>PUNJAB NATIONAL BANK (NOMURA)

Monsoon concerns & rising stressed loans

Investment Conclusion
We believe PNB will continue to underperform SBI and other bank stocks, owing to the following
negative drivers: 1) PNB now has the highest proportion of stressed assets relative to its net
worth among the Indian banks under our coverage. Stressed assets account for 91% of net
worth for PNB against the sector's 59%. PNB's restructured loans rose 100% q-q in 1QFY10, and
the bank has not clarified the reason for such a sharp rise in restructured loans. 2) PNB is the
most exposed Indian bank under our coverage to the northern farm belt, which is under economic
distress owing to weak monsoons. This will likely impact PNB's loan growth, deposit growth and
asset quality in that region. We estimate that around 45% of PNB's total branches and business
are linked to this region.

Summary

■ We are revising upwards our price target on PNB from INR420 to INR695. We have valued PNB's core business at 1.3x P/BV, based on sustainable RoE of 14.5% and CoE of 12.4%. A change in our credit cost assumption from 1.0% of loans to 0.8% of loans and a change in cost of equity from 13.3% to 12.4% are the key drivers of our price target upgrade.

■ Downgrading PNB on monsoon concerns and rising stressed loans: Our previous BUY call on PNB was based on its high provisioning cover, low level of restructured loans relative to other banks and conservative top management. While PNB has outperformed the Sensex by 26% since March, it has underperformed the Bankex and Sensex over the past one month following a
sharp rise in restructured loans in its 1QFY10 results. We believe PNB will continue to underperform SBI (SBI NS, BUY) (see our note, SBI – Upgrading to Buy) and other bank stocks, owing to the following negative drivers: 1) PNB now has the highest proportion of stressed assets relative to its net worth among the Indian banks under our coverage. Stressed assets account for 91% of PNB’s net worth against the sector’s 59%. PNB’s restructured loans rose 100% q-q in 1QFY10, and the bank has not clarified the reason for such a sharp rise in restructured loans. 2) PNB is the most exposed Indian bank to the northern farm belt under our coverage, which is under economic distress owing to weak monsoons. This is likely to affect PNB’s loan growth, deposit growth and asset quality in that region, in our view. We estimate that about 45% of PNB’s total branches and business are linked to this region; and 3) After Dr K. C. Chakrabarthy’s departure in June, the bank does not have a new chairman and there is no news flow on who the
government will appoint next.

■ Revised price target of INR695 at 1.3x P/BV offers potential upside of 1.8%: We are upgrading our price target on PNB from INR420 to INR695. We have valued PNB’s core business at 1.3x P/BV, based on sustainable RoE of 14.5% and CoE of 12.4%. A change in credit cost assumptions from 1.0% of loans to 0.8% of loans and a change in cost of equity from 13.3% to 12.4% are the key drivers of our price target upgrade. For the core business, we have assumed that 25% of the restructured loans will slip to NPL and have accordingly deducted 70% of that slippage as provisions.

■ Earnings upgrade: We are upgrading our EPS for FY10E by 39.1% to INR98. We have lowered our loan-loss provisioning assumption from 1.0% to 0.8% of loans and increased our forecast for trading gains from INR3.5bn to INR6.5bn. We have increased our forecasts for net interest income from INR76,189mn to INR79,168mn and raised our forecast for core non-interest income from INR19,017mn to INR22,069mn. We also upgrade our EPS for FY11E by 40% to INR114.

To see full report: PNB