E Loan growth Net interest margin Fee growth Cost-inc ratio P&L provision (% of loans) Per share data 3/14A 3/15E 3/16E 3/17E Shares (wtd avg.) (mn) EPS (Credit Suisse) (Rs) BVPS (Rs) Tangible BVPS (Rs) DPS (Rs) Key ratios 3/14A 3/15E 3/16E 3/17E Profitability and margins (%) ROE stated ROE - CS adj ROA - CS adj Gearing (x) Asset quality (%) NPL/ gross loans B/S loan loss coverage Loan/ deposit ratio Capital ratios (%) Capital adequacy ratio Tier 1 ratio Equity Tier 1 ratio Growth(%) Revenue Operating expense Pre-provision profit Net profit Deposit Source: Company data, Thomson Reuters, Credit Suisse estimates MF P/E multiple Source: IBES 12MF P/B multiple India Financials Sector 130

131 Asia Pacific / India Consumer Finance Rating OUTPERFORM* Price (12 Jan 15, Rs) 1, Target price (Rs) 1,400.00¹ Upside/downside (%) 34.4 Mkt cap (Rs mn) 236,366 (US$3,803 mn) Number of shares (mn) Free float (%) week price range 1, ADTO - 6M (US$ mn) 11.0 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Share price performance Research Analysts Sunil Tirumalai [email protected] Price (LHS) Rebased Rel (RHS) Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Shriram Transport Finance Co Ltd (SRTR.BO / SHTF IN) COMPANY UPDATE CV recovery play Market leader with an established track record in CV loans; likely to benefit from a turn in the CV cycle. The CV industry is highly cyclical, with the cycles coinciding with economic cycles in the country. With the pick-up in CV sales already coming through (along with cooling down in diesel prices), CV financiers should see recovery in both growth and collections. SHTF is the market leader in the used CV segment and will benefit from the pick-up in the CV cycle. Its credit costs/gnpa levels have remained elevated (2%+/4%) for some time, and should correct with a recovery helping RoE. NIM/RoE decline due to cyclical factors. SHTF suffered steady erosion in returns from 28% RoE in FY10 to 14% in Sep-14 quarter. There have been apprehensions around how much of worsening of NIMs/ROE is due to structural vs cyclical reasons. Our analysis suggests that bulk of the NIM/RoE compression for the company was due to cyclical factors, and the sustainable RoE for the company is 19%+ (and could even spike above briefly, given chances of provision write-backs with SHTF's conservative provisioning policy). Early signs of a recovery in the CV market continue. Our recent channel checks with truck financiers suggest that the cash flow situation for truck operators is showing signs of improvement. Our discussions with used CV NBFCs based in Mumbai indicate that monthly collections have now improved to 1.5x of monthly EMI as against 1x EMI in May 2014, and sub- 1x in Dec However, specific to Shriram, the cooling down of the securitisation market this year (due to relaxation of PSL rules for banks) could lead to some disappointment in the short term. Valuation. Shriram is trading at 2.0x FY16E book. With growth/ earnings expected to pick up with a recovery in the economy, the stock appears attractive. With earnings CAGR of 20% for FY14-17E and ROEs of 19-20%+, Shriram is one of our top picks. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 30, , , ,840.9 Pre -tax profit (Rs mn) 19, , , ,197.9 Net attributable profit (Rs mn) 13, , , ,588.1 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 Ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 131

