IndiaEquityResearch Financials

September05,2011

SectorUpdate
Sep2,2011 Sensex(INR) Nifty(INR) NBFCIndex(INR) Bankex(INR) 16,821 5,040 1,241 10,950 1m (7) (8) (7) (11) 3m (9) (9) (10) (12) 6m (9) (9) (12) (12)

NonbankingFinancials
Newnormsmanageable;banklicenseamixedblessing
The proposed new norms are unlikely to materially impact asset quality or profitability. We estimate a maximum onetime impact of 10% on NPL provisions and 26% on net profits. The prescription of higherTierIcapitalmayerodeROEby300bp,yetleaveitabovethat ofnewbanks.Overall,largeNBFCs'assetqualityandprofitabilitymay stay superior to banks. A banking license may not necessarily be a 'winner'scurse',butanNBFCthatfailstowinalicensemaybespared a significant escalation in costs and erosion in growth and ROE. Precedents and benchmarking indicate that the NFBC structure could preservegrowthandprofitabilityatleastonparwithnewbanks. Tighternormsstructurallypositive;longtermimpactnegligible
The working committee constituted by the central bank has recommended aligning asset classification and provisioning norms for NBFCs with those currentlyfollowedforbanks.Provisioncoverforlargeassetfinancialsishigher thanbanksandunlikelytofallmateriallyafterthenewnorms.Ashiftfrom180 dayassetrecognitionnormsto90dayassetrecognitionwouldexpandNPLsby upto20%.Theerosioninprofitabilityislikelytobeonetimeandbyupto26%.

ProvisioncoverageforlargeassetNBFCs(%) 180dpd SHTF MMFS BAF LICHF 81.9 79.7 78.3 58.7
LoangrowthforNBFCsandbanks(%)
Newbanks 45 NBFCs PSUBanks

90dpd 73.2 71.3 66.8 56.7

30

15

CaponleveragetoughonROE
0 Mar07 Mar08 Mar09 Mar10 Mar1

P/B(oneyrfwd)forNBFCsandbanks
Newbanks 4.5 NBFC(excl.HDFC) PSUbanks

TheprescriptionofhigherTierIcapital,toberaisedoverathreeyearperiod,is likelytoimpactgrowthandROEforthesector.ROEmayerodeby300bp,but isstill likelytoremain abovethat fornew banks.WhilemostNBFCsarewell capitalized,withTierIcapitalabove12%,impactongrowthmaynotbehighas assetfinancialshavebeenhavebeenoperatingoverthepasttwoyearswitha highTierIratio.

3.0

Breakevenfornewbankslikelytobeextended
The new draft bank licensing norms lay stress on the purpose of new banks, whichisfinancialinclusion.Focusonunbankedgeographiesandopeningupof atleast25%branchesinruralareasmayinvolvehighoperatingexpenses,and islikelytodelaythebreakevenforanewbank.AspiringNBFCssuchasShriram TransportFinance(SHTFIN,NR)and MahindraFinance(MMFSIN, NR)witha wide rural presence are suitablyplaced to pursue the goals of financial inclusionlaidoutbythecentralbank.

1.5

0.0 Mar05

Mar07

Mar09

Mar11

Premium/discountofNBFCstonewbanks
10% Premium/DiscountofNBFCstonewbanks

Newbanklicensesmaybeamixedblessing
Promoter groups with existing NBFCs have been given the option to either transfer the existing financial business to the bank or to convert itself into a bank. Existing NBFCs such as SHTF and MMFS, in spite of being suitably positioned, are likely to find both the options a hard choice as the additional burdenarisingfromreserveratios,highoperatingexpensesandtechnological investmentsislikelytoimpactprofitabilityuponconversion.Abankinglicense maynotnecessarilybea'winner'scurse',butanNBFCthatfailstowinalicense maybesparedasignificantescalationincostsanderosioningrowthandROE.
JayneeShah,+9102266842868 jaynee.shah@avendus.com

Averagediscountof7% 0% Averagediscountof1% 10% Jan11,RBI tightening 20% Mar10

Jun10

Sep10

Dec10

Mar11

Jun11

Pleaserefertothedisclaimertowardstheendofthedocument.

