6794024-banking-hsbc-sep07

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ab cGlobal Research

Growth of higher-cost deposits coupledwith slow loan growth adds to downsiderisk on net interest margins

Bad loan provisions continue to growfaster than loans. State-owned banksappear 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 onPNB to Overweight and lower our ratingon Axis to Underweight (V)

Twin risks are prominentIndian 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’.

Bad loan provisions were down sequentially in Q1FY08 but

grew 97% y-o-y. Provisions and NPLs are growing faster innew banks whose net NPL ratio has risen close to that of

state-owned banks. Provisions of the latter decreased in

Q1FY08 but it remains to be seen if this is sustainable.

The current quarter is only the second instance in seven

quarters when bank stocks underperformed in a rising

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

valuation of new banks down to near a 4-year low.

We have an OW rating on Punjab National Bank and OW

(V) ratings on Bank of Baroda and Corporation Bank. We

have Neutral ratings on HDFC Bank, ICICI Bank, Neutral

(V) on Yes Bank, UW (V) ratings on Axis Bank and ING

Vysya and UW on HDFC and SBI.

FIGCommercial Banks

Indian BanksStress on NIMs and asset quality maydepress performance

10 September 2007Anand Shanbhag * AnalystHSBC Securities & Capital Markets (India) Private Limited+91 22 22681234 [email protected]

Saumya Agarwal * Associate HSBC Securities & Capital Markets (India) Private Limited+91 22 22681235 [email protected]

*Employed by a non-US affiliate of HSBC Securities (USA) Inc,and is not registered/qualified pursuant to NYSE and/or NASDregulations

Issuer of report: HSBC Securities and Capital Markets (India)Private Limited

Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it



2

FIGCommercial Banks10 September 2007

ab c

Ill timed deposit growth?High-cost deposits flow in while loangrowth is slowingAcceleration in deposit growth in Q1FY08 hasseen it exceed loan growth for the first time sinceApril 2004. The gap between loan and depositgrowth has converged for the past four quartersand by end of July 2007 deposit growth (+24.2%)slipped above loan growth (+23.8%).

Loan growth and Deposit growth (%)

10%

16%

22%

28%

34%

Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07Deposit grow th Loan grow th

Source: HSBC

Loans / deposits ratio has contracted from c75% inMarch to 70% at end of July, the lowest sinceDecember 2005. The sharp decline in this ratio is at

odds with the vigorous deposit gathering effort stillvisible in most Indian banks.

Loan/ Deposit ratio (%)

50%

55%

60%

65%

70%

75%

80%

Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07

Source: HSBC

Aggressive deposit mobilization continues. Therise in deposit growth correlates with the rise indeposit rates. The Weekly Statistical Supplement(WSS) of the Reserve Bank of India (RBI) reportsthat the band of deposit rates for duration exceedinga year rose from 6.25% - 8% in August 2006 to7.50% - 9.6% in August 2007. Most of this increasehappened before March 2007. WSS data points torates staying unchanged over the past two months.Anecdotal data points to banks continuing to offerrates near 9.5% for durations of 12 to 15 months.

Shrinking loan / deposit ratio mayadd 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 extendinginto 2008 even as loan re-pricing is largely completed Q1FY08 results points to the stress with net interest incomedipping even as loan yields rose



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Adds to the downside risk on NIMsThe 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 theend of 2008.

That would normally be bad for net interestmargins (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 resultsTwo 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 thelevel seen in the previous quarter of March 2007

Growth in net interest income y-o-y

0%

20%

40%

60%

Jun-06 Sep-06 Dec-06 Mar-07 Jun-07PSU New All PVT

Source: HSBC

This trend is visible across all categories of banksin our universe. In particular net interest income

growth slowed down from 22.7% (Public sector),

22.3% (Private sector) and 43.3% (New) duringQ4 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 average134bps 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 (%)

4%

5%

6%

7%

8%

9%

Mar-05 Sep-05 Mar-06 Sep-06 Mar-07PSU 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.



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Growth in Interest expense (%) y-o-y

0%

10%

20%

30%

40%

50%

60%

Mar-06 J un-06 Sep-06 Dec -06 M ar-07 J un-07

Source: HSBC

Rise in benchmark rates has pulledup loan yields

According to first quarter 2008 monetary policy,the weighted average benchmark prime lendingrates increased by 70bps q-o-q for public sectorbanks to 13.1% and 80bps q-o-q for private sectorbanks to 14.9%during Q1FY08.

In particular, yield on advances for the sectorimproved by 100bps q-o-q and c150bps y-o-y to11.2% during Q1FY08. On a sequential basispublic sector banks reported a 100bps increase inyields in Q1FY08, followed by new private sectorbanks which reported a 70bps increase during thesame period.

Yields on advances (%)

9%

10%

11%

12%

Jun-06 Sep-06 Dec-06 Mar-07 Jun-07PSU New All

Source: HSBC

Spreads expandAfter shrinking the past 4 quarters, overall spreadsfor the sector expanded by 60bps q-o-q to 4.4%.

This improvement was brought about by publicsector banks which reported a notable 90bpsincrease in spreads q-o-q to 4.7% in Q1FY08.Incontrast the spreads of new private sector bankscompressed by 50bps q-o-q to 3.3% on the back of high cost of deposits.

Spreads (%)

3.0%

3.5%

4.0%

4.5%

5.0%


Source: HSBC

Rebound in loan growth could

alleviate the situationIn August 2007 some banks cut rates on shortermaturity deposits. However this may not besufficient for funding costs to stabilize as theupward re- pricing has begun and may continuefor up to 2 years. Hence we continue to believemargins will be under stress.

