>CANARA BANK (IDFC SSKI)

We recently met the management of Canara Bank and came back convinced about the bank’s ability to deliver a high RoE over the next couple of years. We expect the RoE improvement to be driven by: (i) an improving core performance; and (ii) receding pressure on asset quality. The bank is well poised to accelerate its credit growth, which along with the calibrated strategy of lower growth in FY08, has led to an uptrend in CASA, NIMs and NII (albeit some base effect). Besides the pick-up in credit growth, renewed focus on cross-selling would also contribute to fee income growth. In Q4FY09, the bank surprised positively on asset quality and reported a decline in Gross NPAs, while restructured assets hovered at the industry average. The bank has de-risked its investment book over the year, with AFS proportion in investment book now at 27.5% (duration of ~2 years) from ~37% in FY08. A lower AFS proportion in the investment book implies lesser volatility in earnings going forward. We expect Canara Bank to report 14% CAGR in net profit over FY09-11, with an average RoE of ~21% over the next couple of years. Stock is currently trading at ~1x FY10 adjusted book. We upgrade our recommendation on the stock to Outperformer with a 12-month price target of Rs350.

The key takeaways from our meeting with Canara Bank management are:

■ Growth strategy – foot on the accelerator!

• Credit growth in FY08 was restricted to ~9% as the bank’s strategy was to consolidate rather than grow aggressively (28% CAGR over FY05-07).
• Since July/ Aug ’08 (when the new Chairman took over the running of the bank), the focus has been on returning to growth. In FY09, the bank grew its deposits by ~21% and advances by ~29%.
• In FY10, credit growth is expected to moderate to 20-22%, in line with RBI guidelines.

■ Outlook for margins – stable!

• NIMs improved by 36bp qoq to ~2.8% in Q4FY09, as loan spreads expanded with a higher rise in yield on advances than cost of deposits. Management expects NIMs to stabilize around 2.8%.
• Lending rates are not expected to fall by more than 50-100bp from here unless cost of funds also falls by a similar extent. We believe there is limited scope for reduction in cost of funds, which as fixed deposits would then become unattractive for investors.

■ Gross NPAs contained; restructuring at 1.5%

• Gross NPAs have come down from Rs25bn in Dec’08 to ~Rs21.7bn in Mar’09 on the back of strong recoveries. The bank’s entire Rs4bn Ratnagiri exposure continues to be a part of its Gross NPAs.
• While provision coverage ratio of ~31% looks low, Canara Bank management reaffirms that including Rs40bn of write-offs by the bank, coverage ratio stands at 77- 78%.
• The bank has restructured Rs20.6bn of loans during FY09, bulk of which are payment deferment and not haircut on interest. As of April’09, applications for restructuring worth Rs20bn are still pending, of which the bank does not expect to restructure more than Rs10bn.

■ Expansion plans

• 200 new branches are expected to be opened this year. Around 77% of all branches are CBS compliant, with a target to reach 100% by March-April’10.
• Alongside productivity initiatives for the bank’s workforce, about 1,800 young people are expected to be hired to lower the age profile of the employees.

To see full report: CANARA BANK