132 Asia Pacific / India Mortgage Finance LIC Housing Finance Ltd Rating OUTPERFORM* Price (12 Jan 15, Rs) Target price (Rs) (from ) ¹ Upside/downside (%) 17.3 Mkt cap (Rs mn) 232,246 (US$3,737 mn) Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 19.2 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Research Analysts Sunil Tirumalai [email protected] Chunky Shah [email protected] (LICH.BO / LICHF IN) INCREASE TARGET PRICE Beneficiary of fall in wholesale rates LICHF in a sweet spot in the mortgage segment. LICHF is the thirdlargest mortgage player in India (second largest among non-banks) with a 10% market share. We believe one of its key strengths is its strong parentage (parent LIC is the largest insurance company in India). Exclusive access to over 7,000 agents of its parent makes LICHF s distribution system quite formidable versus competition, in our view Beneficiary of falling bond yields. Bond markets are the prime funding source (~68%) for LICHF and have increased from 58% in FY11. Bank borrowings have dropped from 30% to 24% during the same period. Rising liquidity continues to push down wholesale funding costs, with AAA bond yields touching 8.5% this week down 60 bp in three months. The easing bond yields cycle is driving a good drop in LICHF funding costs. With falling funding costs and a higher proportion of fixed-interest loan assets, we believe LICHF should start seeing NIM expansion. Strong business momentum. The structural growth story in India s mortgage segment remains strong and HFCs continue to be the most efficient and profitable players in the segment. Even as interest rates and mortgage rates increased sharply, loan growth at LICHF continued to remain healthy. The company has grown faster than industry recently, clocking a three-year loan book CAGR of 21%. We expect LICHF to continue to grow strongly at 20% CAGR over the next three years. Share price performance Price (LHS) Rebased Rel (RHS) 0 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Increase TP to Rs540. We raise our TP for LICHF to Rs540 as with lower funding costs, LICHF should see meaningful earnings uplift. We have factored in better funding costs for LICHF leading to higher NIM leading to earnings change of 2-7% for FY16/FY17. At 2.5x/12.5x FY16E P/B/ P/E, we believe the stock is reasonably valued. We reiterate OUTPERFORM. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 18, , , ,315.9 Pre -tax profit (Rs mn) 18, , , ,829.7 Net attributable profit (Rs mn) 13, , , ,285.7 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 132

133 Asia Pacific / India Consumer Finance Rating OUTPERFORM* Price (12 Jan 15, Rs) Target price (Rs) ¹ Upside/downside (%) 8.5 Mkt cap (Rs mn) 175,549 (US$2,825 mn) Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 7.0 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. Research Analysts Sunil Tirumalai [email protected] Chunky Shah [email protected] Mahindra and Mahindra Financial Services (MMFS.BO / MMFS IN) COMPANY UPDATE Slow recovery under way Strategy of going closer to the customer. MMFS continues to invest into collection efforts (some of the branches in western India have seen headcount growing at +50% over the last year). MMFS is splitting larger branches into smaller better manageable units. Incrementally, a number of rural collection centres that are aimed at improving collection efficiency have been opened in the past 12 months. Should rein in asset quality problems. MMFS' strategy above is aimed at the runaway NPA level of 6%+ for the last few quarters. We believe that as we enter into seasonally strong periods for MMFS, and as new investments into the branch structure as explained above get entrenched, the collections situation should start to improve. Low room to cushion 90DPD transition. Unless the NPA situation eases from current levels, the expected transition to 90DPD NPA recognition could lead to some temporary pain for MMFS financials. The company's low coverage levels (53% as of Sep-14) leave it with very little room for cushioning the impact from tighter NPA recognition rules. Valuation. While MMFS appears to be going through short-term challenges, we believe this is already priced into the stock after a sharp underperformance vs peers. We retain our OUTPERFORM rating and TP of Rs335. Share price performance Price (LHS) Rebased Rel (RHS) Jan-13 May-13 Sep-13 Jan-14 May-14 Sep The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 12/01/15 On 12/01/15 the spot exchange rate was Rs62.15/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Pre-prov op profit (Rs mn) 19, , , ,477.3 Pre -tax profit (Rs mn) 14, , , ,929.8 Net attributable profit (Rs mn) 9, , , ,248.4 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a Consensus EPS (Rs) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rs) P/B (x) ROE (%) ROA (%) Tier 1 ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. India Financials Sector 133

