FIG

Commercial Banks
abc
Global Research

Indian Banks  Growth of higher-cost deposits coupled

with slow loan growth adds to downside
Stress on NIMs and asset quality may risk on net interest margins
depress performance
 Bad loan provisions continue to grow
faster than loans. State-owned banks
appear a little better, for now

 Q307 has seen the rare event of bank

stocks underperform a rising market.
We continue to see value in three state-
owned banks. We raise our rating on
PNB to Overweight and lower our rating
on Axis to Underweight (V)

Twin risks are prominent

Indian banks are raising expensive deposits at a time when
loan growth is at a 3-year low. This could expand the
downside risk to net interest margins (NIMs) as deposit costs
would continue to re-price upwards, long after loan yields
have reset. Results for Q1FY08 reveal some evidence of this
with growth of net interest income down from 27% y-o-y to
15% even as loan yields rose by up to 90bp. The outlook for
NIMs could improve if loan growth were to recover in the
coming ‘busy season’.

10 September 2007 Bad loan provisions were down sequentially in Q1FY08 but
Anand Shanbhag *
grew 97% y-o-y. Provisions and NPLs are growing faster in
Analyst new banks whose net NPL ratio has risen close to that of
HSBC Securities & Capital Markets (India) Private Limited state-owned banks. Provisions of the latter decreased in
+91 22 22681234 anandshanbhag@hsbc.co.in
Q1FY08 but it remains to be seen if this is sustainable.
Saumya Agarwal *
Associate The current quarter is only the second instance in seven
HSBC Securities & Capital Markets (India) Private Limited
quarters when bank stocks underperformed in a rising
+91 22 22681235 saumyaagarwal@hsbc.co.in
market. Back in Q106 it was due to concern over impact of
rising bond yields. Now, it may be the concern over the fall
in NIMs and rise in bad loan provisions. At the same time,
state-owned banks have outperformed with the premium in
*Employed by a non-US affiliate of HSBC Securities (USA) Inc,
and is not registered/qualified pursuant to NYSE and/or NASD
valuation of new banks down to near a 4-year low.
regulations
We have an OW rating on Punjab National Bank and OW
Issuer of report: HSBC Securities and Capital Markets (India)
Private Limited (V) ratings on Bank of Baroda and Corporation Bank. We
have Neutral ratings on HDFC Bank, ICICI Bank, Neutral
Disclaimer & Disclosures
(V) on Yes Bank, UW (V) ratings on Axis Bank and ING
This report must be read with the
disclosures and the analyst certifications Vysya and UW on HDFC and SBI.
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
 FIG
Commercial Banks abc
10 September 2007

Shrinking loan / deposit ratio may

add stress to net interest margins
 High deposit rates lift deposit growth well above loan growth
 Adds to downside risk on NIMs with deposit re-pricing extending
into 2008 even as loan re-pricing is largely completed
 Q1FY08 results points to the stress with net interest income
dipping even as loan yields rose

Ill timed deposit growth? odds with the vigorous deposit gathering effort still
visible in most Indian banks.
High-cost deposits flow in while loan
growth is slowing Loan/ Deposit ratio (%)

Acceleration in deposit growth in Q1FY08 has 80%

seen it exceed loan growth for the first time since 75%
April 2004. The gap between loan and deposit 70%
growth has converged for the past four quarters
65%
and by end of July 2007 deposit growth (+24.2%)
60%
slipped above loan growth (+23.8%).
55%
Loan growth and Deposit growth (%)
50%
34% Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07

28% Source: HSBC

22% Aggressive deposit mobilization continues. The

rise in deposit growth correlates with the rise in
16%
deposit rates. The Weekly Statistical Supplement
10% (WSS) of the Reserve Bank of India (RBI) reports
Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 that the band of deposit rates for duration exceeding
Deposit grow th Loan grow th a year rose from 6.25% - 8% in August 2006 to
Source: HSBC 7.50% - 9.6% in August 2007. Most of this increase
happened before March 2007. WSS data points to
Loans / deposits ratio has contracted from c75% in rates staying unchanged over the past two months.
March to 70% at end of July, the lowest since Anecdotal data points to banks continuing to offer
December 2005. The sharp decline in this ratio is at rates near 9.5% for durations of 12 to 15 months.

2
 FIG
Commercial Banks
10 September 2007
Adds to the downside risk on NIMs
The high-cost deposits now being raised would
increase future deposit costs. The average deposit
costs of Indian banks changes slowly. We
estimate it takes between 12 to 24 months for all
fixed-cost deposits to be reset to higher rates. As
the current process is less than two quarters old,
we believe average deposit costs could rise by the
end of 2008.
That would normally be bad for net interest
margins (NIM) as loan yields rise relatively
quickly with c80% of loans carrying floating
rates. We believe the downside risk to NIMs is
exacerbated at a time when loan growth is falling
and is below deposit growth.
Stress visible in Q1 results
Two trends in the Q1 results are declining net
interest income and increase in cost of funding.
Sharp decline in net interest income growth
We analysed a universe of 25 banks comprising
16 public sector banks, 2 old private sector banks
and 7 new banks. An analysis of first quarter
ended June 2007 results show that the net interest
income growth (y-o-y) has nearly halved from the
level seen in the previous quarter of March 2007
Growth in net interest income y-o-y
60%
40%
20%
0%
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
PSU New All PVT
Source: HSBC
This trend is visible across all categories of banks
in our universe. In particular net interest income
growth slowed down from 22.7% (Public sector),
abc
22.3% (Private sector) and 43.3% (New) during
Q4 FY07 to 12.4% (Public sector), 17.0%(Private
sector) and 24.6% (New) during Q1FY08. This
translates to an average 15% net interest income
growth for the sector during Q1FY08 compared to
27% during Q4FY07.
Cost of funds highest in past 2 years
This is partly explained by the cost of funds,
which has been on an uptrend since March 2005.
Cost of funds for the sector increased an average
134bps y-o-y during Q12008 as compared to a
118bps increase y-o-y during Q4FY07.
In particular the cost of funds for the sector stood
at 6.8% at the end of Q1FY08, 170 bps higher
than the level seen at the end of March 2005.This
was largely brought about by new private banks
offering attractive rates of interest, c10% on short-
term deposits to investors. As a result the cost of
funds for new private sector banks increased by
140bps y-o-y during Q1FY08 compared to a 120
bps increase y-o-y for public sector banks.
Cost of funds (%)
9%
8%
7%
6%
5%
4%
Mar-05 Sep-05 Mar-06 Sep-06 Mar-07
PSU New All
Source: HSBC
As a result there was a surge in banks interest
expense of 52% y-o-y, during Q1FY08, one of the
sharpest increases since March 2006.This was
accompanied by a 68% increase in interest burden
for new private sector banks and 48% increase for
public sector banks.
3
 FIG
Commercial Banks abc
10 September 2007

Growth in Interest expense (%) y-o-y This improvement was brought about by public
60% sector banks which reported a notable 90bps
increase in spreads q-o-q to 4.7% in Q1FY08.In
50%
contrast the spreads of new private sector banks
40%
compressed by 50bps q-o-q to 3.3% on the back
30% of high cost of deposits.
20%
Spreads (%)
10%
5.0%
0%
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 4.5%

Source: HSBC
4.0%

Rise in benchmark rates has pulled 3.5%

up loan yields
3.0%
According to first quarter 2008 monetary policy, Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
the weighted average benchmark prime lending PSU New All
rates increased by 70bps q-o-q for public sector Source: HSBC

banks to 13.1% and 80bps q-o-q for private sector

banks to 14.9%during Q1FY08.
In particular, yield on advances for the sector
improved by 100bps q-o-q and c150bps y-o-y to
11.2% during Q1FY08. On a sequential basis
public sector banks reported a 100bps increase in
yields in Q1FY08, followed by new private sector
banks which reported a 70bps increase during the
same period.
Rebound in loan growth could
alleviate the situation
In August 2007 some banks cut rates on shorter
maturity deposits. However this may not be
sufficient for funding costs to stabilize as the
upward re- pricing has begun and may continue
for up to 2 years. Hence we continue to believe
margins will be under stress.