A potential rebound in loan growth would begood for margins in two ways:

It would expand the loans/deposit ratio. Thisis good because more deposits would then be

deployed in loans where yields are generally

higher than other interest earning assets

Increased loan demand is more likely to

preserve loan yields.

It may be early to predict the extent to which loangrowth could recover in September and beyond. Theconsensus view attributes the fall in loan growth to

slower demand for retail loans. Our discussions witha few banks reveal the hope that loan growth couldrise in the ‘busy season’ that begins in October.



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Still a stress pointLittle comfort from the decline inQ1 provisions

Provisions for NPL and growth in NPL provisions

05000

1000015000

20000250003000035000

Mar-06Jun-06 Sep-06Dec-06 Mar-07Jun-07

0%50%100%150%

200%250%300%350%

Provision for NPA (INRm, LHS)Growth in NPL provisions (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 toseasonality particularly after the sustained rise in

specific provisions in FY07. The decline in

Q1FY07 had been 23% q-o-q.

However a comparison on a year-on -year basis,

points to a 97% growth in provisions for Q1FY08.

This is higher than the loan growth of c23% at theend of June 2007.The sharpest increase in provisions

on a y-o-y basis was seen for new private banks(131%) followed by public sector banks (84%).

New private banks report higherNPL ratiosThe first quarter ended June 2007 saw a marginal

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% atthe end of March 2007 .This was primarily

attributed to the private sector banks, which

reported an increase in net NPL ratios despiterobust 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).

Rising NPLs are largely not fromcorporate customers

Seasonal decline seen in Q1FY08 specific provisions but theuptrend 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 NPLsmay be largely from retail, small business and agriculture



6


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Net NPL(%)

0.7%

0.8%

0.9%

1.0%

1.1%

1.2%

1.3%


Source: HSBC

Sharp growth in private banks’ NPLsAt end of June 2007 the aggregate stock of net NPLsgrew c30% y-o-y compared with 17% y-o-y at theend of March 2007. This was driven by a 90% y-o-ygrowth in the amount of net NPLs for New privatesector banks as compared to growth of 15% y-o-yfor public sector banks.

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

-30%

-10%

10%

30%

50%

70%

90%

110%


Source: HSBC

Debt servicing ability of Indiancorporates stays intactThe following table depicts the interest coverage fornon-financial companies in the BSE500. We have

divided them into five approximately equal groupswith Group-1 containing the largest companies (byrevenue) and Group-5 the smallest. For each quarterinterest coverage is estimated by dividing thereported PBDIT by the reported interest expense.This data points to gradual decline in interestcoverage in most of the groups over the past year.Yet, interest coverage stays high suggesting amplecapability in these companies to service their debt.So, it is unlikely that the corporate sector could have

driven the rise in NPLs. By exclusion we believe it isnon-corporate customers that have driven the rise inNPLs i.e. retail, small business and agriculture loans.

Credit costs have come downAnnualised NPL provisions / loans

0.0%

0.5%

1.0%

1.5%


Source: HSBC, Company reports

The 20bp decline in credit costs between Marchand June was entirely due to public-sector banks(-34bp q-o-q to 0.6%). It rose 13bp q-o-q to 1.1%

for new private banks.

While the overall trend in credit cost is favourablewe see a larger risk to FY08e earnings arising fromrising NPLs and provisions expanding to cover morebanks across the segments.

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 9.3Group 3 7.3 7.3 7.5 7.0 7.3 6.2 7.9 8.4 7.7 7.9Group 4 7.6 8.9 8.0 9.0 6.6 10.0 10.4 10.3 10.6 10.2Group 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



7


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Underperformance in a falling marketor during stress on earningsThe 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 whenBankex rose only 2.6% compared with a 20.1%

rise in the Sensex.

Q106 had seen a large rise in government bondyields. Underperformance in bank stocks correlated

with the then concern over the impact on earnings

arising from contraction in capital gains and an

increase in mark-to-market provisions.

Q307 has similarities with H106

Over the next two to four quarters two factorscould 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 and21% in one quarter. During July and August 2007

this ratio has risen to 24%.

Can outperformance of state-owned banks last?

Performance of banks stocks during Q307 has similarities to H106when concerns prevailed on rising bond yields Outperformance of state-owned banks has pulled down premiumin valuation of new banks near a four-year low We raise our rating on PNB to Overweight and lower our rating onAxis to Underweight

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 10Jun-06 -5.9% -17.4% 63 36 37 10 25 13Sep-06 17.4% 38.9% 64 41 24 7 34 20

Dec-06 10.7% 17.3% 61 38 27 8 33 22Mar-07 -5.2% -7.7% 60 30 31 5 29 17Jun-07 12.1% 22.4% 62 38 22 6 32 23Jul to Aug-07 4.7% -1.4% 44 29 20 7 20 12

Source: Bloomberg, HSBC estimates



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Another metric is based on the number of dayswhen the Bankex outperformed a rising Sensex.

During Q106 the Bankex outperformed on 10 of

the 35 days (i.e. 29%) when the Sensex

appreciated. This ratio was 36% during Q206,

also a quarter when the Bankex underperformed

the Sensex. This ratio rose to exceed 50% in the

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 stockshas shrunkThere 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 haveraised new equity.

The contraction in premium is confirmed by thePE charts. They point to a significant contraction

of the PE premium. The premium at the end of

August appears the lowest in the past four years.

We believe these charts are evidence of the

outperformance in stocks of state-owned banks

relative to their peers and the broad market.

