hdfcsec - research report march 11, 2011

8/7/2019 HDFCSEC - Research Report March 11, 2011

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Nifty Series March 11, 2011

Key Triggers 3 month stock view vis--vis

- One of the best NIMs in the industry Nifty Performer- Improving Asset Quality Bankex Outperformer- Best placed to benefit out of capital market boom Expected price range 3 Months Rs.382-Rs.441

Key Risks- Banking business now getting focus, competition intensifying Post Breakout Levels- Pressure on Margins Support Rs.350- Too dependent on capital markets Resistance Rs.498

Company Background:

Established in 1985, the Kotak Mahindra group has been one of India's most reputed financial conglomerates. In February 2003, KotakMahindra Finance Ltd, the group's flagship company was given the license to carry on banking business by the Reserve Bank of India(RBI). This approval created banking history since Kotak Mahindra Finance Ltd. is the first non-banking finance company in India toconvert itself in to a bank as Kotak Mahindra Bank Ltd. Today, it is one of the fastest growing bank and among the most admiredfinancial institutions in India. Kotak Mahindra Bank has over 245 branches and a customer base of over 8 lakhs. Spread all over India,not just in the metros but in Tier II cities and rural India as well, it is redefining the reach and power of banking.

The bank offers personal finance solutions of every kind from savings accounts to credit cards, distribution of mutual funds to lifeinsurance products. Kotak Mahindra Bank offers transaction banking, operates lending verticals, manages IPOs and provides workingcapital loans. Kotak Bank has one of the largest and most respected Wealth Management teams in India, providing the widest range ofsolutions to high net worth individuals, entrepreneurs, business families and employed professionals. The bank offers several valueadded services to customers including netcards, best compliments cards, Les Concierges, bill payments, home banking services,mutual funds on net, electronic fund transfer on net, mutual fund on phone and other investment platforms. The banks experience hasbeen that different customers partake these at different magnitude, depending on their comfort for risk appetite and technologyfriendliness. The bank has arrangements with UTI Bank and HDFC Bank under which its customers can use s everal hundreds of ATMsof these banks across the city. There is a minor cost involved in the service. But the arrangement has brought in savings for the bankby way of infrastructure costs.

The bank is one of the faster growing ones in the country. It is amongst the top five private banks in India. Though the bank is relativelyyoung as compared to its peers, the group to which the bank belongs is a pioneer in the finance business. Assets managed/ advised bythe Group as on December 31, 2010 was Rs. 510 b n (December 31, 2009 Rs.524 bn; September 30, 2010 Rs .497 bn; March 31, 2010Rs.452 bn). The group has a network of close to 2,000 branches and franchises across the country servicing close to 8.3 mn customeraccounts.

Key Promoter

Mr. Uday S. KotakMr. Uday Kotak is the Executive Vice-Chairman and Managing Director of the Bank, and its principal founder and promoter. Mr. Kotakis an alumnus of Jamnalal Bajaj Institute of Management Studies. In 1985, when he was still in his early twenties, Mr. Kotak thought ofsetting up a bank when private Indian banks were not even seen in the game. First Kotak Capital Management Finance Ltd (which laterbecame Kotak Mahindra Finance Ltd), and then with Kotak Mahindra Finance Ltd, Kotak became the first non-banking financecompany in India's corporate history to be converted into a bank. Over the years, Kotak Mahindra Group grew into several areas likestock broking and investment banking to car finance, life insurance and mutual funds. Among the many awards to Mr. Kotak's credit arethe CNBC TV18 Innovator of the Year Award in 2006 and the Ernst & Young Entrepreneur of the Year Award in 2003. He was featuredas one of the Global Leaders for Tomorrow at the World Economic Forum's annual meet at Davos in 1996.

Kotak Mah Kotak Mahindra Kotak Kotak Mahindra Kotak Mah Kotak Mahindra Kotak Kotak KotakInvestments Old Mutual Life Securities Capital Company International Prime Mahindra Private Equity Trustee

Ltd Insurance Ltd AMC Group Co Ltd

The Bank owns 100% stake in all subsidiaries (except Kotak Mahindra Old Mutual Life, where it holds 74% stake). Apart from theabove, Kotak Mah UK Ltd, Kotak Mahindra Inc, Kotak Investment Advisors Ltd, Kotak Mahindra Trusteeship Services, Kotak ForexBrokerage, Kotak Mahindra Pension Fund, Kotak Mah Financial Services Ltd and Global Investment Opp Fund are also its 100%subsidiaries.

Kotak Mahindra Bank CMP: 427.25

Kotak Mahindra Bank


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Some of the other interests of the group apart from banking:

Kotak Mahindra Old Mutual Life Insurance Ltd: A 74:26 joint venture between Kotak Mahindra Bank Ltd and Old Mutual, Kotak LifeInsurance offers a wide choice of life insurance products such as unit-linked plans, traditional insurance policies and gratuity groupplans to credit-term plans for businesses. With the promise of complete financial independence, Kotak Life Insurance aims to bringabout a change in the mindset of today's informed insurance customer.