Yields on advances (%) A potential rebound in loan growth would be

good for margins in two ways:
12%
 It would expand the loans/deposit ratio. This
11% is good because more deposits would then be
deployed in loans where yields are generally
higher than other interest earning assets
10%

 Increased loan demand is more likely to

9% preserve loan yields.
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
PSU New All It may be early to predict the extent to which loan
growth could recover in September and beyond. The
Source: HSBC
consensus view attributes the fall in loan growth to
Spreads expand slower demand for retail loans. Our discussions with
a few banks reveal the hope that loan growth could
After shrinking the past 4 quarters, overall spreads
rise in the ‘busy season’ that begins in October.
for the sector expanded by 60bps q-o-q to 4.4%.

4
 FIG
Commercial Banks abc
10 September 2007

Rising NPLs are largely not from

corporate customers
 Seasonal decline seen in Q1FY08 specific provisions but the
uptrend persists, particularly in new banks
 Large rise in net NPL ratio of new banks pulls it close to the state-
owned banks
 Interest coverage of corporates stays high implying the new NPLs
may be largely from retail, small business and agriculture

Still a stress point However a comparison on a year-on -year basis,

Little comfort from the decline in
Q1 provisions
Provisions for NPL and growth in NPL provisions
35000
30000
25000
20000
15000
10000
5000
0 0%
Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
Prov ision for NPA (INRm, LHS)
Grow th in NPL prov isions (y -o-y , RHS)
Source: HSBC
We estimate the aggregate specific provisions for
a group of 28 Indian banks (including 10 banks
under our coverage) for Q1FY08 declined by 23%
q-o-q. This may be largely attributed to
seasonality particularly after the sustained rise in
specific provisions in FY07. The decline in
Q1FY07 had been 23% q-o-q.
points to a 97% growth in provisions for Q1FY08.
This is higher than the loan growth of c23% at the
end of June 2007.The sharpest increase in provisions
on a y-o-y basis was seen for new private banks
350% (131%) followed by public sector banks (84%).
300%
250% New private banks report higher
200%
NPL ratios
150%
100% The first quarter ended June 2007 saw a marginal
50% deterioration in the overall asset quality of
banks.Net NPL (%) for the sector stood at 1.08%
at the end of June 2007 as compared to 1.06% at
the end of March 2007 .This was primarily
attributed to the private sector banks, which
reported an increase in net NPL ratios despite
robust credit growth. In contrast net NPL of
public sector bank reported an improvement.
As of June 30, 2007 Net NPL(%) of New private
sector banks stood at 1.05% (+ 15bps q-o-q) ,
followed by old private banks at 1.06% (+10bps q-o-
q) and public sector banks at 1.10% (-2 bps q-o-q).

5
 FIG
Commercial Banks abc
10 September 2007

Net NPL(%) divided them into five approximately equal groups

1.3% with Group-1 containing the largest companies (by
1.2% revenue) and Group-5 the smallest. For each quarter
1.1% interest coverage is estimated by dividing the
1.0% reported PBDIT by the reported interest expense.
0.9%
This data points to gradual decline in interest
coverage in most of the groups over the past year.
0.8%
Yet, interest coverage stays high suggesting ample
0.7%
capability in these companies to service their debt.
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
So, it is unlikely that the corporate sector could have
PSU New All
Source: HSBC driven the rise in NPLs. By exclusion we believe it is
non-corporate customers that have driven the rise in
Sharp growth in private banks’ NPLs NPLs i.e. retail, small business and agriculture loans.
At end of June 2007 the aggregate stock of net NPLs Credit costs have come down
grew c30% y-o-y compared with 17% y-o-y at the Annualised NPL provisions / loans
end of March 2007. This was driven by a 90% y-o-y
1.5%
growth in the amount of net NPLs for New private
sector banks as compared to growth of 15% y-o-y
for public sector banks. 1.0%

Growth in net NPL y-o-y (%)

0.5%
110%
90%
70% 0.0%
50% Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
30% PSU New All

10% Source: HSBC, Company reports

-10%
-30% The 20bp decline in credit costs between March
Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 and June was entirely due to public-sector banks
PSU New All (-34bp q-o-q to 0.6%). It rose 13bp q-o-q to 1.1%
Source: HSBC for new private banks.

While the overall trend in credit cost is favourable

Debt servicing ability of Indian
we see a larger risk to FY08e earnings arising from
corporates stays intact
rising NPLs and provisions expanding to cover more
The following table depicts the interest coverage for banks across the segments.
non-financial companies in the BSE500. We have

Interest coverage ratio (x) of BSE 500 companies

Companies Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07
Group 1 14.6 11.7 12.5 10.3 15.3 10.9 13.0 13.5 12.4 12.2
Group 2 10.1 8.7 9.5 8.6 9.2 9.6 10.4 10.5 9.7 9.3
Group 3 7.3 7.3 7.5 7.0 7.3 6.2 7.9 8.4 7.7 7.9
Group 4 7.6 8.9 8.0 9.0 6.6 10.0 10.4 10.3 10.6 10.2
Group 5 10.2 7.2 8.1 9.0 13.5 8.9 13.2 10.1 7.3 8.0
Source: Datastream, HSBC estimates

6
 FIG
Commercial Banks abc
10 September 2007

Can outperformance of
state-owned banks last?
 Performance of banks stocks during Q307 has similarities to H106
when concerns prevailed on rising bond yields
 Outperformance of state-owned banks has pulled down premium
in valuation of new banks near a four-year low
 We raise our rating on PNB to Overweight and lower our rating on
Axis to Underweight

Underperformance in a falling market increase in mark-to-market provisions.

or during stress on earnings
The first two months of Q3CY07 have seen a rare
instance of bank stocks underperform in a rising
market. Indian bank stocks usually outperform the
broad market when the latter is rising and
underperform when it is falling. The exception
during the past seven quarters was Q106 when
Bankex rose only 2.6% compared with a 20.1%
rise in the Sensex.
Q106 had seen a large rise in government bond
yields. Underperformance in bank stocks correlated
with the then concern over the impact on earnings
arising from contraction in capital gains and an
Q307 has similarities with H106
Over the next two to four quarters two factors
could potentially have a similar effect on bank
stocks, stress on NIM and, NPL provisions.
Metrics of performance by bank stocks
In Q106 and Q206 there were 10 days each that
saw the Bankex fall and the Sensex rise. Another
perspective is that the Bankex fell c30% of the
days when the Sensex rose. This ratio was below
20% in three of the following four quarters and
21% in one quarter. During July and August 2007
this ratio has risen to 24%.

Relative performance of Sensex and Bankex

__ Appreciation in__ _________________________________ Number of days _________________________________
Quarter ended Sensex Bankex Trading days Rise in Sensex (a) Fall in Bankex (b) (a & b) Bankex > Sensex (c) (a & c)
Mar-06 20.1% 2.6% 60 35 31 10 19 10
Jun-06 -5.9% -17.4% 63 36 37 10 25 13
Sep-06 17.4% 38.9% 64 41 24 7 34 20
Dec-06 10.7% 17.3% 61 38 27 8 33 22
Mar-07 -5.2% -7.7% 60 30 31 5 29 17
Jun-07 12.1% 22.4% 62 38 22 6 32 23
Jul to Aug-07 4.7% -1.4% 44 29 20 7 20 12
Source: Bloomberg, HSBC estimates

7
 FIG
Commercial Banks abc
10 September 2007

P/B (x) of state-owned and new private banks Premium in P/B of private relative to state-owned
4.2 140%

105%
2.8
70%
1.4
35%
State ow ned banks Private banks
0.0 0%
Mar.03 Apr.04 May.05 Jun.06 Jul.07 Mar.03 Apr.04 May.05 Jun.06 Jul.07

Source: Bloomberg, HSBC Source: Bloomberg, HSBC

Another metric is based on the number of days The contraction in premium is confirmed by the
when the Bankex outperformed a rising Sensex. PE charts. They point to a significant contraction
During Q106 the Bankex outperformed on 10 of of the PE premium. The premium at the end of
the 35 days (i.e. 29%) when the Sensex August appears the lowest in the past four years.
appreciated. This ratio was 36% during Q206,
We believe these charts are evidence of the
also a quarter when the Bankex underperformed
outperformance in stocks of state-owned banks
the Sensex. This ratio rose to exceed 50% in the
relative to their peers and the broad market.
following quarters when Bankex outperformed
reaching 61% during Q207. July and August 2007
have seen this ratio fall back to 41%.