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

0.0

1.4

2.8

4.2

Mar.03 Apr.04 May.05 Jun.06 Jul.07

State ow ned banks Private banks

0%

35%

70%

105%

140%

Mar.03 Apr .04 May.05 Jun.06 Jul.07

Source: Bloomberg, HSBC Source: Bloomberg, HSBC

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

0

6

12

18

24

30

Mar.03 Apr.04 May.05 Jun.06 Jul.07

State-ow ned Private

0%

45%

90%

135%

180%

Mar.03 A pr.04 May.05 Jun.06 Jul.07

Source: Bloomberg, HSBC Source: Bloomberg, HSBC



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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 2.3BOB IN 282 379 V 34% OW 34 41 258 292 11.2 9.2 1.5 1.3CRPBK IN 335 419 V 25% OW 45 53 296 336 9.3 7.9 1.4 1.2HDFC IN 2,111 1,985 NV -6.0% U W 70 86 356 403 28.3 23.0 5.6 4.9HDFCB IN 1,185 1,270 NV 7% N 43 56 333 366 29.6 22.7 3.8 3.5ICICIBC IN 921 1,024 NV 11% N 36 45 420 442 28.8 22.7 2.4 2.3PNB IN 491 591 NV 21% OW 56 65 365 415 10.6 9.0 1.6 1.4SBIN IN 1,631 1,506 NV -8% UW 94 112 732 820 16.0 13.5 2.1 1.8VYSB IN 247 231 V -6% UW 11 15 119 262 20.5 15.2 1.9 0.9YES IN 190 190 V 0.3% N 5 7 53 61 39.6 25.8 3.6 3.1

Source: HSBC



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Axis BankFresh capital likely to sustain highloan growthAxis Bank (AXBK) has preserved its loan growth

momentum even as it has decelerated in peers and

in the industry. At end June 2007 customer assets

(loans) of AXBK grew 49% y-o-y to reach

INR477bn. Among the first generation new banks

AXBK is now the fastest growing bank.

The drivers of loan growth largely stay the same

as in previous years; i.e. corporate, SME, mid-

corporate and agriculture loans. Loans to SME

and mid-corporate segments grew 65% y-o-y

while agriculture loans grew 120% y-o-y. Retailassets grew 23% y-o-y in value and 21% y-o-y by

volume. The share of retail loans contracted from

30% a year ago to 23% at end of June 2007.

Savings bank deposits keep pace with loan

growth.At 50% y-o-y the growth in AXBK’s SB deposits

is on par with loan growth, continuing to be well

ahead of state-owned banks where SB deposits

growth is in the teens. AXBK’s SB deposits

growth correlates with the expansion of its

network of retail outlets (branches). It added 369branches in the four years ended March 2007 with

over a hundred each added during FY06 and

FY07. However, the most recent quarter points to

a slowdown with only 13 branches being added.

Underweight (V), target price INR603Assumptions used in the DCF

Explicit Forecast Semi-Explicit Forecast

Growth 24.2% 20.0%ROE 17.3% 20.9%ROA 1.0% 1.1%

Source: HSBC

We continue to value AXBK using a combinationof 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%

loan CAGR, and 20% 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 INR471 per share.

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

12-month period ended June 2007 at 20.2x and3.8x respectively. We apply these to our forecast

EPS and book value at June 2008 to arrive at

values of INR560 and INR911 respectively.

Our target price of INR603 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 lower our rating from Neutral

(V) to Underweight (V) after the rally in the stock over the past four weeks now gives potential

downside to our target price.

Risk factorsNPL provisions could exceed our forecasts

leading to lower net profit . AXBK’s specific NPL

provisions have been lower than most peers.

Fee income could exceed our forecasts leading to

a higher net profit. AXBK’s fee intensity has beenlower than that in ICBK and HDBK but has been

rising. If this trend persists then the growth in fees

would exceed our forecasts.

Operating expense could exceed our forecasts

leading to a lower net profit



11


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Financials & valuation: Axis Bank Ltd Underweight Financial statements

Year to 03.2007a 03.2008e 03.2009e 03.2010e

P&L summary (INRm)

Net interest income 15,671 21,875 28,834 36,352Net fees/commissions 9,038 12,874 15,935 19,084Trading profits 580 160 75 42Other income -504 -349 -8 316Total income 24,784 34,560 44,836 55,795Operating expense -12,146 -16,899 -22,153 -27,838Bad debt charge -2,676 -3,914 -5,337 -6,589Other 0 0 0 0HSBC PBT 9,962 13,747 17,346 21,368

Exceptionals 0 0 0 0PBT 9,962 13,747 17,346 21,368Taxation -3,372 -4,663 -5,894 -7,271Minorities + preferences 0 0 0 0Attributable profit 6,590 9,085 11,452 14,097HSBC attributable profit 6,590 9,085 11,452 14,097

Balance sheet summary (INRm)

Ordinary equity 33,932 82,515 91,376 102,883HSBC ordinary equity 33,932 82,515 91,376 102,883Customer loans 41,369 80,116 98,666 120,818Debt securities holdings 243,012 306,799 390,044 473,644Customer deposits 520,159 671,939 874,455 1,076,228Interest earning assets 352,109 460,558 579,173 704,459Total assets 328,937 421,240 523,134 631,547

Capital (%)

RWA (INRm) 566,434 770,419 974,027 1,184,220Core tier 1 6.4 11.0 9.5 8.8Total tier 1 6.4 11.0 9.5 8.8Total capital 11.6 15.9 14.2 13.3

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 24.4Operating expense 49.2 39.1 31.1 25.7Pre-provision profit 39.5 39.7 28.4 23.2EPSHSBS EPS 34.4 11.1 26.1 23.1DPS 27.0 34.2 6.7 0.0NAV (including goodwill) 16.9 95.9 10.7 12.6

Ratios (%)