Kotak Securities Ltd: Kotak Securities is one of the largest broking houses in India with a wide geographical reach. Kotak Securities

opera tions include stock broking and distribution of various financial products including private and secondary placement of debt, equityand mutual funds.

Kotak Mahindra Capital Company: Kotak Investment Banking (KMCC) is a full-service investment bank in India offering a wide suite ofcapital market and advisory solutions to leading domestic and multinational corporations, banks, financial institutions and governmentcompanies. Its services encompass Equity & Debt Capital Markets, M&A Advisory, Private Equity Advisory, Restructuring andRecapitalization services, Structured Finance services and Infrastructure Advisory & Fund Mobilization.

Kotak Mahindra Prime Ltd: Kotak Mahindra Prime Ltd is among India's largest dedicated passenger vehicle finance companies. KMPLoffers loans for the entire range of passenger cars, multi -utility vehicles and pre-owned cars. Also on offer are inventory funding andinfrastructure funding to car dealers with strategic arrangements via various car manufacturers in India as their preferred financier.

Kotak International Business: Kotak International Business specializes in providing a range of services to overseas customers seekingto invest in India. For institutions and high net worth individuals outside India, Kotak International Business offers asset managementthrough a range of offshore funds with specific advisory and discretionary investment management services.

Kotak Mahindra Asset Management Company Ltd: Kotak Mahindra Asset Management Company offers a complete bouquet of assetmanagement products and services that are designed to suit the diverse risk return profiles of each and every type of investor. KMAMCand Kotak Mahindra Bank are the sponsors of Kotak Mahindra Pension Fund Ltd, which has been appointed as one of six fundmanagers to manage pension funds under the New Pension Scheme (NPS).

Kotak Private Equity Group: Kotak Private Equity Group helps nurture emerging businesses and mid-size enterprises to evolve intotomorrow's industry leaders. With a proven track record of helping build companies, KPEG also offers expertise with a combination ofequity capital, strategic support and value added services. What differentiates KPEG is not merely funding companies, but also havinga close involvement in their growth as board members, advisors, strategists and fund-raisers.

Kotak Realty Fund: Kotak Realty Fund deals with equity investments covering sectors such as hotels, IT parks, residential townships,shopping centres, industrial real estate, health care, retail, education and property management. The investment focus here is ondevelopment projects and enterprise level investments, both in real estate intensive businesses.

Shareholding Pattern

Shareholding Pattern% Holding as on

31/12/2010% Holding as on




31/12/2009Promoter 45.61 45.79 48.17 48.23 48.27FII 23.99 25.03 25.97 28.56 28.93Other Institutions 5.84 6.22 6.39 4.98 4.78Public and Non Institutions 24.56 22.96 19.47 18.23 18.02Total 100.00 100.00 100.00 100.00 100.00The Bank allotted 16400000 Preferential Shares on 11/08/2010 at Rs.833 per share (FV Rs.10) to Sumitomo Mitsui Banking Corporation (Source: Capitaline Database)

Investment Rationale:

Well placed to benefit out of economic growth

Indias macro economic indicators portend supernormal growth in financial services. Kotak Mahindra Bank (KMB) together with itssubsidiaries has a presence across financial services lending, broking, investment banking, life insurance, asset management, andproprietary investments. Given its integrated business model, an established brand and quality management, KMB is in a good spot tobenefit from the buoyancy in the sector.

Indias GDP would double to US$2t over the next six years, driven by accelerated growth in manufacturing and services. Changingdemographics in favor of a younger population in India, rising disposable incomes and changing mindset of people in favor ofconsumption would be the key drivers of GDP growth, going forward.

The savings rate in India has been increasing since independence and has crossed 33.7% in FY10. The savings rate has acceleratedsignificantly over last 6-8 years in tandem with stronger growth in GDP. Higher GDP growth and increasing savings rate would lead tohigher investible surplus, which would further drive economic activity. Corporate savings have also increased significantly in the recentpast. As these savings get converted into investments (organic or inorganic), economic expansion would receive further impetus .


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Improving asset quality

The bank has managed to report better a sset quality at the end of FY10. It reported a Gross NPA of Rs 767.33 crs while the Net NPAswere Rs 360.24 crs for FY10. Gross NPAs as a percentage of the total gross assets stood at 3.62% while the Net NPAs stood at 1.73%of the net assets at the end of FY10. There has been an improvement in the quality of assets over the past few years for the bank. Thebank though increased its Gross NPAs on an absolute and percentage basis for FY10, managed to reduce the Net NPAs on bothabsolute and percentage basis.

By the end of 9MFY11, the asset quality further strengthened. The Gross NPAs dropped both on an absolute and percentage basis. Itfell from Rs 751.14 crs in Q2FY11 to Rs 744.20 crs in Q3FY11 while the Gross NPA% stood at 2.53% as against 2.78% in Q2FY11.The Net NPAs also behaved in the similar fashion. The Net NPAs stood at Rs 235.28 crs in Q3FYY11 as against Rs 253.01 crs inQ2FY11. The Net NPA% stood at 0.81% in Q3FY11 as against 0.95% in Q2FY11. The improving performance on asset quality wasdue to a fall in incremental slippages and higher recoveries and upgrades. The Gross and Net NPA % after peaking in FY09 has begunto fall sharply.