Discount in state-owned banks stocks

has shrunk
There appears to be a sharp decrease in the
premium in P/B(x) of new private banks relative
to state-owned banks during Q307. A part of this
is explained by a reversion of an expansion in the
premium in the preceding quarter. Another reason
is the enlarged book value in new banks that have
raised new equity.

PE of state-owned and new private banks Premium in PE of private relative to state-owned

30 180%
24
135%
18
12 90%

6 45%
State-ow ned Private
0
0%
Mar.03 Apr.04 May.05 Jun.06 Jul.07
Mar.03 Apr.04 May.05 Jun.06 Jul.07

Source: Bloomberg, HSBC Source: Bloomberg, HSBC

8
 FIG
Commercial Banks abc
10 September 2007

Ratings, target prices and target valuation

Price Target Volatility Potential Rating ____EPS_____ ___ BPS _____ __Target P/E___ _Target P/BV _
(6 Sep) price upside 08f 09f 08f 09f 08f 09f 08f 09f
AXSB IN 660 603 V -9% UW 26 33 236 262 23.2 18.4 2.6 2.3
BOB IN 282 379 V 34% OW 34 41 258 292 11.2 9.2 1.5 1.3
CRPBK IN 335 419 V 25% OW 45 53 296 336 9.3 7.9 1.4 1.2
HDFC IN 2,111 1,985 NV -6.0% UW 70 86 356 403 28.3 23.0 5.6 4.9
HDFCB IN 1,185 1,270 NV 7% N 43 56 333 366 29.6 22.7 3.8 3.5
ICICIBC IN 921 1,024 NV 11% N 36 45 420 442 28.8 22.7 2.4 2.3
PNB IN 491 591 NV 21% OW 56 65 365 415 10.6 9.0 1.6 1.4
SBIN IN 1,631 1,506 NV -8% UW 94 112 732 820 16.0 13.5 2.1 1.8
VYSB IN 247 231 V -6% UW 11 15 119 262 20.5 15.2 1.9 0.9
YES IN 190 190 V 0.3% N 5 7 53 61 39.6 25.8 3.6 3.1
Source: HSBC

9
 FIG
Commercial Banks abc
10 September 2007

Axis Bank We continue to value AXBK using a combination

of DCF, PE and P/B. Our three-stage DCF uses
Fresh capital likely to sustain high
explicit forecasts until FY10 followed by 10 years
loan growth
of semi-explicit forecasts, where we assume 20%
Axis Bank (AXBK) has preserved its loan growth
loan CAGR, and 20% dividend payout. The final
momentum even as it has decelerated in peers and
stage of 12 years assumes convergence of ROE
in the industry. At end June 2007 customer assets
and COE (assumed to be 13.5%). This method
(loans) of AXBK grew 49% y-o-y to reach
results in a value of INR471 per share.
INR477bn. Among the first generation new banks
AXBK is now the fastest growing bank. We estimate the mean PE and mean P/B for the
12-month period ended June 2007 at 20.2x and
The drivers of loan growth largely stay the same
3.8x respectively. We apply these to our forecast
as in previous years; i.e. corporate, SME, mid-
EPS and book value at June 2008 to arrive at
corporate and agriculture loans. Loans to SME
values of INR560 and INR911 respectively.
and mid-corporate segments grew 65% y-o-y
while agriculture loans grew 120% y-o-y. Retail Our target price of INR603 is a weighted average
assets grew 23% y-o-y in value and 21% y-o-y by where we assign a weight of 50% to our DCF
volume. The share of retail loans contracted from value and 25% to our PE and P/B values
30% a year ago to 23% at end of June 2007. respectively. We lower our rating from Neutral
(V) to Underweight (V) after the rally in the stock
Savings bank deposits keep pace with loan
over the past four weeks now gives potential
growth.
downside to our target price.
At 50% y-o-y the growth in AXBK’s SB deposits
is on par with loan growth, continuing to be well Risk factors
ahead of state-owned banks where SB deposits NPL provisions could exceed our forecasts
growth is in the teens. AXBK’s SB deposits leading to lower net profit. AXBK’s specific NPL
growth correlates with the expansion of its provisions have been lower than most peers.
network of retail outlets (branches). It added 369
Fee income could exceed our forecasts leading to
branches in the four years ended March 2007 with
a higher net profit. AXBK’s fee intensity has been
over a hundred each added during FY06 and
lower than that in ICBK and HDBK but has been
FY07. However, the most recent quarter points to
rising. If this trend persists then the growth in fees
a slowdown with only 13 branches being added.
would exceed our forecasts.
Underweight (V), target price INR603
Operating expense could exceed our forecasts
Assumptions used in the DCF
leading to a lower net profit
Explicit Forecast Semi-Explicit Forecast
Growth 24.2% 20.0%
ROE 17.3% 20.9%
ROA 1.0% 1.1%
Source: HSBC

10
 FIG
Commercial Banks abc
10 September 2007

Financials & valuation: Axis Bank Ltd Underweight

Financial statements Core profitability (% RWAs) and leverage
Year to 03.2007a 03.2008e 03.2009e 03.2010e Year to 03.2007a 03.2008e 03.2009e 03.2010e
P&L summary (INRm) Net interest income 3.3 3.3 3.3 3.4
Net fees/commissions 0.0 0.0 0.0 0.0
Net interest income 15,671 21,875 28,834 36,352 Trading profits 0.1 0.0 0.0 0.0
Net fees/commissions 9,038 12,874 15,935 19,084 Total income 0.1 0.1 0.1 0.1
Trading profits 580 160 75 42
Other income -0.1 -0.1 0.0 0.0
Other income -504 -349 -8 316
Operating expense -2.6 -2.5 -2.5 -2.6
Total income 24,784 34,560 44,836 55,795 Pre-provision profit 2.7 2.6 2.6 2.6
Operating expense -12,146 -16,899 -22,153 -27,838 Bad debt charge -0.6 -0.6 -0.6 -0.6
Bad debt charge -2,676 -3,914 -5,337 -6,589
HSBC attributable profit 1.4 1.4 1.3 1.3
Other 0 0 0 0
Leverage (x) 15.2 11.5 10.0 11.1
HSBC PBT 9,962 13,747 17,346 21,368 Return on average equity
Exceptionals 0 0 0 0
PBT 9,962 13,747 17,346 21,368
Taxation -3,372 -4,663 -5,894 -7,271 Valuation data
Minorities + preferences 0 0 0 0
Attributable profit 6,590 9,085 11,452 14,097 Year to 03.2007a 03.2008e 03.2009e 03.2010e
HSBC attributable profit 6,590 9,085 11,452 14,097 PE* 24.0 17.4 13.8 11.2
Balance sheet summary (INRm) Pre-provision multiple 14.7 13.1 10.2 8.2
P/NAV 5.5 2.8 2.5 2.2
Ordinary equity 33,932 82,515 91,376 102,883 REP multiple
HSBC ordinary equity 33,932 82,515 91,376 102,883 Equity cash flow yield (%) -2.6 -2.2 -1.2 -0.3
Customer loans 41,369 80,116 98,666 120,818 Dividend yield (%) 0.7 0.9 1.0 1.0
Debt securities holdings 243,012 306,799 390,044 473,644
Customer deposits 520,159 671,939 874,455 1,076,228
Interest earning assets 352,109 460,558 579,173 704,459 Issuer information
Total assets 328,937 421,240 523,134 631,547 Share price (INR) 659.75 Target price (INR) 603.00 Up/downside (%) -8.6
Capital (%)
Reuters (Equity) AXBK.BO Bloomberg (Equity) AXSB IN
RWA (INRm) 566,434 770,419 974,027 1,184,220 Market cap (USDm) 5,761 Market cap (INRm) 235,019
Core tier 1 6.4 11.0 9.5 8.8 Free float (%) 32.4
Total tier 1 6.4 11.0 9.5 8.8 Country India Sector COMMERCIAL BANKS
Total capital 11.6 15.9 14.2 13.3 Analyst Anand Shanbhag Contact +9122 2268 1234
Notes: price at close of 06 Sep 2007