Cost/income ratio 49.0 48.9 49.4 49.9Bad debt charge 10.8 6.4 6.0 6.0Customer loans/deposits 8.0 11.9 11.3 11.2NPL/loan 0.0 0.0 0.0 0.0NPL/RWA 0.0 0.0 0.0 0.0Provision to risk assets/RWA 71.7 73.3 75.1 75.9Net write-off/RWA 0.0 0.0 0.0 0.0Coverage 0.0 0.0 0.0 0.0ROE (including goodwill) 21.0 15.6 13.2 14.5

Per share data (INR)

EPS reported (fully diluted) 27.51 37.92 47.80 58.84HSBC EPS (fully diluted) 27.51 37.92 47.80 58.84DPS 4.54 6.09 6.50 6.50NAV 120.49 236.06 261.41 294.33NAV (including goodwill) 120.49 236.06 261.41 294.33

Core profitability (% RWAs) and leverage

Year to 03.2007a 03.2008e 03.2009e 03.2010e

Net interest income 3.3 3.3 3.3 3.4Net fees/commissions 0.0 0.0 0.0 0.0Trading profits 0.1 0.0 0.0 0.0Total income 0.1 0.1 0.1 0.1Other income -0.1 -0.1 0.0 0.0Operating expense -2.6 -2.5 -2.5 -2.6Pre-provision profit 2.7 2.6 2.6 2.6Bad debt charge -0.6 -0.6 -0.6 -0.6HSBC attributable profit 1.4 1.4 1.3 1.3Leverage (x) 15.2 11.5 10.0 11.1Return on average equity

Valuation data

Year to 03.2007a 03.2008e 03.2009e 03.2010e

PE* 24.0 17.4 13.8 11.2Pre-provision multiple 14.7 13.1 10.2 8.2P/NAV 5.5 2.8 2.5 2.2REP multipleEquity cash flow yield (%) -2.6 -2.2 -1.2 -0.3Dividend yield (%) 0.7 0.9 1.0 1.0

Issuer information

Share price(INR) 659.75 Target price (INR) 603.00 Up/downside (%) -8.6

Reuters (Equity) AXBK.BO Bloomberg (Equity) AXSB INMarket cap (USDm) 5,761 Market cap (INRm) 235,019Free float (%) 32.4Country India Sector COMMERCIAL BANKSAnalyst Anand Shanbhag Contact +9122 2268 1234

Notes: price at close of 06 Sep 2007



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Bank of BarodaLoan growth down to sensible levelBOB’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 haspulled 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. Webelieve BOB’s extraordinarily high loan growth in

FY06 and FY07 needs to be seen in this context.

Relatively low impact on profitabilityThe 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 inall 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 tothe contraction seen in other state-owned banks.

Overweight (V), target price INR379Assumptions used in the DCF


Growth 15.8% 15.0%ROE 14.9% 17.8%ROA 0.8% 0.9%

Source: HSBC

We continue to value BOB using a combination

of DCF, PE and P/B. Our three-stage DCF uses


of semi-explicit forecasts, where we assume

15.0% loan CAGR and 20.0% dividend payout.

The final stage of 12 years assumes convergenceof 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 factorsNet 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 theirlong term average. Should they rise more than our

forecasts net profit growth would be lower.

Corporation BankLow cost ratios a protective factorQ1FY08 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 than50bp 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 forCRBK. This contraction is similar to other banks.

The edge in costs reflects CRBK’s long standing

efficient use of manpower. We estimate the

efficiency by dividing the number of employeesby 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.



13


ab c

Overweight (V), target price INR419Assumptions used in the DCF


Growth 16.0% 15.0%ROE 16.8% 16.6%ROA 1.1% 1.1%

Source: HSBC

We continue to value CRBK using a combination




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



12-month period ended June 2007 at 8.4x and





where we assign a weight of 50% to our DCF and

25% to our PE and P/B values respectively.

Risk factorsDecline 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 DevelopmentFinance CorporationBack as the leaderSeveral reasons could explain why many

commercial banks seem to going slow in the home

loan market. Default rates may be higher than whatwas priced into the loans. Another reason could be

the large proportion of home loans ranging from

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

mandated priority sectors. In contrast HDFC has

maintained its portfolio growth in the high 20s.

While that was below market growth in 2005 and

2006, today it may exceed that.

Stable NIM with an upward biasWe note a steady expansion in HDFC’s NIM over

the past four years despite the competition andchanging trend in interest rates. HDFC wassuccessful in shifting the profile of its home loansfrom largely fixed rate loans till 2002 to largelyfloating rate loans by 2006. It has also succeeded inchurning the mix of its borrowed funds. BetweenMarch 2001 and March 2007 the proportion of loansand bonds rose from 44% to 70% and the proportionof deposits fell from 47% to 18%.

Proven lending systems provide theedge in the current marketIndia’s home loan market could be approachinganother inflection point. For most of the pastdecade, property prices were stable, interest rateswere falling and incomes were rising. Improvedaffordability coupled with the huge latent demandtriggered the boom in the lending market.

For close to six quarters now, conditions havestopped improving. Affordability has clearly

worsened as property prices have zoomed up. In thissituation HDFC’s experience could make a hugedifference relative to newcomers among commercialbanks. Given the long duration of home loans (10 to15 years at origin) none of the commercial bankshave completed one lending cycle. We believe theweighted average of the home loan book in manybanks could be less than 3 years. HDFC’s three-decade-long experience should endow it withsuperior ability to assess customers, propertydevelopers and also to deal with cases where debtservicing may be interrupted. These strengths arevisible in the trend of declining cost ratios and lowprovisioning, in our view.



14


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Underweight, target price INR1985Assumptions used in DCF


Growth 20.9% 20.0%ROE 13.6% 20.6%ROA 2.6% 2.3%

Source: HSBC

We continue to value HDFC using a combination


explicit forecasts until FY10, followed by 10

years of semi-explicit forecasts where we assume


The final stage of 12 years assumes convergenceof 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.