Asset Quality

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Gross NPA Net NPA GNPA% NNPA%

Wealth management business a key focus

KMB has a wealth management unit within its elf, which focuses on HNIs. The groups scale and reach, coupled with a strong brand hasenabled the bank to scale up its wealth management unit. It is currently the wealth manager/advisor to over 3,700 families and around30% of the top-300 wealthy families in India. It is present in 14 cities, with about 110 relationship managers. With strong economicprospects forecasted, we believe that wealth management should grow at a much stronger pace.

According to NCAER, India have more 400,000 households with investible assets of over Rs10m each. Wealth Management offers ahuge and highly profitable opportunity and very few Indian banks are currently focusing on this segment. KMB could continue to remaina dominant player in this business, given its established relationships and synergies arising out of its IB and asset managementbusinesses.

Loan Book of the bank set to growThe advances of the banks have grown decently over the past few years. It stood at Rs 28884.8 crs at the end of 9MFY11 as comparedto Rs 20775.05 crs at the end of FY10. The advances of the bank are set to grow in the coming years as the demand for funds haveincreased over the recent past. This is despite the immense competition in the market for the bank especially in the form of PSU banksthat may lend for comparatively cheaper rates. The advances of the bank have grown steadily over the past few quarters for the bankespecially since Q1FY11.


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Advances

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The loan book of the bank consists of lending to the corporate banking segment, CVs and CEs, Personal Loans, Mortgage Loans,Agriculture finance, and other advances.

Advances Split: Rs Crs - standalone Q3FY11 Q2FY11 Q1FY11 Q4FY10 Q3FY10CVs and CEs 5058.6 4536.2 4030.1 3693.5 3424.4Personal Loans 1221.4 1147.0 1169.5 1315.0 1441.7Mortgage Loans 6626.1 5983.2 5246.9 4711.6 4020.1Agriculture Finance 3752.8 3328.3 2924.6 3088.6 2497.3Corporate Banking 10407.4 9883.1 8324.4 6476.1 8476.4Others 1818.5 1628.8 1493.1 1490.2 1545.7Total Advances 28884.8 26506.6 23188.6 20775.0 21405.6

Advances as per segmental classification (Standalone) Q3FY11 Q2FY11 Q1FY11Retail 15446.80 14619.90 13604.40Corporate 13375.80 11809.40 9487.60Others 62.30 77.30 96.60Total Advances 28884.90 26506.60 23188.60Investment / Treasury Assets 14286.70 13935.20 15613.00Total Advances and Investments 43171.60 40441.80 38801.60 Advances Split: Rs Crs - Consolidated Q3FY11 Q2FY11 Q1FY11 Q4FY10 Q3FY10Commercial vehicles & Construction equipments 5058.60 4536.20 4030.10 3693.50 3424.60Auto Loans 7993.50 7846.50 7064.40 6541.80 5885.90Mortgage loans 6626.10 5983.20 5299.20 4765.00 4074.50Personal loans 1226.80 1159.30 1192.70 1354.00 1492.40Agriculture Finance 3752.80 3328.30 2924.60 3088.60 2497.30Corporate Banking 11594.00 11038.90 9219.40 7194.30 8934.60Others 3844.50 3622.50 3247.80 3087.00 3027.80Total Advances 40096.30 37514.90 32978.20 29724.20 29337.10 The above table shows the advances split of the bank over the past few quarters. It can be observed here th at the bank, over the pastone-year reduced its exposure to the personal loans and other segments while it has increased its exposure in the corporate bankingsegment to a decent extent. CV and CE segment has however seen an increase in advances consistently and the bank is keen toincrease its exposure in this segment going ahead.

The capital adequacy ratio is comfortable (much above the 9% minimum) and the Bank need not raise equity funds in a hurry toincrease its lendings for some more quarters.


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Capital Adequacy Ratio

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FY08 FY09 FY10 9MFY11

Standalone CAR% Group CAR%

Strong deposit franchise with growing CASA deposits set to continue fuelling the growth of KMBThe current accounts and savings account ratio (CASA) helps determine the cost of deposits of any particular bank. The proportion ofCASA to the total deposits becomes important in controlling the expenses liabilities of any given bank. The general trend observedwithin the Indian banks in terms of their CASA is in the range of 30% to 45% of the total deposits.

Deposits and CASA%

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Total De osits CASA%

The deposits of KMB have been growing handsomely over the past years. The CASA content in the total deposits have also beengrowing constantly hence reducing the expense liability of the bank. The total deposits at the end of FY10 stood at Rs 19500 crs a sagainst Rs 13877 crs at the end of FY09. This is without considering the certificate of deposits. The higher proportion of the CASA inthe overall deposits has helped the bank contain its cost of deposits and hence reduce the overal l interest expenses. For Q3FY11, thetotal deposits stood including CODs stood at Rs 28288 crs as against Rs 22186 crs in Q3FY10 and Rs 28287 crs in Q2FY11. It can beobserved here that no significant increase was seen in the deposits during the third quarter as the entire banking industry in the countryfaced a similar problem of depleting deposits during the quarter. Even though the bank has been able to maintain a good momentum inthe deposit growth over the past few years, the current situation and the industry outlook has created pressure in the deposit growth ofthe bank.