Ratio, growth & per share analysis

Year to 03.2007a 03.2008e 03.2009e 03.2010e
Year-on-year % change
Total income 44.1 39.4 29.7 24.4
Operating expense 49.2 39.1 31.1 25.7
Pre-provision profit 39.5 39.7 28.4 23.2
EPS
HSBS EPS 34.4 11.1 26.1 23.1
DPS 27.0 34.2 6.7 0.0
NAV (including goodwill) 16.9 95.9 10.7 12.6
Ratios (%)
Cost/income ratio 49.0 48.9 49.4 49.9
Bad debt charge 10.8 6.4 6.0 6.0
Customer loans/deposits 8.0 11.9 11.3 11.2
NPL/loan 0.0 0.0 0.0 0.0
NPL/RWA 0.0 0.0 0.0 0.0
Provision to risk assets/RWA 71.7 73.3 75.1 75.9
Net write-off/RWA 0.0 0.0 0.0 0.0
Coverage 0.0 0.0 0.0 0.0
ROE (including goodwill) 21.0 15.6 13.2 14.5
Per share data (INR)
EPS reported (fully diluted) 27.51 37.92 47.80 58.84
HSBC EPS (fully diluted) 27.51 37.92 47.80 58.84
DPS 4.54 6.09 6.50 6.50
NAV 120.49 236.06 261.41 294.33
NAV (including goodwill) 120.49 236.06 261.41 294.33

11
 FIG
Commercial Banks
10 September 2007
Bank of Baroda
Loan growth down to sensible level
BOB’s total loans (including overseas loans) grew
by 38.0% in FY06, 39.6% in FY07 and 27% at the
end of June 2007.
Retail, infrastructure and agriculture were the key
growth drivers in FY07 growing 46.4%, 48% and
51% respectively.
Five years of below-average loan growth has
pulled down market share of Bank of Baroda
(BOB) to an estimated 3.5% at the end of FY05.
Back in FY00, BOB had a market share of 4.8%
and was next only to SBI among the state-owned
banks. By March 2005, it had slipped two ranks
and was less than half the size of ICICI Bank. We
believe BOB’s extraordinarily high loan growth in
FY06 and FY07 needs to be seen in this context.
Relatively low impact on profitability
The average ROE for FY05-07 was 12.9%
compared with 17.1% in the preceding five years.
Three of these five years saw very strong revenue
from capital gains, which have since declined in
all the banks. BOB appears to have managed the
impact on profitability arising from high growth
well. Between FY04 and FY07, its NIM
contracted by an estimated 27bp. This is close to
the contraction seen in other state-owned banks.
Overweight (V), target price INR379
Assumptions used in the DCF
Explicit Forecast Semi-Explicit Forecast
Growth 15.8%
ROE 14.9%
ROA 0.8%
Source: HSBC
We continue to value BOB using a combination
of DCF, PE and P/B. Our three-stage DCF uses
explicit forecasts until FY10 followed by 10 years
of semi-explicit forecasts, where we assume
15.0% loan CAGR and 20.0% dividend payout.
12
abc
The final stage of 12 years assumes convergence
of ROE and COE (assumed to be 13.5%). This
method results in a value of INR446 per share.
The mean PE and the mean P/B for the 12-month
period ended June 2007 are estimated at 9.1x and
1.1x respectively. We apply these to our forecast
EPS and BV at June 2008 to arrive at values of
INR325 and INR298 respectively.
Risk factors
Net interest margin may fall below our forecasts
resulting in a lower net profit. The trend of decline
in NIM may last longer than our forecasts.
NPL provisions could rise more than our forecasts
resulting in a lower net profit. BOB’s NPL
provisions, relative to loans remain below their
long term average. Should they rise more than our
forecasts net profit growth would be lower.
Corporation Bank
Low cost ratios a protective factor
Q1FY08 saw a 14% increase in operating
expenses. In FY07 operating expenses stood at
1.72% of total assets, the lowest among the state-
owned banks. It provides CRBK with more than
50bp lead over the bank (PNB IN) with the
highest cost ratio. In effect, this compensates for
CRBK’s lower NII and fee income
This ratio contracted by 71bp the past decade for
CRBK. This contraction is similar to other banks.
The edge in costs reflects CRBK’s long standing
efficient use of manpower. We estimate the
15.0%
17.8%
efficiency by dividing the number of employees
0.9% by the sum of year-end deposits and loans. It
indicates that, adjusted for size, CRBK only
employs c80% as many people as Bank of Baroda
and less than two-thirds of SBI and Punjab
National Bank.
 FIG
Commercial Banks
10 September 2007
Overweight (V), target price INR419
Assumptions used in the DCF
Explicit Forecast Semi-Explicit Forecast
Growth 16.0%
ROE 16.8%
ROA 1.1%
Source: HSBC
We continue to value CRBK using a combination
of DCF, PE and P/B. Our three-stage DCF uses
explicit forecasts until FY10 followed by 10 years
of semi-explicit forecasts, where we assume
15.0% loan CAGR, and 20.0% dividend payout.
The final stage of 12 years assumes convergence
of ROE and COE (assumed to be 13.5%). This
method results in a value of INR453 per share.
We estimate the mean PE and mean P/B for the
12-month period ended June 2007 at 8.4x and
1.2x respectively. We apply these to our forecast
EPS and book value at June 2008 to arrive at
values of INR394 and INR378 respectively.
Our target price of INR419 is a weighted average
where we assign a weight of 50% to our DCF and
25% to our PE and P/B values respectively.
Risk factors
Decline in net interest margin could persist longer
than our forecasts leading to lower net profit.
Decline in fee intensity could be more than our
forecasts leading to a fall in net profit.
NPL provisions could exceed our forecasts
leading to lower than estimated net profit.
Housing Development
Finance Corporation
Back as the leader
Several reasons could explain why many
commercial banks seem to going slow in the home
loan market. Default rates may be higher than what
was priced into the loans. Another reason could be
the large proportion of home loans ranging from
abc
c30% in ICICI Bank to 15% in state-owned banks.
Banks are lending more to other segments such as
corporates, SMEs and infrastructure besides the
15.0% mandated priority sectors. In contrast HDFC has
16.6% maintained its portfolio growth in the high 20s.
1.1%
While that was below market growth in 2005 and
2006, today it may exceed that.
Stable NIM with an upward bias
We note a steady expansion in HDFC’s NIM over
the past four years despite the competition and
changing trend in interest rates. HDFC was
successful in shifting the profile of its home loans
from largely fixed rate loans till 2002 to largely
floating rate loans by 2006. It has also succeeded in
churning the mix of its borrowed funds. Between
March 2001 and March 2007 the proportion of loans
and bonds rose from 44% to 70% and the proportion
of deposits fell from 47% to 18%.
Proven lending systems provide the
edge in the current market
India’s home loan market could be approaching
another inflection point. For most of the past
decade, property prices were stable, interest rates
were falling and incomes were rising. Improved
affordability coupled with the huge latent demand
triggered the boom in the lending market.
For close to six quarters now, conditions have
stopped improving. Affordability has clearly
worsened as property prices have zoomed up. In this
situation HDFC’s experience could make a huge
difference relative to newcomers among commercial
banks. Given the long duration of home loans (10 to
15 years at origin) none of the commercial banks
have completed one lending cycle. We believe the
weighted average of the home loan book in many
banks could be less than 3 years. HDFC’s three-
decade-long experience should endow it with
superior ability to assess customers, property
developers and also to deal with cases where debt
servicing may be interrupted. These strengths are
visible in the trend of declining cost ratios and low
provisioning, in our view.
13
 FIG
Commercial Banks abc
10 September 2007

Underweight, target price INR1985 Risk factors

Assumptions used in DCF Net interest margin could fall below our forecasts.
Explicit Forecast Semi-Explicit Forecast If future increases in funding costs are not entirely
Growth 20.9% 20.0% passed on NIM would be lower than our forecast
ROE 13.6% 20.6%
ROA 2.6% 2.3% leading to lower net profit than our estimates.
Source: HSBC
Impact of revised tax rules could be larger than
our forecasts. We have assumed that the impact of
We continue to value HDFC using a combination
decreased tax shelter to be offset by increase in
of DCF, PE and P/B. Our three-stage DCF uses
capital gains and decrease in cost ratios. Should
explicit forecasts until FY10, followed by 10
these elements not be sufficient the net profit
years of semi-explicit forecasts where we assume
could fall below our forecasts.
20.0% loan CAGR and 40.0% dividend payout.

The final stage of 12 years assumes convergence

of ROE and COE (assumed to be 13.5%). This
method results in a value of INR1,013 per share.
This value is supplemented by INR714 being the
estimated value of associates and subsidiaries.