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.

Risk factorsNet interest margin could fall below our forecasts .

If future increases in funding costs are not entirely

passed on NIM would be lower than our forecast

leading to lower net profit than our estimates.

Impact of revised tax rules could be larger thanour forecasts . We have assumed that the impact of

decreased tax shelter to be offset by increase in

capital gains and decrease in cost ratios. Should

these elements not be sufficient the net profitcould fall below our forecasts.

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 276HDFC Standard Life 134 78% 104.8 387HDFC Chubb 0.4 74% 0.3 1HDFC AMC 18 50% 9.1 34

Intelenet 8 50% 3.8 14HDFC Venture Capital 0.7 81% 0.6 2

Total 194 714

Source: HSBC



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HDFC BankMarket share expansion resumesafter new equityThe 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 yearago. 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 balancingROE with market share expansionThe 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% (March2007). 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 topreserving profitabilityOver the past five years HDBK’s ROA has

stabilised near 1.4%. The relative stability is the

result of sharp increases in loan provisions andoperating expense on one hand, and revenues on

the other.

Combined specific loan loss provisions & generalprovisions for standard assets rose from 0.44% (of total assets) for FY02 to 0.84% for FY07. This risewas offset by increases in NII (3.15% to 4.50%) andin fee income (1.03% to 1.80%).

The strength in net interest income (and theconsequent expansion of NIM) is facilitated byHDBK’s strength in low-cost deposits. The latterhave grown faster than loans. The high proportion of low cost deposits is the result of steady expansion inbranches – a four-fold increase to 684 branches infive years. This investment and branch costs raiseHDBK’s cost ratios above peers.

HDBK actively uses its branch network as frontoffices for distribution of third-party products suchas mutual funds and life insurance. We believerevenue from these to be a significant element in feerevenue. The rise in NPL provisions can also becorrelated with the rise in NII. Part of the growth in

retail assets in recent years was in higher yield assetsthat also demanded higher provisions.

In the net analysis HDBK’s business model hasdiffered from most peers, and has been successful.Our forecasts assume the bank continues tomaintain its high ROA even as it leverages its newequity to grow faster.

Neutral, target price INR1,270Assumptions used in the DCF

Explicit Forecast Semi-Explicit ForecastGrowth 20.9% 20.0%ROE 13.6% 20.6%ROA 2.6% 2.3%

Source: HSBC

We continue to value HDBK using a combinationof DCF, PE and P/B. Our three-stage DCF usesexplicit forecasts until FY10 followed by 10 yearsof semi-explicit forecasts, where we assume25.0% loan CAGR and 25.0% dividend payout.

The final stage of 12 years assumes convergenceof ROE and COE (assumed to be 13.5%). Thismethod results in a value of INR1,033 per share.



16


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We estimate the mean PE and mean P/B for the12-month period ended June 2007 at 29.0x and




Our target price of INR1,270 is a weighted

average where the DCF value is assigned a weightof 50% and the PE and P/B values are assigned

weights of 25% each.

Risk factorsNet 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 inHDBK’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 BankIncreased uncertainty over unlockingvalue

The Reserve Bank of India (RBI) has not approvedthe 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 listedconcerns 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 theadditional delay in the creation of the holding

company. The imputed value in a proposed deal to

sell a 5.9% stake in this company has been a criticalelement 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 potentialrebound in NIM are positivesThe 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 assetshas 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 INR200bnof 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 INR1024We continue to value ICBK using a combination

of DCF, PE and P/B. Our three-stage DCF usesexplicit forecasts until FY10 followed by 10 years



The final stage of 12 years assumes convergence

of ROE and COE (assumed to be 13.5%). This




17


ab c

Assumptions used in the DCF


Growth 18.9% 20.0%ROE 11.3% 18.8%ROA 1.0% 1.1%

Source: HSBC

This value is supplemented by the estimated valueof INR265 for ICBK’s stakes in associates andsubsidiaries. The combined DCF + sum-of-the-parts value is INR970 per share.

We continue to supplement this with estimatesbased on PE and P/B values for the stock. Weestimate the mean PE and mean P/B for the 12-month period ended June 2007 at 23.9x and 2.9xrespectively. We apply these to our forecast EPSand book value at June 2008 to arrive at values of INR905 and INR1,250 respectively.

Our target price of INR1,024 is a weightedaverage where the DCF and sum-of-the-parts

value is assigned a weight of 50% and the PE andP/B values are assigned weights of 25% each.

Sum-of-parts valuation

Stake Value(INR bn)

Valuecorresponding

to stake (INR bn)

Value pershare(INR)

ICICI PrudentialLife Insurance

74% 325 241 217

ICICI LombardGeneral Insurance

74% 14 10.1 9

ICICI PrudentialAMC

51% 19 9.7 9

ICICI Securities 100% 24 23.6 21Others 100% 10 10.0 9Total 294 265

Source: HSBC, Company reports

Risk factorsLoan provisions may rise above our forecastsresulting in a lower-than-estimated net profit . Thespurt in general provisions in Q4FY07 indicatesthe relatively large exposure of ICBK to loansmade to sectors deemed to be ‘sensitive’ by theReserve Bank of India. A possible rise indelinquency on such loans and others couldrequire more loan provisions.

Fee income growth may slow down . Competitionbetween banks, or a decrease in the volume of

activity that drives fee income, could result in

ICBK’s fee income falling below our forecasts,

resulting in a decrease in net profit.

ING Vysya BankRecovery in loan and deposit growthLoan growth picked up to 23% at the end of June

2007 as compared to 17% at the end of March 2007.