The CASA as a percentage of total deposits stood at 31% at the end of FY10. In Q3FY11, the CASA% stood at 28% as against 31.9%in Q2FY11 mainly due to the flat growth witnessed in deposits. The bank has been quite aggressive in the previous fiscal year in termsof its overall branch network. The total branch network of the bank stood at 249 branches at the end of FY10. The same stood at 178branches a couple of years ago. At the end of 9MFY11, the branch network of the bank stood at 298. The bank is looking to take thetotal branches to 320 by the end of FY11 and to 500 branches by the end of FY12. With more branches to come up in the comingyears, the bank could witness further increase in the CASA ratio in the next couple of years.


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Strong performance of the subsidiary companies

KMBs subsidiaries include, Kotak Mahindra Prime, Kotak Securities, Kotak Mahindra Capital Company, Kotak Mahindra Life Insuranceand Kotak Mahindra AMC amongst others.

The group companies have performed pretty well over the years. The bank has been formed only few years ago, while some of itsgroup companies have been in for years now. Kotak Securities, one of the most respected brokerage houses in the country is a majorcontributor towards the success of the group.

The key performance of the group companies is expected to continue growing in the coming years. This will add strength to theconsolidated figures of KMB going ahead. The key performances of some of the subsidiary companies:

Company Business Stake PAT Remarks9MFY11 FY10

Kotak MahindraCapitalCompany

InvestmentBanking 100% 23.96 21.85

Kotak was named Best Investment Bank for Equity Finance in India in theEuromoney Real Estate Poll 2010.

Kotak MahindraPrime

Car Finance,Other Lending 100% 231.0 166.4

Total advances as on December 31, 2010 was up 40% y-o-y to Rs 10439.4crs. Net NPA of KMP as on December 31, 2010 stood at Rs 39.2 crs. Carbusiness net NPA ratio stood at 0.23% as on December 31, 2010.

Kotak SecuritiesStock Broking 100% 145.8 260.1

For 9MFY11, the total income of the company stood at Rs 568.1 crs asagainst Rs 650.6 crs in 9MFY10. Kotak Securities has a network of over

1,358 offices (own & franchisees) across 448 cities and towns a nd servicesmore than 6,33,000 secondary market customers. Kotak Securitiesaccounted for 3.7% of total average daily market volumes for 9MFY11.

Kotak MahindraOld Mutual LifeInsurance Life Insurance 74% 30.1 69.2

The total AUM of the company at the end of 9MFY11 stood at Rs 7800 crsas against Rs 5700 crs in 9MFY10. The total branch network howeverreduced to 203 by the end of December 2010 as against 214 branches atthe end of December 2009

Kotak MahindraAMC

AssetManagement 100% 9.0 65.5

The fall in the profits of this company has been quite drastic, as the companyhad witnessed huge losses in Q2FY11 and Q1FY11. Also the income of thecompany continued to fall during the three quarters of FY11, which led to asubstantial fall in the bottomline of the company.

Company Wise PATCompany Rs Crs Q3FY11 Q3FY10 Q2FY11 9MFY11 9MFY10 FY1Kotak Mahindra Bank 187.87 142.38 194.70 569.48 358.60 561.11Kotak Mahindra Prime 93.68 49.44 61.33 231.00 107.83 166.41Kotak Securities 46.64 59.18 51.74 145.78 209.32 260.10Kotak Mah Capital Company 7.62 1.58 7.31 21.85 10.53 23.86Kotak Mahindra Old Mutual Life Insurance 23.61 19.33 13.44 30.13 24.80 69.22Kotak Mahindra AMC and Trustee Company 7.24 22.85 -2.43 13.74 57.65 72.46International Subsidiaries 8.20 22.56 12.26 36.13 66.45 80.34Kotak Investment Advisors 5.44 11.46 10.52 26.80 32.74 39.75Kotak Mahindra Investments 2.76 6.13 7.99 18.31 27.84 34.66Others -0.05 -0.14 -0.11 -0.10 -0.31 -0.49Total Consolidated PAT 383.03 334.78 356.76 1093.14 895.46 1307.44Affiliates, Minority Int. and Other Adj. 0.54 -3.38 7.34 -17.78 -7.01 -0.44PAT (after MI and Adj) 383.57 331.40 364.11 1075.37 888.45 1307.00Source: Capitaline

Kotak Mahindra Asset Management Company Asset Management

The Average AUM of the company at the end of 9MFY11 stood at Rs 29.9 Bn as against Rs 34.1 Bn in 9MFY10. The group companieshave been performing well over the last many years (except Kotak Mahindra AMC) and is expected to do well going ahead. DomesticMF Debt rules the asset management book of the company with 45% of the overall assets under management coming from the sector.