We estimate the mean PE and mean P/B for the

12-month period ended June 2007 at 25.2x and
7.1x respectively. We apply these to our forecast
EPS and book value at June 2008 to arrive at
values of INR1,868 and INR2,616 respectively.

Our target price of INR1,985 is a weighted average

where we assign a weight of 50% to our DCF value
and 25% to our PE and P/B values respectively.

Estimated values used in sum-of-the-parts

Value (INR bn) % stake Value corresponding to stake (INR bn) Value per share (INR)
Unrealized gains on listed investments 75 100% 74.9 276
HDFC Standard Life 134 78% 104.8 387
HDFC Chubb 0.4 74% 0.3 1
HDFC AMC 18 50% 9.1 34
Intelenet 8 50% 3.8 14
HDFC Venture Capital 0.7 81% 0.6 2

Total 194 714

Source: HSBC

14
 FIG
Commercial Banks
10 September 2007
HDFC Bank
Market share expansion resumes
after new equity
The last two quarters of FY07 had seen loan
growth in HDFC Bank (HDBK) slip below the
industry mean. This was the first time ever in
HDBK’s 12-year long history that it had grown
slower than the industry. Q1FY08 saw HDBK’s
loans grow 29% y-o-y, higher than the industry
average but well below the c40% levels a year
ago. We believe the bank stays committed to a
target of above-industry growth and our forecasts
assume FY08e loan growth would exceed that for
the industry. This would be facilitated by the
cUSD1bn new equity capital raised in July 2007.
The best track record on balancing
ROE with market share expansion
The data indicates that HDBK has been more
successful at preserving ROE than peers even as it
continues to expand market share.
HDBK’s ROE has generally been higher and more
stable relative to other banks. Over the past 10
years it has been in high-teens with the lowest
being 17.7%. Except for a three-year spell (FY03 to
FY05), HDBK’s ROE has exceeded the mean for
state-owned banks as well as for new private banks.
During this period, HDBK expanded its market
share from 0.2% (March 1998) to 2.7% (March
2007). HDBK has raised capital thrice in the 10-
year period ended March 2007 – less frequently
than compared with other Indian new banks.
Fee intensity and NIM are key to
preserving profitability
Over the past five years HDBK’s ROA has
stabilised near 1.4%. The relative stability is the
result of sharp increases in loan provisions and
operating expense on one hand, and revenues on
the other.
abc
Combined specific loan loss provisions & general
provisions for standard assets rose from 0.44% (of
total assets) for FY02 to 0.84% for FY07. This rise
was offset by increases in NII (3.15% to 4.50%) and
in fee income (1.03% to 1.80%).
The strength in net interest income (and the
consequent expansion of NIM) is facilitated by
HDBK’s strength in low-cost deposits. The latter
have grown faster than loans. The high proportion of
low cost deposits is the result of steady expansion in
branches – a four-fold increase to 684 branches in
five years. This investment and branch costs raise
HDBK’s cost ratios above peers.
HDBK actively uses its branch network as front
offices for distribution of third-party products such
as mutual funds and life insurance. We believe
revenue from these to be a significant element in fee
revenue. The rise in NPL provisions can also be
correlated with the rise in NII. Part of the growth in
retail assets in recent years was in higher yield assets
that also demanded higher provisions.
In the net analysis HDBK’s business model has
differed from most peers, and has been successful.
Our forecasts assume the bank continues to
maintain its high ROA even as it leverages its new
equity to grow faster.
Neutral, target price INR1,270
Assumptions used in the DCF
Explicit Forecast Semi-Explicit Forecast
Growth 20.9% 20.0%
ROE 13.6% 20.6%
ROA 2.6% 2.3%
Source: HSBC
We continue to value HDBK using a combination
of DCF, PE and P/B. Our three-stage DCF uses
explicit forecasts until FY10 followed by 10 years
of semi-explicit forecasts, where we assume
25.0% loan CAGR and 25.0% dividend payout.
The final stage of 12 years assumes convergence
of ROE and COE (assumed to be 13.5%). This
method results in a value of INR1,033 per share.
15
 FIG
Commercial Banks
10 September 2007
We estimate the mean PE and mean P/B for the
12-month period ended June 2007 at 29.0x and
5.0x respectively. We apply these to our forecast
EPS and book value at June 2008 to arrive at
values of INR1336 and INR1672 respectively.
Our target price of INR1,270 is a weighted
average where the DCF value is assigned a weight
of 50% and the PE and P/B values are assigned
weights of 25% each.
Risk factors
Net interest margin could descend below our
forecasts resulting in a lower net profit. HDBK
has the highest NIM for any of the large Indian
banks and we assume it falls as deposit costs rise.
The resumption of branch expansion is likely to
help preserve a high NIM.
Fee income growth may slow down. Competition
between banks or a decrease in the volume of
activity that drives fee income could result in
HDBK’s fee income falling below our forecasts,
resulting in a decrease in net profit.
Provisions may exceed our forecasts leading to a
lower net profit than we have estimated.
ICICI Bank
Increased uncertainty over unlocking
value
The Reserve Bank of India (RBI) has not approved
the proposal by ICICI Bank (ICBK) to create an
intermediate holding company named ICICI
Financial Services to house unlisted subsidiaries in
insurance and asset management. RBI has listed
concerns over this structure and seems to favour the
bank holding company structure, after a proper legal
framework is created. This is a setback to ICBK’s
plans to unlock value using the holding company
channel. One thing that seems certain after RBI
released the discussion paper on 27th August is the
additional delay in the creation of the holding
company. The imputed value in a proposed deal to
16
abc
sell a 5.9% stake in this company has been a critical
element in the valuation of ICBK. This is a time-
bound deal that needs all approvals in place before
implementation. We replaced the imputed value of
the life insurance business in our sum-of-the-parts
with a lower value based on current business, New
Business Achieved Profits, Net Asset Value and our
estimates for future life insurance business (see our
29 August 2007 report “RBI’s holding company
structure concerns affect valuation”).
Lower cost ratio and potential
rebound in NIM are positives
The ratio of operating expense/customer assets
decreased for five successive quarters to 4.2% for
Q1FY08. This is creditable as it has happened
during a period when growth in customer assets
has been slowing down. Between March 2006 and
June 2007, y-o-y growth in customer assets
decreased from 55% to 36%.
We see three possible reasons for ICBK’s spread
to expand during the quarter ending September
2007: a) close to half of ICICI’s deposits are
believed to be high-value ‘bulk’ deposits from
corporates. The cost of such deposits has
decreased in the past four months, following the
decline in India’s aggregate loan growth from
c30% to c23%, b) ICICI raised close to INR200bn
of fresh equity in June 2007. These funds would
replace expensive deposits leading to a decline in
interest expense; c) Lagged effect of increase in
reference rates could expand loan yields.
Neutral, target price INR1024
We continue to value ICBK using a combination
of DCF, PE and P/B. Our three-stage DCF uses
explicit forecasts until FY10 followed by 10 years
of semi-explicit forecasts, where we assume
20.0% loan CAGR and 30.0% dividend payout.
The final stage of 12 years assumes convergence
of ROE and COE (assumed to be 13.5%). This
method results in a value of INR704 per share.
 FIG
Commercial Banks abc
10 September 2007

Assumptions used in the DCF Fee income growth may slow down. Competition
Explicit Forecast Semi-Explicit Forecast between banks, or a decrease in the volume of
Growth 18.9% 20.0% activity that drives fee income, could result in
ROE 11.3% 18.8%
ROA 1.0% 1.1% ICBK’s fee income falling below our forecasts,
Source: HSBC resulting in a decrease in net profit.