Loans had grown at an anaemic 13% duringFY06.Deposit growth recovered to 26% y-o-y at the

end of June 2007 as compared to 16% at the end of

March 2007.While below the growth in the new

private banks it is higher than state-owned banks.

Recovery in non–interest income.Q1FY08 saw non interest income surge by 93%y-

o-y after having declined 27% during Q1FY07.

With the bank’s ATMs expanding and possessing

the capability to accept a wide range of plasticpayment cards, a wider segment of ATM

cardholders from across the banks can transact

business at them.

Increased focus on private banking business

Vysya now offers an expanded range of

investment solutions, leading to an increase in

assets under management and clients. Kolkata was

added as a new private banking centre, in addition

to the existing centres of Delhi, Mumbai, Pune

and Bangalore.

Asset quality continues to improve

Net NPL ratio fell to 0.84% at the end of June

2007 as compared to 0.95% at end of FY07.

While Vysya’s trend is consistent with most

Indian banks it is more creditable to cut the ratiowhen loan growth has stayed low. Overall,

Vysya’s loan growth in FY06 and FY07 was

about half that of the industry and an even lower

fraction of the growth in new private banks.



18


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Underweight (V), target price INR231Assumptions used in the DCF


Growth 15.7% 15.0%ROE 12.0% 17.9%ROA 0.6% 0.9%

Source: HSBC

We continue to value Vysa using a combination



of semi-explicit forecasts where we assume 15.0%

loan CAGR and 18% dividend payout. The final


and COE (assumed to be 13.5%). This method

results in a value of INR219 per share.







where we assign a weight of 50% to our DCF value

and 25% to our PE and P/B values, respectively.

Risk factorsDecrease 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. Thisis 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.

Punjab National BankRecovery in non-interest incomeNon interest income grew by a robust 54% in

Q1FY08 as compared to growth of a mere 11% in

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 feeintensity 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 positiveQ1FY08 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 INR591Assumptions used in the DCF


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 semi-explicit forecasts where we assume 15.0%

loan CAGR and 20.0% dividend payout. The final


and COE (assumed to be 13.5%). This methodresults in a value of INR608 per share.



1.5x respectively. We apply these to our forecastEPS and book value at June 2008 to arrive at




19


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Financials & valuation: Punjab National Bank Overweight Financial statements

Year to 03.2007a 03.2008e 03.2009e 03.2010e

P&L summary (INRm)

Net interest income 55,146 62,814 71,612 80,681Net fees/commissions 11,467 13,038 14,715 16,280Trading profits -139 732 561 638Other income -905 -148 1,011 2,027Total income 65,569 76,436 87,899 99,626Operating expense -33,262 -37,379 -42,070 -47,213Bad debt charge -10,615 -13,572 -15,921 -18,004Other 0 0 0 0HSBC PBT 21,691 25,485 29,908 34,409

Exceptionals 0 0 0 0PBT 21,691 25,485 29,908 34,409Taxation -6,291 -7,915 -9,279 -10,670Minorities + preferences 0 0 0 0Attributable profit 15,401 17,571 20,629 23,739HSBC attributable profit 15,401 17,571 20,629 23,739

Balance sheet summary (INRm)

Ordinary equity 104,355 117,774 133,702 152,185HSBC ordinary equity 104,355 117,774 133,702 152,185Customer loans 973,926 1,190,672 1,414,114 1,658,900Debt securities holdings 562,689 639,083 734,434 838,236Customer deposits 1,377,186 1,649,070 1,954,185 2,284,737Interest earning assets 1,693,071 1,990,004 2,333,491 2,710,183Total assets 1,619,876 1,911,063 2,236,632 2,592,040

Capital (%)

RWA (INRm) 1,075,429 1,276,824 1,489,238 1,722,152Core tier 1 8.9 8.5 8.4 8.3Total tier 1 8.9 8.5 8.4 8.3Total capital 12.3 11.4 10.8 10.4

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 13.3Operating expense 10.0 12.4 12.5 12.2Pre-provision profit 10.7 20.9 17.3 14.4EPSHSBS EPS 7.0 14.1 17.4 15.1DPS 66.7 10.0 13.6 12.0NAV (including goodwill) 11.3 12.9 13.5 13.8

Ratios (%)

Cost/income ratio 50.7 48.9 47.9 47.4Bad debt charge 1.2 1.3 1.2 1.2Customer loans/deposits 70.7 72.2 72.4 72.6NPL/loan 3.5 2.8 2.8 2.8NPL/RWA 3.2 2.7 2.7 2.8Provision to risk assets/RWA 2.7 2.7 2.8 2.9Net write-off/RWA 0.0 0.0 0.0 0.0Coverage 83.1 100.0 102.3 102.2ROE (including goodwill) 15.5 15.8 16.4 16.6

Per share data (INR)

EPS reported (fully diluted) 58.05 66.23 77.76 89.48HSBC EPS (fully diluted) 58.05 66.23 77.76 89.48DPS 10.00 11.00 12.50 14.00NAV 330.97 373.53 424.04 482.66NAV (including goodwill) 330.97 373.53 424.04 482.66

Core profitability (% RWAs) and leverage

Year to 03.2007a 03.2008e 03.2009e 03.2010e

Net interest income 5.7 5.3 5.2 5.0Net fees/commissions 0.0 0.0 0.0 0.0Trading profits 0.0 0.1 0.0 0.0Total income 0.1 0.1 0.1 0.1Other income -0.1 0.0 0.1 0.1Operating expense -3.5 -3.2 -3.0 -2.9Pre-provision profit 3.4 3.3 3.3 3.3Bad debt charge -1.1 -1.2 -1.2 -1.1HSBC attributable profit 1.6 1.5 1.5 1.5Leverage (x) 9.7 10.6 11.0 11.2Return on average equity