India Equity Research

NonbankingFinancials

Tighternormsstructurallypositive,impactonprofitabilitynegligible
Theworkingcommitteeconstitutedbythecentralbankhasrecommendedaligningassetclassification and provisioning norms for NBFCs with those currently followed for banks. Provision cover for large assetfinancialsishigherthanthatforbanksandisunlikelytofallmateriallyafterthenewnorms.The shift from 180day asset recognition normsto 90day assetrecognitionwould expand NPLs by up to 20%.Weestimatemaximumonetimeerosioninprofitabilityof26%. Exhibit1: EstimatedincreaseingrossNPLs(%)forlargeassetfinancialsonchangeinnorms
IncreaseinGNPLsonchangeinnorms(asonJun11) ShriramTransportFinance MahindraFinance BajajAutoFinance LICHousingFinance Source:Company,AvendusResearch % 11.9 11.8 17.3 3.5

Exhibit2: ProvisioncoverageratioasonJun11anduponchangeinnorms
(%) ShriramTransportFinance MahindraFinance BajajAutoFinance LICHousingFinance Source:Company,AvendusResearch 180dpd 81.9 79.7 78.3 58.7 90dpd 73.2 71.3 66.8 56.7

Exhibit3: Incrementalprovisions/netprofitasonJun11forassetfinancials
Theonetimeerosionin profitabilitydoesnot exceed26%forlarge NBFCsonanincreasein GrossNPLs.
(%) ShriramTransportFinance MahindraFinance BajajAutoFinance LICHousingFinance Source:Company,AvendusResearch Incrementalprovision/Netprofit 20 17 25 26

CaponleveragetoughonROE
TheprescriptionofhigherTierIcapital,toberaisedoverathreeyearperiod,islikelytoimpactgrowth andROEforthesector.ROEmayerodeby300bp,butisstilllikelytoremainabovethatfornewbanks. While most NBFCs are wellcapitalized, with TierI capital above 12%, impact on growth may not be highasassetfinancialshavebeenhavebeenoperatingoverthepasttwoyearswithahighTierIratio. Exhibit4: Loangrowth(%)largeassetNBFCs,new&PSUbanks
45 NBFCs Newbanks PSUBanks

Exhibit5: ROEforlargeassetfinancials,newandPSUbanks
24 NBFCs Newbanks PSUBanks

30

20

15

16

0 Mar07 Mar08 Mar09 Mar10 Mar11

12 Mar07 Mar08 Mar09 Mar10 Mar11

Source:Company,AvendusResearch

Source:Company,AvendusResearch

Financials 2

India Equity Research

NonbankingFinancials

Newbanklicensesmaybeamixedblessing
Promoter groups with existing NBFCs have been given the option to either transfer the existing financialbusinesstothebankortoconvertitselfintoabank.ExistingNBFCssuchasShriramTransport Finance(SHTFIN,NR)andMahindraFinance(MMFSIN,NR),inspiteofbeingsuitablypositioned,are likelytofindboththeoptionsahardchoiceastheadditionalburdenarisingfromreserveratios,high operatingexpensesandtechnologicalinvestmentsislikelytoimpactprofitabilityuponconversion.The precedentofKotakMahindraBank(KMB)betweenMar02andMar05indicatepressureonprofitability intheyearofconversiontoabank.Thus,abankinglicensemaynotnecessarilybea'winner'scurse', butanNBFCthatfailstowin alicensemay besparedasignificantescalationincostsanderosionin growthandROE. Exhibit6: Cost/assets(%)forNBFCsandbanks
NBFCs 3.0 Newbanks PSUBanks 3.0