This value is supplemented by the estimated value

ING Vysya Bank
of INR265 for ICBK’s stakes in associates and Recovery in loan and deposit growth
subsidiaries. The combined DCF + sum-of-the- Loan growth picked up to 23% at the end of June
parts value is INR970 per share. 2007 as compared to 17% at the end of March 2007.
Loans had grown at an anaemic 13% during
We continue to supplement this with estimates
FY06.Deposit growth recovered to 26% y-o-y at the
based on PE and P/B values for the stock. We
end of June 2007 as compared to 16% at the end of
estimate the mean PE and mean P/B for the 12-
month period ended June 2007 at 23.9x and 2.9x March 2007.While below the growth in the new
respectively. We apply these to our forecast EPS private banks it is higher than state-owned banks.
and book value at June 2008 to arrive at values of Recovery in non–interest income.
INR905 and INR1,250 respectively.
Q1FY08 saw non interest income surge by 93%y-
Our target price of INR1,024 is a weighted o-y after having declined 27% during Q1FY07.
average where the DCF and sum-of-the-parts With the bank’s ATMs expanding and possessing
value is assigned a weight of 50% and the PE and the capability to accept a wide range of plastic
P/B values are assigned weights of 25% each. payment cards, a wider segment of ATM
Sum-of-parts valuation
cardholders from across the banks can transact
business at them.
Stake Value Value Value per
(INR bn) corresponding share
to stake (INR bn) (INR) Increased focus on private banking business
ICICI Prudential 74% 325 241 217 Vysya now offers an expanded range of
Life Insurance investment solutions, leading to an increase in
ICICI Lombard 74% 14 10.1 9
General Insurance assets under management and clients. Kolkata was
ICICI Prudential 51% 19 9.7 9 added as a new private banking centre, in addition
AMC
to the existing centres of Delhi, Mumbai, Pune
ICICI Securities 100% 24 23.6 21
Others 100% 10 10.0 9 and Bangalore.
Total 294 265
Asset quality continues to improve
Source: HSBC, Company reports
Net NPL ratio fell to 0.84% at the end of June
Risk factors 2007 as compared to 0.95% at end of FY07.
While Vysya’s trend is consistent with most
Loan provisions may rise above our forecasts
Indian banks it is more creditable to cut the ratio
resulting in a lower-than-estimated net profit. The
when loan growth has stayed low. Overall,
spurt in general provisions in Q4FY07 indicates
the relatively large exposure of ICBK to loans Vysya’s loan growth in FY06 and FY07 was
made to sectors deemed to be ‘sensitive’ by the about half that of the industry and an even lower
Reserve Bank of India. A possible rise in fraction of the growth in new private banks.
delinquency on such loans and others could
require more loan provisions.

17
 FIG
Commercial Banks
10 September 2007
Underweight (V), target price INR231
Assumptions used in the DCF
Explicit Forecast Semi-Explicit Forecast
Growth 15.7%
ROE 12.0%
ROA 0.6%
Source: HSBC
We continue to value Vysa using a combination
of DCF, PE and P/B. Our three-stage DCF uses
explicit forecasts until FY10 followed by 10 years
of semi-explicit forecasts where we assume 15.0%
loan CAGR and 18% dividend payout. The final
stage of 12 years assumes convergence of ROE
and COE (assumed to be 13.5%). This method
results in a value of INR219 per share.
We estimate the mean PE and mean P/B for the
12-month period ended June 2007 at 24.1x and
1.6x respectively. We apply these to our forecast
EPS and book value at June 2008 to arrive at
values of INR295 and INR192 respectively.
Our target price of INR231 is a weighted average
where we assign a weight of 50% to our DCF value
and 25% to our PE and P/B values, respectively.
Risk factors
Decrease in cost ratios may be slower than our
forecasts resulting in a lower net profit. Our
forecasts assume a contraction of 7.2% in the ratio
of operating expense / operating income over the
next three years.
Increase in NPL provisions could exceed our
forecasts. We assume annual specific loan-loss
provisions to stay steady near 0.6% of loans. This
is close to the lowest level (0.5% in Fy05 and
FY06) seen in a decade. Should accretion to NPLs
exceed our forecasts the bank would need
additional NPL provisions.
18
abc
Punjab National Bank
Recovery in non-interest income
Non interest income grew by a robust 54% in
15.0%
17.9% Q1FY08 as compared to growth of a mere 11% in
0.9% Q1FY07. Strength in fee income was a bright spot
in PNBK’s FY07 performance. Combined fee
income (commission, exchange and brokerage
and forex commissions) grew 31.1% y-o-y. This
was near the highest among the state-owned
banks. Further, PNBK had an increase in fee
intensity over the previous three years. We
estimate fee intensity as the ratio of combined fee
income to deposits. PNBK’s fee intensity was
next only to that of SBI
Decline in provisions is a key positive
Q1FY08 saw a 16% decline in provisions and
contingencies as compared to a growth of c215%
in Q1FY07. In FY07 a surge in specific
provisions for PNBK played a large role in
depressing FY07 profitability.
Overweight, target price INR591
Assumptions used in the DCF
Explicit Forecast Semi-Explicit Forecast
Growth 16.5% 15.0%
ROE 16.7% 17.4%
ROA 1.0% 1.0%
Source: HSBC
We continue to value PNBK using a combination
of DCF, PE and P/B. Our three-stage DCF uses
explicit forecasts until FY10 followed by 10 years
of semi-explicit forecasts where we assume 15.0%
loan CAGR and 20.0% dividend payout. The final
stage of 12 years assumes convergence of ROE
and COE (assumed to be 13.5%). This method
results in a value of INR608 per share.
We estimate the mean PE and mean P/B for the
12-month period ended June 2007 at 9.9x and
1.5x respectively. We apply these to our forecast
EPS and book value at June 2008 to arrive at
values of INR575 and INR573 respectively.
 FIG
Commercial Banks abc
10 September 2007

Financials & valuation: Punjab National Bank Overweight

Financial statements Core profitability (% RWAs) and leverage
Year to 03.2007a 03.2008e 03.2009e 03.2010e Year to 03.2007a 03.2008e 03.2009e 03.2010e
P&L summary (INRm) Net interest income 5.7 5.3 5.2 5.0
Net fees/commissions 0.0 0.0 0.0 0.0
Net interest income 55,146 62,814 71,612 80,681 Trading profits 0.0 0.1 0.0 0.0
Net fees/commissions 11,467 13,038 14,715 16,280 Total income 0.1 0.1 0.1 0.1
Trading profits -139 732 561 638
Other income -0.1 0.0 0.1 0.1
Other income -905 -148 1,011 2,027
Operating expense -3.5 -3.2 -3.0 -2.9
Total income 65,569 76,436 87,899 99,626 Pre-provision profit 3.4 3.3 3.3 3.3
Operating expense -33,262 -37,379 -42,070 -47,213 Bad debt charge -1.1 -1.2 -1.2 -1.1
Bad debt charge -10,615 -13,572 -15,921 -18,004
HSBC attributable profit 1.6 1.5 1.5 1.5
Other 0 0 0 0
Leverage (x) 9.7 10.6 11.0 11.2
HSBC PBT 21,691 25,485 29,908 34,409 Return on average equity
Exceptionals 0 0 0 0
PBT 21,691 25,485 29,908 34,409
Taxation -6,291 -7,915 -9,279 -10,670 Valuation data
Minorities + preferences 0 0 0 0
Attributable profit 15,401 17,571 20,629 23,739 Year to 03.2007a 03.2008e 03.2009e 03.2010e
HSBC attributable profit 15,401 17,571 20,629 23,739 PE* 8.4 7.4 6.3 5.5
Balance sheet summary (INRm) Pre-provision multiple 4.8 4.0 3.4 3.0
P/NAV 1.5 1.3 1.2 1.0
Ordinary equity 104,355 117,774 133,702 152,185 REP multiple
HSBC ordinary equity 104,355 117,774 133,702 152,185 Equity cash flow yield (%) -0.3 2.2 3.7 4.8
Customer loans 973,926 1,190,672 1,414,114 1,658,900 Dividend yield (%) 2.0 2.2 2.5 2.9
Debt securities holdings 562,689 639,083 734,434 838,236
Customer deposits 1,377,186 1,649,070 1,954,185 2,284,737
Interest earning assets 1,693,071 1,990,004 2,333,491 2,710,183 Issuer information
Total assets 1,619,876 1,911,063 2,236,632 2,592,040 Share price (INR) 490.50 Target price (INR) 591.00 Up/downside (%) 20.5
Capital (%)
Reuters (Equity) PNBK.BO Bloomberg (Equity) PNB IN
RWA (INRm) 1,075,429 1,276,824 1,489,238 1,722,152 Market cap (USDm) 3,791 Market cap (INRm) 154,656
Core tier 1 8.9 8.5 8.4 8.3 Free float (%) 42.2
Total tier 1 8.9 8.5 8.4 8.3 Country India Sector Commercial Banks
Total capital 12.3 11.4 10.8 10.4 Analyst Anand Shanbhag Contact +9122 2268 1234
Notes: price at close of 06 Sep 2007