134 Companies Mentioned (Price as of 12-Jan-2015) Aditya Birla Nuv (ABRL.BO, Rs ) Axis Bank Limited (AXBK.BO, Rs501.55, OUTPERFORM, TP Rs593.0) BFS (BJFS.BO, Rs1270.5) Bajaj Finance Ltd (BJFN.BO, Rs , OUTPERFORM, TP Rs4350.0) Bank of Baroda (BOB.BO, Rs1079.7) Bank of India (BOI.BO, Rs298.85) DHFL (DWNH.NS, Rs437.3) GIC Housing (GICH.NS, Rs280.7) Gruh Finance (GRUH.NS, Rs293.8) HDFC Bank (HDBK.BO, Rs965.1, OUTPERFORM, TP Rs1178.0) Housing Development Finance Corp (HDFC.BO, Rs1129.7) ICICI Bank (ICBK.BO, Rs346.45, NEUTRAL, TP Rs363.0) IDFC Ltd (IDFC.BO, Rs155.3) ING Vysya Bank (VYSA.BO, Rs960.0) Indiabulls Housing Finance Ltd (INBF.BO, Rs497.85, OUTPERFORM, TP Rs630.0) Indian Overseas Bank (IOBK.BO, Rs60.7) IndusInd Bank (INBK.BO, Rs831.4, OUTPERFORM, TP Rs946.0) Jammu and Kashmir Bank (JKBK.BO, Rs150.35) Kotak Mahindra Bank Ltd (KTKM.BO, Rs1373.0) L&T Finance Holdings Limited (LTFH.BO, Rs67.55) LIC Housing Finance Ltd (LICH.BO, Rs460.2, OUTPERFORM, TP Rs540.0) Magma Fincorp Ltd (MAGM.NS, Rs106.7) Mahindra and Mahindra Financial Services Ltd (MMFS.BO, Rs308.65, OUTPERFORM, TP Rs335.0) Punjab National Bank Ltd (PNBK.BO, Rs209.2) RHFL (RHFL.NS, Rs684.45) Reliance Capital Ltd (RLCP.BO, Rs470.3) SKS Microfinance Ltd. (SKSM.BO, Rs441.45, NEUTRAL[V], TP Rs390.0) Shriram City Union Finance Ltd (SHCU.BO, Rs1983.1, UNDERPERFORM, TP Rs1570.0) Shriram Transport Finance Co Ltd (SRTR.BO, Rs1041.8, OUTPERFORM, TP Rs1400.0) State Bank Of India (SBI.BO, Rs307.05) Sundaram Finance (SNFN.BO, Rs1311.5) Union Bank of India (UNBK.BO, Rs235.85) Yes Bank Ltd (YESB.BO, Rs777.9, OUTPERFORM[V], TP Rs863.0) Important Global Disclosures Disclosure Appendix Sunil Tirumalai and Ashish Gupta, each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. 3-Year Price and Rating History for Axis Bank Limited (AXBK.BO) AXBK.BO Closing Price Target Price Date (Rs) (Rs) Rating 23-Feb O 16-Oct Jan Oct Apr May Jun Nov * Asterisk signifies initiation or assumption of coverage. O U T PERFO RM India Financials Sector 134

135 3-Year Price and Rating History for HDFC Bank (HDBK.BO) HDBK.BO Closing Price Target Price Date (Rs) (Rs) Rating 24-Feb O 09-Apr Jul Nov Jan Apr May Nov * Asterisk signifies initiation or assumption of coverage. O U T PERFO RM 3-Year Price and Rating History for ICICI Bank (ICBK.BO) ICBK.BO Closing Price Target Price Date (Rs) (Rs) Rating 31-Jan N 30-Apr Jul Oct Jan Jul Oct Apr May Oct Nov * Asterisk signifies initiation or assumption of coverage. N EU T RA L 3-Year Price and Rating History for IndusInd Bank (INBK.BO) INBK.BO Closing Price Target Price Date (Rs) (Rs) Rating 24-Feb N 19-Apr Jul Jan Jul U 14-Oct Apr May O 11-Sep Nov * Asterisk signifies initiation or assumption of coverage. N EU T RA L U N D ERPERFO RM O U T PERFO RM India Financials Sector 135

136 3-Year Price and Rating History for LIC Housing Finance Ltd (LICH.BO) LICH.BO Closing Price Target Price Date (Rs) (Rs) Rating 20-May O * 19-Aug Oct Apr May Oct Dec * Asterisk signifies initiation or assumption of coverage. O U T PERFO RM 3-Year Price and Rating History for Mahindra and Mahindra Financial Services Ltd (MMFS.BO) MMFS.BO Closing Price Target Price Date (Rs) (Rs) Rating 29-Jan U * 24-Apr N 21-Oct Apr O 19-May Jul Sep Oct Nov * Asterisk signifies initiation or assumption of coverage. U N D ERPERFO RM N EU T RA L O U T PERFO RM 3-Year Price and Rating History for SKS Microfinance Ltd. (SKSM.BO) SKSM.BO Closing Price Target Price Date (Rs) (Rs) Rating 12-Jul R 23-Aug U 12-Sep NR 30-Apr * 19-May R * Asterisk signifies initiation or assumption of coverage. REST RICT ED U N D ERPERFO RM N O T RA T ED India Financials Sector 136