Exhibit7: ROA(%)forNBFCsandbanks
NBFCs Newbanks PSUBanks

2.5

2.0

2.0

1.0

1.5 Mar07 Mar08 Mar09 Mar10 Mar11

0.0 Mar07 Mar08 Mar09 Mar10 Mar11

Source:Company,AvendusResearch

Source:Company,AvendusResearch

ProfitabilityleadofKMB overnewbanks contractedafter conversiontoabank

Exhibit8: Cost/assets(%)forKMB(Mar02Mar05) Exhibit9: ROA(%)forKMB(Mar02Mar05)

KMB 21.0 4.0 14.0 Yearofconversion 2.0 Newbanks PSUBanks 6.0 KMB Newbanks PSUBanks

7.0

0.0 Mar02 Mar03 Mar04 Mar05

0.0 Mar02 Mar03 Mar04 Mar05

Source:Company,AvendusResearch

Source:Company,AvendusResearch

TheNFBCstructurecouldpreservegrowthandprofitabilityatleastonparwithnewbanksinspiteof tightened norms. Asset financials underperformed new banks by c7% since Jan11 on concerns regardingregulatorytightening.Much ofthepessimism on NBFCsislikelyover,withthediscountto newbanks(excludingholdingcompanystructureslikeKotakMahindraBank,HDFCBankandsubsidiary valuationsofICICIBank)nowdeclinedto2%fromatwoyearlowof15%asonJun11.

Financials 3

India Equity Research

NonbankingFinancials

Exhibit10: OneyearforwardP/BfornewandoldbankswithinBankexandNBFCs(excludingHDFC)
4.5 Newbanks NBFC(excl.HDFC) PSUbanks

3.0

1.5

0.0 Mar05

Mar06

Mar07

Mar08

Mar09

Mar10

Mar11

Source:Bloomberg,AvendusResearch

IncludingHDFCBankand KMB,thenewbanktrade atapremiumtoasset NBFCsonaP/Bbasis

Exhibit11: P/BdiscountofNBFCs(exclHDFC)tonewbanksand12monthmovingaverage
40% P/BdiscountofNBFCstonewbanks 12monthmovingaverage

0%

40%

80% Mar04

Mar05

Mar06

Mar07

Mar08

Mar09

Mar10

Mar11

Source:Bloomberg,AvendusResearch

Wearriveatthe premium/discountof NBFCstonewbanks excludingtheimpactof holdingcompany valuationsinnewbanks. Hence,excludingKotak MahindraBank,HDFC Bankandsubsidiary valuationsofICICIBank, assetfinancialsareat2% discounttonewbanks

Exhibit12: Premium/discountofassetNBFCstonewbanks(exclsubsidiaryvaluationsofICICIBk)
10% Premium/DiscountofNBFCstonewbanks Averagediscountof7% 0% Averagediscountof1%

10%

Jan11,Beginningof tighteningnormsfor NBFCsbyRBI

20% Mar10

May10

Jul10

Sep10

Nov10

Jan11

Mar11

May11

Jul11

Source:Bloomberg,AvendusResearch

Financials 4

India Equity Research

AnalystCertification

NonbankingFinancials

I,JayneeShah,MBA,researchanalystandauthorofthisreport,herebycertifythatalloftheviewsexpressedinthisdocumentaccuratelyreflectourpersonalviewsaboutthe subject company/companies and its or their securities. We further certify that no part of our compensation was, is or will be, directly or indirectly related to specific recommendationsorviewsexpressedinthisdocument.

Disclaimer
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DisclosureofInterestStatement(asofSeptember6,2011)

KotakMahindraBank ShriramTransportFinance MahindraFinance LICHousingFinance BajajAutoFinance

Analystownership ofthestock No No No No No

Avendusoritsassociatecompanys ownershipofthestock No No No No No

InvestmentBankingmandatewith associatecompaniesofAvendus No No No No No

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Financials 5