Ratio, growth & per share analysis

Year to 03.2007a 03.2008e 03.2009e 03.2010e
Year-on-year % change
Total income 10.4 16.6 15.0 13.3
Operating expense 10.0 12.4 12.5 12.2
Pre-provision profit 10.7 20.9 17.3 14.4
EPS
HSBS EPS 7.0 14.1 17.4 15.1
DPS 66.7 10.0 13.6 12.0
NAV (including goodwill) 11.3 12.9 13.5 13.8
Ratios (%)
Cost/income ratio 50.7 48.9 47.9 47.4
Bad debt charge 1.2 1.3 1.2 1.2
Customer loans/deposits 70.7 72.2 72.4 72.6
NPL/loan 3.5 2.8 2.8 2.8
NPL/RWA 3.2 2.7 2.7 2.8
Provision to risk assets/RWA 2.7 2.7 2.8 2.9
Net write-off/RWA 0.0 0.0 0.0 0.0
Coverage 83.1 100.0 102.3 102.2
ROE (including goodwill) 15.5 15.8 16.4 16.6
Per share data (INR)
EPS reported (fully diluted) 58.05 66.23 77.76 89.48
HSBC EPS (fully diluted) 58.05 66.23 77.76 89.48
DPS 10.00 11.00 12.50 14.00
NAV 330.97 373.53 424.04 482.66
NAV (including goodwill) 330.97 373.53 424.04 482.66

19
 FIG
Commercial Banks
10 September 2007
Our target price of INR591 is a weighted average
where we assign a weight of 50% to our DCF
value and 25% to our PE and P/B values
respectively. We raise the rating from Neutral to
Overweight to reflect the potential upside of 21%.
Risk factors
Loan provisions may rise above our forecasts
resulting in a lower net profit. The rise in specific
provisions seen in FY07 may last longer than our
forecasts. While we assume a gentle rise in
provisions for future years we assume they will not
test the peaks seen in the early years of this decade.
NIM may shrink from current level. PNBK has
one of the highest NIMs for all Indian banks. It
could decline if future growth were to be funded
by a higher proportion of high-cost deposits.
State Bank of India
Stability of NIM may be short lived
SBI has been one of the rare Indian banks that
preserved its NIM in the past quarter. The spread
between deposit costs (5.35%) and loan yield
(9.80%) reached 4.45% for Q1Fy08. this is the
highest in the past 17 quarters and could be
entirely attributed to the rapid re-pricing of loans
off the series of increases in the PLR during
FY07. Loan yield expanded by 113bp between
Q1FY08 and FY07 compared with 56bp rise in
the average cost of deposits.
We foresee stress on NIM in the next three
quarters as deposit cost rises. Lending yields may
not rise more unless SBI raises the PLR again, an
unlikely prospect.
SBI is yet to demonstrate vigour in its low cost
deposits. Savings banks (SB) deposits grew by
only 13% in the past 12 months, well below the
c50% growth seen in new private banks. This is
an indication that the investments in ATMs and
core banking IT platform are yet to help in the
core function of galvanising low-cost deposits.
20
abc
Inexorable rise in NPL provisions
Specific provisions for Q1FY08 grew 195%
y-o-y. In part this reflects the low base. It also is a
sign that the rebound in provisions that began in
Q4FY06 is continuing. A study of the rolling 4-
quarter specific provisions reveals the ratio to be
0.55% for Q1FY08, well below the high of 1.9%
seen in the quarter ended Q1FY05. The reported
amount of net NPLs has risen 23% in the past two
quarters. This is an unfamiliar risk for SBI as the
current rise in NPLs is the first ever, since the
wave of growth in retail loans began in 2003.
Proposed merger is a milestone
The proposed merger of (announced in late August
after both the boards approved it) 100%
subsidiary, State Bank of Saurashtra with SBI
would the first instance of two healthy state-owned
banks merging. Implementation of this deal would
be an inflection point in the consolidation of
Indian banks. The leadership in banks has long
agreed that consolidation is necessary but progress
has been lacking. Consensus belief is that the
employee unions, backed by the left-wing parties,
would obstruct mergers.
Uncertainty over value unlocking
measures
The future of SBI’s holding company would
depend on RBI’s final decision on the proposed
‘intermediate holding company’ model. We
believe it may take an indeterminate time before
all the necessary conditions are fulfilled to
RBI’s satisfaction.
The other activity planned for FY08 is the follow-
on public offer. One uncertainty here is the size of
the offer. Until the SBI Act is amended the
government’s stake can only fall to 55%, from the
prevailing 59.7% and SBI can only sell 45 million
new shares. The amendment to permit the
government’s stake to fall to 51% was reportedly
approved a week ago by the Standing Committee
on Finance of India’s Parliament. It would only be
effective after it is approved by parliament.
 FIG
Commercial Banks abc
10 September 2007

Recent reports indicate the government may agree
to a rights offering by SBI in FY08 followed by a
public offer.
YES Bank
Young bank in the fast lane
YES has been growing its loan book at greater
than c100% y-o-y, one of the highest among
peers. Loan growth slowed down from 161% at
the end of March 2007 to 118% at the end of June
2007. However c65% of loan book comprises
advances to large corporate and government
bodies with loans to SME comprising c35%
Strength in fee intensity
Both drivers of revenue, net interest income and
non-interest income continue to record a robust
growth. Net interest income grew by 67% y-o-y
and non-interest income by 115% y-o-y.
Exceptionally strong fee income has been the
pillar of Yes Bank’s profitability. In both FY06
and FY07 aggregate fee income exceeded net
interest income (NII). Yes had a reasonably high
net interest margin (NIM) of 3.4% for FY06which
declined to 2.5% for FY07 and 2.3% for Q1FY08.
We estimate the mean PE and mean P/B for the
12-month period ended June 2007 at 40.4x and
4.7x respectively. We apply these to our estimated
EPS and book value at June 2008 to arrive at
values of INR201 and INR252 respectively.
Our blended target price of INR190 is a weighted
average where we assign a weight of 50% to our
DCF value and 25% to our PE and P/B values
respectively. This values the stock at 39.6x FY08f
EPS and 3.6x March 2008f book value per share.
Risk factors
 Slower than estimated loan growth could
affect earnings growth, DCF forecast as well
as the PE.
 NPL provisions rising above our forecast
could hurt earnings.
 Preservation of fee intensity at current levels
could expand profitability and EPS beyond
our forecasts.
 Increase in proportion of low-cost deposits
could expand NIM and EPS beyond
our forecasts.

Neutral (V), target price INR190

We value the stock using a combination of DCF,
PE and P/B. Our three-stage DCF uses explicit
forecasts until FY10 followed by 10 years of semi-
explicit forecasts where we assume 23% loan
CAGR and 10% dividend payout. We assume
ROA converges to 1.1% at the end of the semi-
explicit period. ROE during the semi-explicit
period is determined by the leverage (dependent
on the growth), ROA and dividend payout. The
final stage of 12 years assumes convergence of
ROE and COE (assumed to be 13.5%). This
method results in a value of INR142 per share.

21
 FIG
Commercial Banks abc
10 September 2007

Disclosure appendix
Analyst certification
The following analyst(s), who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject
security(ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal view(s) and that no
part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained
in this research report: Anand Shanbhag and Saumya Agarwal

Important disclosures
Stock ratings and basis for financial analysis
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which
depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations.
Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities
based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon;
and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative,
technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating.
HSBC has assigned ratings for its long-term investment opportunities as described below.

This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when
HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at
www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this
website.

HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's
existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating
systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research
report. In addition, because research reports contain more complete information concerning the analysts' views, investors
should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not
be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities

Stock ratings
HSBC assigns ratings to its stocks in this sector on the following basis:

For each stock we set a required rate of return calculated from the risk free rate for that stock's domestic, or as appropriate,
regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents
the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a
stock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over the
next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the
stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10
percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.

Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility
status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review,
expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily
triggering a rating change.

*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12
months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However,

22
 FIG
Commercial Banks abc
10 September 2007

stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past
month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating,
however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.

Prior to this, from 7 June 2005 HSBC applied a ratings structure which ranked the stocks according to their notional target
price vs current market price and then categorised (approximately) the top 40% as Overweight, the next 40% as Neutral and
the last 20% as Underweight. The performance horizon is 2 years. The notional target price was defined as the mid-point of the
analysts' valuation for a stock.