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Asset Management - Q3FY11

45%

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9%Domestic MF Debt Domestic MF Equity Alternate AssetOffshore Funds Insurance PMS

Kotak Securities Stock Broking

For 9MFY11, the total income of the company stood at Rs 568.1 crs as against Rs 650.6 crs in 9MFY10. The PAT for 9MFY11 stood atRs 145.8 crs as against Rs 209.3 crs in 9MFY10. It clocked average daily volumes of around Rs 4600 crs during 9MFY11 compared toaround Rs 4000 crs during 9MFY10. Kotak Securities accounted for 3.7% of total average daily market volumes for 9MFY11.

Branches and Franchisee

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Kotak Mahindra Old Mutual Life Insurance Life Insurance

For 9MFY11, the company reported a net profit of Rs 30.1 crs as against Rs 24.8 crs in 9MFY10. The total AUM of the company at theend of 9MFY11 stood at Rs 7800 crs as against Rs 5700 crs in 9MFY10. The total branch network however reduced to 203 by the endof December 2010 as against 214 branches at the end of December 2009.

Adjusted Premium Equivalent

5.39.411.89.5

1.01.7

1.21.3

11.815.410.05.9

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Healthy key ratios of the bank

Some of the key financial ratios of the bank have been healthy and impressive at the end of 9MFY11. The bank at the end of 9MFY11reported a CAR of 18.7% with tier 1 ratio of 16.5%, a healthy one and much above the minimum requirement of 9% by the RBI. TheRONW of the bank stood at 15.6% in 9MFY11 marginally lower than 16.9% in 9MFY10. The Provision Coverage ratio of the bank washealthy at 72% at the end of 9MFY11. The credit deposit ratio of the bank stood at a healthy 87% at the end of FY10. As at March 31,2010, excluding the acquired stressed assets, the gross non-performing assets of the Bank stood at Rs. 498.3 crs (2.38% of advances)while the net non-performing assets stood at Rs. 257.2 crs (1.25% of advances). Another impressive ratio of the bank has been the

cost to income ratio. KMB reported a CI Ratio of 47.84% in FY10 down from 66.76% in FY09. However at the end of 9MFY11, the ratiowas slightly higher at 53.67%, though still healthy. Going ahead if the bank can bring down its cost income ratio further, it could boostthe bottomline of the bank significantly.

Consolidated Ratios:Particulars FY08 FY09 FY10 9MFY11NIM 5.60% 6.10% 6.30% 5.40%BVPS 84.5 94.3 113.6 142.6RONW 22.30% 10.50% 18.20% 15.60%ROAA 2.9% 1.6% 2.7% 2.0%Group CAR 20.20% 22.80% 19.30% 17.60%CAR Standalone 18.70% 19.90% 18.40% 18.70%Tier 1 CAR Standalone 14.50% 16.00% 15.40% 16.50%AUM - Rs Bn 365 339 452 510

Advances - Rs Bn 220 225 297 401Total Assets - Rs Bn 406 402 551 700Net NPA% 0.33% 1.18% 1.14% 0.51%

Source: Bank PresentationIndustry Scenario

Banking Sector in India

The evolution of the modern commercial banking industry in India can be traced to 1786 with the establishment of the Bank of Bengal inCalcutta. Three presidency banks were set up in Calcutta, Bombay and Madras. In 1860, the limited liability concept was introduced inbanking, resulting in the establishment of joint stock banks. In 1921, the three presidency banks were amalgamated to form the ImperialBank of India, which took on the role of a commercial bank, a bankers bank and a banker to the Government. The establishment of RBIas the central bank of the country in 1935 ended the quasi-central banking role of the Imperial Bank of India. In order to serve theeconomy in general and the rural sector in particular, the All India Rural Credit Survey Committee recommended the creation of a state-partnered and state sponsored bank taking over the Imperial Bank of India and integrating with it, the former state-owned and state

associate banks. Accordingly, the State Bank of India (SBI) was constituted in 1955. Subsequently in 1959, the State Bank of India(Subsidiary Bank) Act was passed, enabling the SBI to take over eight former state-associate banks as its subsidiar ies. In 1969, 14private banks were nationalized followed by six private banks in 1980. Since 1991, many financial reforms have been introducedsubstantially transforming the banking industry in India.