Valuation data

Year to 03.2007a 03.2008e 03.2009e 03.2010e

PE* 8.4 7.4 6.3 5.5Pre-provision multiple 4.8 4.0 3.4 3.0P/NAV 1.5 1.3 1.2 1.0REP multipleEquity cash flow yield (%) -0.3 2.2 3.7 4.8Dividend yield (%) 2.0 2.2 2.5 2.9

Issuer information

Share price(INR) 490.50 Target price (INR) 591.00 Up/downside (%) 20.5

Reuters (Equity) PNBK.BO Bloomberg (Equity) PNB INMarket cap (USDm) 3,791 Market cap (INRm) 154,656Free float (%) 42.2Country India Sector Commercial BanksAnalyst Anand Shanbhag Contact +9122 2268 1234

Notes: price at close of 06 Sep 2007



20


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Our target price of INR591 is a weighted averagewhere 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 factorsLoan 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 inprovisions 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 IndiaStability of NIM may be short livedSBI 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 thehighest 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 betweenQ1FY08 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 andcore banking IT platform are yet to help in the

core function of galvanising low-cost deposits.

Inexorable rise in NPL provisionsSpecific provisions for Q1FY08 grew 195%y-o-y. In part this reflects the low base. It also is asign that the rebound in provisions that began inQ4FY06 is continuing. A study of the rolling 4-quarter specific provisions reveals the ratio to be0.55% for Q1FY08, well below the high of 1.9%seen in the quarter ended Q1FY05. The reportedamount of net NPLs has risen 23% in the past twoquarters. This is an unfamiliar risk for SBI as the

current rise in NPLs is the first ever, since thewave of growth in retail loans began in 2003.

Proposed merger is a milestoneThe proposed merger of (announced in late Augustafter both the boards approved it) 100%subsidiary, State Bank of Saurashtra with SBIwould the first instance of two healthy state-ownedbanks merging. Implementation of this deal wouldbe an inflection point in the consolidation of Indian banks. The leadership in banks has longagreed that consolidation is necessary but progresshas been lacking. Consensus belief is that theemployee unions, backed by the left-wing parties,would obstruct mergers.

Uncertainty over value unlockingmeasuresThe future of SBI’s holding company woulddepend on RBI’s final decision on the proposed‘intermediate holding company’ model. We

believe it may take an indeterminate time beforeall the necessary conditions are fulfilled toRBI’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 thegovernment’s stake can only fall to 55%, from theprevailing 59.7% and SBI can only sell 45 millionnew shares. The amendment to permit thegovernment’s stake to fall to 51% was reportedlyapproved a week ago by the Standing Committeeon Finance of India’s Parliament. It would only beeffective after it is approved by parliament.



21


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Recent reports indicate the government may agreeto a rights offering by SBI in FY08 followed by a

public offer.

YES BankYoung bank in the fast laneYES 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% atthe 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 intensityBoth 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 FY06and 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.

Neutral (V), target price INR190We 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% loanCAGR 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%). Thismethod results in a value of INR142 per share.

We estimate the mean PE and mean P/B for the12-month period ended June 2007 at 40.4x and

4.7x respectively. We apply these to our estimated



Our blended target price of INR190 is a weighted

average where we assign a weight of 50% to ourDCF 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 forecastcould 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.



22


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Disclosure appendixAnalyst certificationThe following analyst(s), who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subjectsecurity(ies) or issuer(s) and any other views or forecasts expressed herein accurately reflect their personal view(s) and that nopart of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views containedin this research report: Anand Shanbhag and Saumya Agarwal

Important disclosuresStock ratings and basis for financial analysisHSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, whichdepend 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 opportunitiesbased 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 whenHSBC 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 thiswebsite.

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

Rating definitions for long-term investment opportunitiesStock 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 representsthe value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For astock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over thenext 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, thestock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10percentage 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 volatilitystatus 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 12months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However,



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stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the pastmonth'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 targetprice vs current market price and then categorised (approximately) the top 40% as Overweight, the next 40% as Neutral andthe last 20% as Underweight. The performance horizon is 2 years. The notional target price was defined as the mid-point of theanalysts' valuation for a stock.

From 15 November 2004 to 7 June 2005, HSBC carried no ratings and concentrated on long-term thematic reports whichidentified themes and trends in industries, but did not make a conclusion as to the investment action that potential investorsshould 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 thestock 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. Thetarget 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 opportunitiesAs 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 disclosuresDisclosure checklist

Company Ticker Recent price Price Date Disclosure

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

Source: HSBC



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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 atwww.hsbcnet.com/research.

* HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures1 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 Researchoperate and have a management reporting line independent of HSBC's Investment Banking business. Chinese Wallprocedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/orprice sensitive information is handled in an appropriate manner.



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Disclaimer* Legal entities as at 22 August 2007 'UAE' HSBC Bank Middle East Limited, Dubai; 'HK' The Hongkong and Shanghai BankingCorporation Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC 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 Markets (India) Private Limited, Mumbai; 'JP' HSBC Securities (Japan) Limited, Tokyo; 'EG' HSBC Securities Egypt S.A.E., Cairo; 'CN' HSBC Investment Bank Asia Limited, Beijing RepresentativeOffice; The Hongkong and Shanghai Banking Corporation Limited, Singapore branch; The

Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch; HSBC Securities(South Africa) (Pty) Ltd, Johannesburg; 'GR' HSBC Pantelakis Securities S.A., Athens; HSBC Bank

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, GrupoFinanciero HSBC, HSBC Bank Brasil S.A. - Banco Múltiplo.