From 15 November 2004 to 7 June 2005, HSBC carried no ratings and concentrated on long-term thematic reports which
identified themes and trends in industries, but did not make a conclusion as to the investment action that potential investors
should take.

Prior to 15 November 2004, HSBC's ratings system was based upon a two-stage recommendation structure: a combination of
the analysts' view on the stock relative to its sector and the sector call relative to the market, together giving a view on the
stock relative to the market. The sector call was the responsibility of the strategy team, set in co-operation with the analysts.
For other companies, HSBC showed a recommendation relative to the market. The performance horizon was 6-12 months. The
target price was the level the stock should have traded at if the market accepted the analysts' view of the stock.

Rating distribution for long-term investment opportunities

As of 10 September 2007, the distribution of all ratings published is as follows:
Overweight (Buy) 47% (25% of these provided with Investment Banking Services)
Neutral (Hold) 35% (23% of these provided with Investment Banking Services)
Underweight (Sell) 18% (18% of these provided with Investment Banking Services)

Information regarding company share price performance and history of HSBC ratings and price targets in respect of its long-
term investment opportunities for the companies the subject of this report,is available from www.hsbcnet.com/research.

HSBC & Analyst disclosures

Disclosure checklist
Company Ticker Recent price Price Date Disclosure
AXIS BANK LTD AXBK.BO 651.20 07-Sep-2007 2, 5
BANK OF BARODA BOB.NS 275.60 07-Sep-2007 2, 5, 6, 9
CORPORATION BANK CRBK.NS 334.10 07-Sep-2007 2, 6, 9
HDFC HDFC.NS 2126.95 07-Sep-2007 2, 6, 9
HDFC BANK HDBK.NS 1196.55 07-Sep-2007 2, 6, 9
ICICI BANK ICBK.NS 920.05 07-Sep-2007 2, 3, 6, 9
PUNJAB NATIONAL BANK PNBK.BO 489.95 07-Sep-2007 2, 6
STATE BANK OF INDIA SBI.NS 1620.30 07-Sep-2007 2, 9
VYSYA BANK VYSA.BO 244.45 07-Sep-2007 6
YES BANK YESB.BO 187.95 07-Sep-2007 4
Source: HSBC

23
 FIG
Commercial Banks abc
10 September 2007

1 HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months.
2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next
3 months.
3 At the time of publication of this report, HSBC is a market maker in securities issued by this company.
4 As of 31 August 2007 HSBC beneficially owned 1% or more of a class of common equity securities of this company.
5 As of 31 July 2007, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of investment banking services.
6 As of 31 July 2007, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of non-investment banking-securities related services.
7 As of 31 July 2007, this company was a client of HSBC or had during the preceding 12 month period been a client of
and/or paid compensation to HSBC in respect of non-securities services.
8 A covering analyst/s has received compensation from this company in the past 12 months.
9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as
detailed below.
10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this
company, as detailed below.

 Anand Shanbhag has a long position in the shares of State Bank of India.

 Anand Shanbhag has a long position in the shares of Bank of Baroda.

 Anand Shanbhag's spouse has a long position in the shares of Corporation Bank.

 Anand Shanbhag has a long position in the shares of ICICI Bank.

 Anand Shanbhag has a long position in the shares of Housing Development Finance Corporation. A member of Anand
Shanbhag's family has a long position in the shares of HDFC Bank.

 Anand Shanbhag has a long position in the shares of Housing Development Finance Corporation.
Analysts are paid in part by reference to the profitability of HSBC which includes investment banking revenues.

For disclosures in respect of any company, please see the most recently published report on that company available at
www.hsbcnet.com/research.

* HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures
1 This report is dated as at 10 September 2007.
2 All market data included in this report are dated as at close 06 September 2007, unless otherwise indicated in the report.
3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its
Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research
operate and have a management reporting line independent of HSBC's Investment Banking business. Chinese Wall
procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or
price sensitive information is handled in an appropriate manner.

24
 FIG
Commercial Banks abc
10 September 2007

Disclaimer
* Legal entities as at 22 August 2007 Issuer of report
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Corporation Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Markets (India) Private Limited
Securities (Canada) Inc, Toronto; HSBC Bank, Paris branch; HSBC France; 'DE' HSBC Trinkaus &
Burkhardt AG, Dusseldorf; 000 HSBC Bank (RR), Moscow; 'IN' HSBC Securities and Capital Registered Office
Markets (India) Private Limited, Mumbai; 'JP' HSBC Securities (Japan) Limited, Tokyo; 'EG' HSBC 52/60 Mahatma Gandhi Road
Securities Egypt S.A.E., Cairo; 'CN' HSBC Investment Bank Asia Limited, Beijing Representative Fort, Mumbai 400 001, India
Office; The Hongkong and Shanghai Banking Corporation Limited, Singapore branch; The Telephone: +91 22 2267 4921
Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch; HSBC Securities Fax: +91 22 2263 1983
(South Africa) (Pty) Ltd, Johannesburg; 'GR' HSBC Pantelakis Securities S.A., Athens; HSBC Bank
Website: www.hsbcnet.com/research
plc, London, Madrid, Milan, Stockholm, Tel Aviv, 'US' HSBC Securities (USA) Inc, New York; HSBC
Yatirim Menkul Degerler A.S., Istanbul; HSBC México, S.A., Institución de Banca Múltiple, Grupo
Financiero HSBC, HSBC Bank Brasil S.A. - Banco Múltiplo.
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25
 abc

Global Banks Research Team

Global Emerging Europe, Middle East & Africa
Carlo Digrandi Equity & Credit Research
Analyst, Global Sector Co-Head Nadia Kabbani
+44 20 7991 6843 carlo.digrandi@hsbcib.com Analyst
+ 44 20 7991 6701 nadia.kabbani@hsbcib.com
Robin Down
Analyst, Global Sector Co-Head Asia
+44 20 7991 6926 robin.down@hsbcib.com Equity Research
Europe Todd Dunivant
Analyst, Head of Banks, Asia Pacific
Equity +852 2996 6599 tdunivant@hsbc.com.hk
Peter Barkow
Analyst Anand Shanbhag
+49 211 910 3276 peter.barkow@hsbc.de Analyst
+91 22 2268 1234 anandshanbhag@hsbc.co.in
Matthew Czepliewicz
Analyst Brett Hemsley
+44 20 7991 6709 matthew.czepliewicz@hsbcib.com Analyst
+81 3 5203 3627 brett.hemsley@hsbc.co.jp
Leigh Goodwin
Analyst Shary Wu
+44 20 7991 6828 leigh.goodwin@hsbcib.com Analyst
+852 2996 6585 sharywu@hsbc.com.hk
Sophia Skourti
Analyst Kathy Park
+30 210 696 5214 sophia.skourti@hpss.hsbc.gr Analyst
+822 3706 8755 kathypark@kr.hsbc.com
Peter Toeman
Analyst Saumya Agarwal
+44 20 7991 6791 peter.toeman@hsbcib.com Associate
+91 22 2268 1235 saumyaagarwal@hsbc.co.in
Credit Research
Carlo Mareels York Pun
Analyst Associate
+44 20 7991 6722 carlo.mareels@hsbcib.com +852 2822 4396 yorkkypun@hsbc.com.hk

Oliver Burrows Credit Research

Analyst Dilip Shahani
+44 20 7991 5632 oliver.burrows@hsbcib.com Analyst, Head Credit Research
+852 2822 4520 dilipshahani@hsbc.com.hk
Devendran Mahendran
Analyst
+852 2822 4521 devendran.mahendran@hsbc.com.hk
North America
Specialist Sales Credit Research
Van Hesser
David Bhonslay Analyst, Global Head of Credit Research
+1 212 525 3114 van.hesser@us.hsbc.com
+1 212 525 0211 david.bhonslay@us.hsbc.com
Daphne Feng
Matthew Charlton
Analyst
+44 20 7991 5392 matt.charlton@hsbcib.com
+1 212 525 3035 daphne.feng@us.hsbc.com
Paula Cricca
+1 212 525 3296 paula.cricca@us.hsbc.com
Nigel Grinyer
+44 20 7991 5386 nigel.grinyer@hsbcib.com
Nicolette Theodoropoulos
+44 20 7991 5361 nicolette.theodoropoulos@hsbcib.com
Juergen Werner
+49 211 910 4461 juergen.werner@hsbc.de