The banking system in India is significantly different from that of other Asian nations because of the countrys unique geographic, social,and economic characteristics. India has a large population and land size, a diverse culture, and extreme disparities in income, whichare marked among its regions. There are high levels of illiteracy among a large percentage of its population but, at the same time, thecountry has a large reservoir of managerial and technologically advanced talents. Between about 30 and 35 percent of the populationresides in metro and urban cities and the rest is spread in several semi-urban and rural centers. The countrys economic policyframework combines socialistic and capitalistic features with a heavy bias towards public sector investment. India has followed the pathof growth-led exports rather than the export led growth of other Asian economies, with emphasis on self-reliance through importsubstitution. These features are reflected in the structure, size, and diversity of the countrys banking and financial sector. The bankingsystem has had to serve the goals of economic polic ies enunciated in successive five-year development plans, particularly concerningequitable income distribution, balanced regional economic growth, and the reduction and elimination of private sector monopol ies in

trade and industry. In order for the banking industry to serve as an instrument of state policy, it was subjected to various nationalizationschemes in different phases (1955, 1969, and 1980). As a result, banking remained internationally isolated (few Indian banks hadpresence abroad in international financial centers) because of preoccupations with domestic priorities, especially massive branchexpansion and attracting more people to the system. Moreover, the sector has been assigned the role of providing support to othereconomic sectors such as agriculture, small-scale industries exports, and banking activities in the developed commercial centers (i.e.,metro, urban, and a limi ted number of semi-urban centers).

The banking systems international isolation was also due to strict branch licensing controls on foreign banks already operating in thecountry as well as entry restrictions facing new foreign banks. A criterion of reciprocity is required for any Indian bank to open an officeabroad. These features have left the Indian banking sector with weaknesses and strengths. A big challenge facing Indian banks is how,under the current ownership structure, to attain operational efficiency suitable for modern financial intermediation. On the other hand, ithas been relatively easy for the public sector banks to re-capitalize, given the increases in non-performing assets (NPAs), as theirGovernment dominated ownership structure has reduced the conflicts of interest that private banks would face.


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The last decade has seen many positive developments in the Indian banking sector. The policy makers, which comprise the ReserveBank of India (RBI), Ministry of Finance and related government and financial sector regulatory entities, have made seve ral notableefforts to improve regulation in the sector. The sector now compares favorably with banking sectors in the region on metrics like growth,profitability and non-performing assets (NPAs). A few banks have established an outstanding track record o f innovation, growth andvalue creation. This is reflected in their market valuation. However, improved regulations, innovation, growth and value creation in thesector remain limited to a small part of it. The cost of banking intermediation in India is higher and bank penetration is far lower than inother markets. Indias banking industry must strengthen itself significantly if it has to support the modern and vibrant economy, which

India aspires to be. While the onus for th is change lies mainly with bank managements, an enabling policy and regulatory frameworkwill also be critical to their success.

The failure to respond to changing market realities has stunted the development of the financial sector in many developing countries. Aweak banking structure has been unable to fuel continued growth, which has harmed the long-term health of their economies.

The banking industry is consolidating, both regionally and within individual countries. Continued local consolidation will most likely beinduced by existing economies of scale, in particular in retail banking, as well as by the competitive advantage that foreign-ownedbanks enjoy due to premium consumer perception and better access to funding, in addition to frequently having a more sophisticatedproduct offering. The trend towards consolidation in the global financial services industry is stimulating the emergence of competitors inthe market offering broad ranges of products and services, broad access to capital, and greater operating efficiency and pricing power.This is coupled with a shift from mere price competition to competition based on other factors such as innovation, customer service andthe range of products and services offered.

The number of customer transactions continues to grow at a considerably higher rate than the growth of the underlying balances oraccounts. Many banks are therefore seeking to reduce the cost of servicing individual transactions to maintain their profit margins.Installing automated, secure transaction channels requires significant investment and therefore gives larger-scale banks a competitiveadvantage. Despite widespread adoption by both banks and customers of these new transaction methods, the reduction in the use oftraditional transaction methods has been slower than expected with many banking customers preferring to use the old methods.However, there is a trend among the younger portfolio of customers of increased use in system-aided self-service methods, particularlyfor savings accounts, credit cards and simple investments. It is likely that the use of 24-hour self-service channels, such as ATMs,internet, mobile phone and voice response units and the sophistication of products sold via such channels will increase, as suchservices become increasingly commonplace. The growing importance of these channels may reduce the importance of extensivebranch networks and result in increased competition from other financial institutions. It may also lower barriers to entry into the marketfor new competitors such as providers of direct or electronic banking services.

The banking sector in India has become increasingly more competitive in recent years. Public sector banks have lost their market shareto the more dynamic private sector banks and, to a lesser extent, to foreign banks. The scheduled commercia l banks in India, unliketheir global counterparts, showed considerable resilience against the backdrop of global financial crisis and its effects on Indiaseconomy. While the balance sheet of public sector banks maintained their growth momentum, the private sector banks and foreignbanks registered a deceleration in growth rate. The profitability ratios of Indian commercial banks are relatively moderate but their corerecurring income and profits are on a rising trend. Public sector banks appear marginally less profitable than their private sectorcounterparts, and foreign banks in India appear to be more profitable. Going forward, the increasing disintermediation and competitionfor good quality credit could exert some pressure on revenue streams and margins. The robust deposit franchises of the larger Indianbanks and, in particular, the public sector banks, helps to ensure such banks sources of relatively cheap and stable funding andprovides them with a comfortable liquidity profile.