Issuer of report HSBC Securities and CapitalMarkets (India) Private Limited Registered Office52/60 Mahatma Gandhi RoadFort, Mumbai 400 001, India

Telephone: +91 22 2267 4921Fax: +91 22 2263 1983Website: www.hsbcnet.com/research

This document has been issued by HSBC Securities and Capital Markets (India) Private Limited ("HSBC") for the information of its customers only. HSBCSecurities and Capital Markets (India) Private Limited is regulated by the Securities and Exchange Board of India. If it is received by a customer of anaffiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. This document is not andshould not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. HSBC has based this document oninformation obtained from sources it believes to be reliable but which it has not independently verified; HSBC makes no guarantee, representation orwarranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of the Research Division of HSBConly and are subject to change without notice. HSBC and its affiliates and/or their officers, directors and employees may have positions in any securitiesmentioned in this document (or in any related investment) and may from time to time add to or dispose of any such securities (or investment). HSBC and itsaffiliates may act as market maker or have assumed an underwriting commitment in the securities of companies discussed in this document (or in related

investments), may sell them to or buy them from customers on a principal basis and may also perform or seek to perform investment banking or underwritingservices for or relating to those companies and may also be represented in the supervisory board or any other committee of those companies. The informationand opinions contained within the research reports are based upon publicly available information and rates of taxation applicable at the time of publicationwhich are subject to change from time to time. Past performance is not necessarily a guide to future performance. The value of any investment or incomemay go down as well as up and you may not get back the full amount invested. Where an investment is denominated in a currency other than the localcurrency of the recipient of the research report, changes in the exchange rates may have an adverse effect on the value, price or income of that investment. Incase of investments for which there is no recognised market it may be difficult for investors to sell their investments or to obtain reliable information about itsvalue or the extent of the risk to which it is exposed.HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receivingand/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the UnitedStates and not with its non-US foreign affiliate, the issuer of this report.In the UK this report may only be distributed to persons of a kind described in Article 19(5) of the Financial Services and Markets Act 2000 (FinancialPromotion) Order 2001. The protections afforded by the UK regulatory regime are available only to those dealing with a representative of HSBC Bank plc inthe UK. In Singapore, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch for the generalinformation of institutional investors or other persons specified in Sections 274 and 304 of the Securities and Futures Act (Chapter 289) (“SFA”) andaccredited investors and other persons in accordance with the conditions specified in Sections 275 and 305 of the SFA. This publication is not a prospectus asdefined in the SFA. It may not be further distributed in whole or in part for any purpose. The Hongkong and Shanghai Banking Corporation LimitedSingapore Branch is regulated by the Monetary Authority of Singapore. In Australia, this publication has been distributed by HSBC Stockbroking (Australia)Pty Limited (ABN 60 007 114 605) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). It makes norepresentations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particularperson or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particularneeds of any recipient. In Japan, this publication has been distributed by HSBC Securities (Japan) Limited. In Hong Kong, this document has beendistributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business for the information of itsinstitutional and professional customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and ShanghaiBanking Corporation Limited makes no representations that the products or services mentioned in this document are available to persons in Hong Kong orare necessarily suitable for any particular person or appropriate in accordance with local law. All inquiries by such recipients must be directed to TheHongkong and Shanghai Banking Corporation Limited.© Copyright. HSBC Securities and Capital Markets (India) Private Limited 2007, ALL RIGHTS RESERVED. No part of this publication may bereproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, withoutthe prior written permission of HSBC Securities and Capital Markets (India) Private Limited. (March 2005) MICA (P) 316/06/2007



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Global

Carlo DigrandiAnalyst, Global Sector Co-Head +44 20 7991 6843 [email protected]

Robin DownAnalyst, Global Sector Co-Head +44 20 7991 6926 [email protected]

Europe

EquityPeter BarkowAnalyst +49 211 910 3276 [email protected]

Matthew CzepliewiczAnalyst +44 20 7991 6709 [email protected]

Leigh GoodwinAnalyst +44 20 7991 6828 [email protected]

Sophia SkourtiAnalyst +30 210 696 5214 [email protected]

Peter ToemanAnalyst +44 20 7991 6791 [email protected]

Credit ResearchCarlo MareelsAnalyst +44 20 7991 6722 [email protected]

Oliver BurrowsAnalyst

+44 20 7991 5632 [email protected]

Specialist SalesDavid Bhonslay+1 212 525 0211 [email protected]

Matthew Charlton+44 20 7991 5392 [email protected]

Paula Cricca+1 212 525 3296 [email protected]

Nigel Grinyer+44 20 7991 5386 [email protected]

Nicolette Theodoropoulos+44 20 7991 5361 [email protected]

Juergen Werner+49 211 910 4461 [email protected]

Emerging Europe, Middle East & AfricaEquity & Credit ResearchNadia KabbaniAnalyst + 44 20 7991 6701 [email protected]

Asia

Equity ResearchTodd DunivantAnalyst, Head of Banks, Asia Pacific +852 2996 6599 [email protected]

Anand ShanbhagAnalyst +91 22 2268 1234 [email protected]

Brett HemsleyAnalyst

+81 3 5203 3627 [email protected] WuAnalyst +852 2996 6585 [email protected]

Kathy Park Analyst +822 3706 8755 [email protected]

Saumya AgarwalAssociate+91 22 2268 1235 [email protected]

York PunAssociate +852 2822 4396 [email protected]

Credit ResearchDilip ShahaniAnalyst, Head Credit Research +852 2822 4520 [email protected]

Devendran MahendranAnalyst +852 2822 4521 [email protected]

North America

Credit ResearchVan HesserAnalyst, Global Head of Credit Research +1 212 525 3114 [email protected]

Daphne FengAnalyst +1 212 525 3035 [email protected]

Global Banks Research Team

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