137 3-Year Price and Rating History for Shriram Transport Finance Co Ltd (SRTR.BO) SRTR.BO Closing Price Target Price Date (Rs) (Rs) Rating 06-Mar O 08-Oct * 04-Jan May Jul Oct Apr May Aug Oct Dec * Asterisk signifies initiation or assumption of coverage. O U T PERFO RM 3-Year Price and Rating History for Yes Bank Ltd (YESB.BO) YESB.BO Closing Price Target Price Date (Rs) (Rs) Rating 24-Jan U 12-Mar R 09-Apr U 25-Apr Jul Aug Jan Jul Oct Apr May O 30-Oct Nov Jan * Asterisk signifies initiation or assumption of coverage. U N D ERPERFO RM REST RICT ED O U T PERFO RM The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts stock rating are defined as follows: Outperform (O) : The stock s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outper forms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperfor ms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-japan Asia stocks, ratings are based on a stock s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock s absolute total return potential to its current share price and (2) the relative attractiveness of a stock s total return pote ntial within an analyst s coverage universe. For Australian and New Zealand stocks, 12 -month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the % and % levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock s total return relative to the average total return of the relevant country or regional benchmark. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. India Financials Sector 137

138 Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts sector weightings are distinct from analysts stock ratings and are based on the analyst s expectations for the fundamentals and/or valuation of the sector* relative to the group s historic fundamentals and/or valuation: Overweight : The analyst s expectation for the sector s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst s expectation for the sector s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst s expectation for the sector s fundamentals and/or valuation is cautious over the next 12 months. *An analyst s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cov er multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is: Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 46% (54% banking clients) Neutral/Hold* 38% (50% banking clients) Underperform/Sell* 14% (43% banking clients) Restricted 2% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are dete rmined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdin gs, and other individual factors. Credit Suisse s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. Price Target: (12 months) for Shriram Transport Finance Co Ltd (SRTR.BO) Method: We value Shriram's stock price at a 14x P/E on two-year forward EPS of Rs100, to arrive at a target price of Rs1,400 per share. Risk: Risks to our target price of Rs1,400 for Shriram Transport Finance Co are: (1) credit losses in the non-core asset financing businesses that Shriram is entering; (2) regulatory risks on off-balance-sheet funding (securitisation/assignment); and (3) a sharp rise in interest rates in the economy. Price Target: (12 months) for LIC Housing Finance Ltd (LICH.BO) Method: Our target price of Rs540 for LIC Housing Finance Ltd is based on a P/E (price-to-earnings) multiple of 12.5x on our 24M forward EPS (earnings per share) of Rs45. Risk: Risks to our target price of Rs540 for LIC Housing Finance Ltd include: (1) a slowdown in mortgages; (2) a reversal of the declining interest rate scenario; and (3) frequent management changes. Price Target: (12 months) for ICICI Bank (ICBK.BO) Method: We value ICICI Bank based on sum of the parts at a target price of Rs363. We value the core bank at 2.2x fwd adj book value. Risk: Key risks to our Rs363 target price for ICICI Bank price are: ( 1) significant slowdown in lending in high interest rate environment, (2) substantial deterioration in asset quality environment, (3) slower international growth, (4) deterioration in the insurance business being worse than expected. Price Target: (12 months) for IndusInd Bank (INBK.BO) Method: The target price of Rs946 for IndusInd Bank has been arrived at on the basis of 18x fwd earnings of Rs47. Risk: Risks to our target price of Rs946 for IndusInd Bank include slower recovery in CV cycle and continued asset quality pressure. India Financials Sector 138