Recent Performance of the bank Q3FY11

The operating performance of financing business was strong in 9MFY11 with robust advance growth and consistent decline in NPLs.However, considering the high inflation and r ising interest rate environment, management moderated loan growth target to 30% forFY11 (from 35-40% earlier). Reported NIMs, which have also come off 90bps since Q4FY10 to 5.4%, are expected to sustain in the5.0-5.4% range over FY10-12E. Earnings of capital market businesses will continue to reel under pressure due to increasedfragmentation, lower yields and redemption pressure.

On a s tandalone basis , the bank reported a 36.4% y-o-y jump in its interest income from Rs 832.41 crs in Q3FY10 to Rs 1135.40 crs inQ3FY11. The interest expenses of the bank stood at Rs 563.92 crs in Q3FY11 as against Rs 345.76 crs in Q3FY10 and Rs 470.89 crsin Q2FY11. The net interest income as a result jumped 17.43% on a y-o-y basis and 5.08% on a q-o-q basis to Rs 571.48 crs inQ3FY11. For 9MFY11, the net interest income stood at Rs 1623.5 crs registering a jump of 21.88% y-o-y. The PAT of the bank at theend of Q3FY11 stood at Rs 187.87 crs as against Rs 142.38 crs in Q3FY10 and Rs 194.71 crs in Q2FY11. For 9MFY11, the PAT stoodat Rs 569.48 crs as against Rs 358.60 crs in 9MFY10.

On a consolidated basis, the group reported a 39.60% y-o-y growth in its interest income from Rs 1184.70 crs in Q3FY10 to Rs 1653.80crs in Q3FY11. The interest expenses of the group stood at Rs 730.87 crs as against Rs 444.92 crs in Q3FY10. The net interestincome of the group stood at Rs 922.93 crs in Q3FY11 as against Rs 739.78 crs in Q3FY10 while for 9MFY11 the net interest incomeon a consolidated basis stood at Rs 2558.53 crs as against Rs 2044.40 crs in 9MFY10. The PAT of the group stood at Rs 383.57 crsas against Rs 331.40 crs in Q3FY10 and for 9MFY11 it stood at Rs 1075.36 crs as against Rs 888.45 crs in 9MFY10.


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Risks and Concerns

The asset quality at the moment is impressive, but could deteriorate going ahead w ith increasing lending by the bank.

The CASA of the bank needs to consistently grow as the business grows as this helps the bank reduce its cost of deposits. Otherprivate sector banks like Axis and ICICI have healthier CASA ratios.

The cost to income ratio of the bank needs to be maintained at lower levels. Currently the cost income ratio of the bank is healthy butnot as good as many other banks hence it needs to improve its cos t income ratio further.

The bank has reported a fall in NIMs for period ended 31 st December 2010. It is important that the bank is able to come out of thesame trend going forward and improve its NIMs in order to remain competent. If the bank is unable to get cheaper borrowing, thespreads could narrow down thereby putting pressure on the margins of the bank.

Intense competition from global and local players in equity markets could pose a major challenge to KMB in maintaining its marketshare and leadership position.

The deposits have taken a beating for most banks in the country over the past couple of quarters and KMB has not been anexception. If the trend continues and revival is not fast then it could impact the overall business of the bank negatively.

Most of the business of the group is mainly dependent on the capital markets, though the dependence on an overall basis is fallinggradually. Hence in an event of downfall in the capital markets, the business of the group could get affected. 26% of its PBT in FY10

was derived from capital market activities.Conclusion

Kotak Mahindra Bank is one of the leading private sector banks in the country. It follows a different model of business (banking andequities). It has strong loan book growth and is expected to perform well going ahead. The bank from the current 300 branches isexpected to open another 200 and take the tally to 500 branches in another 12 months period. This will help the bank increase itsoverall customer base and spread the network across the country.

Though the bank is comparatively new, the Kotak Group is well established in the financial services sector in the country. The bankboasts of having a fine quality management. The bank has performed very well over the past few years, making it extremelycompetitive in the industry.

The different parameters of the bank have been quite impressive for KMB by the end of FY10. The bank has a healthy CAR of 18.4%.The Cost Income ratio of the bank has been quite impressive as it came down from the levels of 66% a year ago, to 47.84% by the end

of FY10. At the end of 9MFY11, the cost to income ratio of the bank stood at 53.67%. The management of expenses of the bank hasbeen quite impressive. The loan book has grown at a pace of 25% for the past 2 years and is expected to grow further going ahead withmore demands fo r funds arising out of the growing economy.

The NIMs of the bank stands atop all other banks at 6.33% for FY10 and at 5.4% at the end of Q3FY11. The bank could look tomaintain the NIMs in the range of 5% to 5.5% going ahead, however there is a huge pres sure on margins for all banks and maintainingit in the aforesaid range could be a bit tough for KMB in the next couple of quarters.

The CASA ratio of the bank has also been quite impressive. It stood at 31% of the total deposits considering the certificate of depositsat the end of FY10 while it stood at 35.4% at the end of Q3FY11. The Credit Deposit ratio of the bank at the end of FY10 stood at ahealthy 87%. The group companies of the bank have also performed quite well over the past few years. Kotak Securities, one of thepremium brokerage houses has done exceedingly well for the bank and remains one of the consistent contributors towards the groupssuccess, however over the past few quarters it has not done well due to the lackluster performance of the equity markets. Also the bankhas done well in order to achieve a strong provision coverage ratio of 72%, which is above the minimum 70% requirement of RBI.Going ahead as the bank is not required to increase its provisions substantially, the profits could see some more growth.