139 Price Target: (12 months) for Axis Bank Limited (AXBK.BO) Method: We are valuing Axis Bank at 2.4x fwd book, 10% premium to its historical trading average multiple (8-year)to arrive at our target price of Rs593. Risk: Key risks to our Rs593 target for Axis Bank price include: (1) significant slowdown in lending in high interest rate environment, (2) substantial deterioration in asset quality environment, (3)significant increase in competition and (4) sharp rise in wholesale deposit rates. Price Target: (12 months) for Indiabulls Housing Finance Ltd (INBF.BO) Method: Our 12M target price of Rs630 for Indiabulls is based on 10x P/E multiple over our 24M forward EPS of Rs63. Risk: Risks to our Rs630 target price include: (1) Sharp rise in competitive pressures in LAP segment, which is a key contributor to profitability at Indiabulls, and (2) a slowdown in the housing market in India, leading to slowdown in growth for Indiabulls. Price Target: (12 months) for HDFC Bank (HDBK.BO) Method: We are valuing HDFC Bank at 19x fwd earnings to arrive at our target price of Rs1,178. Risk: Key upside risks to our target price of Rs1,178 for HDFC Bank are pick-up in asset growth, benign retail asset quality, M&A activity in the longer-term. Downside risks are a reversal in asset environment, significant increase in competition, high stock valuations and significant slowdown in consumer lending. Price Target: (12 months) for Bajaj Finance Ltd (BJFN.BO) Method: Our 12M forward Rs4,350 target price for Bajaj Finance is based on 14x P/E multiple over 24M forward EPS of Rs308. Risk: Risks to our target price of Rs4,350 include: (1) sharp rise in competition in loans against property and small business lending segments, leading to a drop in margins, and (2) a drop in asset quality arising from risks to economic growth. Price Target: (12 months) for Yes Bank Ltd (YESB.BO) Method: We are valuing Yes Bank at 13x fwd earnings to arrive at our target price of Rs863. Risk: Key risks to our target price of Rs863 for Yes Bank are: (1) Slower-than-expected recovery, (2) tighter access to funds, (3) increase in asset quality issues. Price Target: (12 months) for SKS Microfinance Ltd. (SKSM.BO) Method: Our 12M forward target price of Rs390 on SKS is based on 2.4x PB multiple applied on 24M forward book value (adjusted for tax benefits). Risk: Upside risks to our Rs390 target price include: (1) stronger-than-expected growth in the company's MFI business, (2) relaxation in regulations either on ticket sizes, spreads or multiple lending. Downside risks to our target price include: (1) political risks like in AP 2010, and (2) systemic risks from the self help group system. Price Target: (12 months) for Shriram City Union Finance Ltd (SHCU.BO) Method: Our 12M forward target price of Rs1,570 for Shriram City Union is based on 12x PE multiple (10% discount to Shriram Transport's target multiple) applied on 24M forward EPS of Rs131. Risk: The risks to our Rs1,570 target price on SCUF include: (1) sharp rise in growth across gold loans and SME segments leading to higher than expected earnings, and (2) a benign competitive environment leading to expansion of margins in a falling interest rate environment. Price Target: (12 months) for Mahindra and Mahindra Financial Services Ltd (MMFS.BO) Method: Our target price of Rs335 for Mahindra and Mahindra Financial Services is based on 11.5x 24M forward EPS of Rs29 (10% discount to historical mean multiple for MMFS). Risk: Key risks to our target price of Rs335 for Mahindra and Mahindra Financial Services are: (1) adverse impact on business from weak monsoons, (2) rise in competition, (3) worsening asset quality and (4) impact from potential NBFC guidelines. Please refer to the firm's disclosure website at for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (INBK.BO, SKSM.BO, LTFH.BO, BOI.BO, VYSA.BO, BOB.BO, MAGM.NS, KTKM.BO, IDFC.BO) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. India Financials Sector 139

140 Credit Suisse provided investment banking services to the subject company (SKSM.BO, LTFH.BO, VYSA.BO, IDFC.BO) within the past 12 months. Credit Suisse provided non-investment banking services to the subject company (KTKM.BO) within the past 12 months Credit Suisse has managed or co-managed a public offering of securities for the subject company (SKSM.BO, LTFH.BO, IDFC.BO) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (SKSM.BO, LTFH.BO, VYSA.BO, IDFC.BO) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (LICH.BO, YESB.BO, SKSM.BO, SHCU.BO, LTFH.BO, BOI.BO, VYSA.BO, BOB.BO, MAGM.NS, IDFC.BO) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (KTKM.BO) within the past 12 months As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (AXBK.BO, YESB.BO, SKSM.BO, MMFS.BO, MAGM.NS, HDFC.BO, IDFC.BO). For other important disclosures concerning companies featured in this report, including price charts, please visit the website at or call +1 (877) Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (SRTR.BO, LICH.BO, ICBK.BO, INBK.BO, AXBK.BO, INBF.BO, HDBK.BO, BJFN.BO, YESB.BO, SKSM.BO, SHCU.BO, MMFS.BO, JKBK.BO, LTFH.BO, BOI.BO, VYSA.BO, BOB.BO, IOBK.BO, MAGM.NS, PNBK.BO, UNBK.BO, SBI.BO, HDFC.BO, KTKM.BO, IDFC.BO) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (YESB.BO, SKSM.BO, LTFH.BO, VYSA.BO, IDFC.BO) within the past 3 years. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. To the extent this is a report authored in whole or in part by a non-u.s. analyst and is made available in the U.S., the following are important disclosures regarding any non-u.s. analyst contributors: The non-u.s. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-u.s. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities (India) Private Limited... Sunil Tirumalai ; Chunky Shah ; Kush Shah ; Ashish Gupta ; Prashant Kumar For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at or call +1 (877) India Financials Sector 140

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When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to pay the purchase price only. BK1908 India Financials Sector 141