The bank is performing well as compared to its peers. It faces stiff competition from peers, both public and private banks. With the banklooking to increase its overall branches, it could see a growth in the deposits and increase in the CASA ratio. The growing Indianeconomy could help the bank in increasing its loan book as more demand for money is expected in the country going ahead.

At the CMP of Rs.427.25, the bank quotes at 2.6 times its FY12 E Consolidated ABV.


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Financials

Standalone ResultsParticulars Q3FY11 Q3FY10 % Chg Q2FY11 % Chg 9MFY11 9MFY10 % ChgInterest Earned 1135.40 832.41 36.40 1014.72 11.89 3070.92 2374.86 29.31Interest/Discount on Advances 878.44 645.43 36.10 776.14 13.18 2348.6068 1845.52 27.26Income on Investments 248.91 186.67 33.34 234.48 6.16 708.86 528.3917 34.15Interest on bal with RBI 7.96 0.13 5883.98 3.63 118.96 12.8418 0.533 2309.34

Others 0.09 0.18 -49.27 0.47 -80.93 0.6129 0.4165 47.15Other Income 165.34 136.42 21.20 139.33 18.67 441.7396 376.7374 17.25Total Income 1300.74 968.83 34.26 1154.05 12.71 3512.66 2751.60 27.66Interest Expended 563.92 345.76 63.09 470.89 19.76 1447.42 1042.7642 38.81Employee Expenses 198.49 132.61 49.67 168.74 17.63 532.8513 381.7992 39.56Other Operating Expenses 223.61 161.93 38.09 187.66 19.16 575.5746 465.6491 23.61Operating Expenses 422.10 294.55 43.30 356.40 18.43 1108.43 847.45 30.80Total Expenditure 986.02 640.31 53.99 827.29 19.19 2555.85 1890.21 35.21Net Interest Income 571.48 486.65 17.43 543.83 5.08 1623.50 1332.10 21.88Operating Profit before Prov & Cont 314.72 328.52 -4.20 326.75 -3.68 956.82 861.39 11.08Prov & Cont 42.66 119.28 -64.24 45.51 -6.26 144.261 358.3199 -59.74PBT 272.06 209.23 30.03 281.25 -3.27 812.55 503.07 61.52Tax 84.19 66.85 25.93 86.54 -2.71 243.0774 144.4693 68.26PAT 187.87 142.38 31.95 194.71 -3.51 569.48 358.60 58.81

Equity 368.15 347.69 5.88 366.70 0.39 368.1507 347.6959 5.88CAR - Basel II 18.66 17.01 9.70 19.43 -3.96 18.66 17.01 9.70EPS 2.54 2.03 25.12 2.65 -4.33 7.9 5.12 54.30Gross NPA 744.20 928.24 -19.83 751.14 -0.92 744.20 928.24 -19.83Net NPA 235.28 467.52 -49.67 253.01 -7.01 235.2833 467.52 -49.67Gross NPA% 2.53 4.25 2.78 2.53 4.25Net NPA% 0.81 2.18 0.95 0.81 2.18Return On Assets 0.38 0.40 0.44 1.26 1.12

Source: Capitaline

Segmental FinancialsParticulars Rs Crs (Standalone) Q3FY11 Q3FY10 Q2FY11 FY10 FY09 Segmental Revenue 1631.29 1196.49 1433.10 4840.66 4473.33Corporate/Wholesale Banking 415.39 260.63 378.88 1156.39 887.93

Treasury and BMU 389.58 307.02 336.72 1126.23 833.21Retail Banking 826.32 628.84 717.50 2558.04 2752.19Less: Intersegmental Revenues 330.55 227.66 279.31 956.88 1134.71Add: Unallocable Revenues 0.00 0.00 0.26 0.08 0.15Total Segment Revenues 1300.74 968.83 1154.05 3883.86 3338.77Segmental PBT 272.06 209.24 280.99 813.98 425.91Corporate/Wholesale Banking 131.05 68.40 138.22 385.46 225.34Treasury and BMU 57.26 106.31 55.21 367.46 129.29Retail Banking 83.75 34.53 87.56 61.06 71.28Less: Interest 0.00 0.00 0.00 2.88 0.00Add: Other Income 0.00 0.00 0.26 0.00 0.15Net PBT 272.06 209.24 281.25 811.10 426.06Capital Employed 6377.03 4141.29 6136.90 4344.37 3758.76Corporate/Wholesale Banking 1658.24 1010.19 1522.50 1142.23 986.96

Treasury and BMU 1870.15 1540.21 2073.72 1534.34 1244.93Retail Banking 2848.64 1590.89 2540.68 1667.80 1526.87Unallocated Net Assets 200.55 149.58 191.53 140.75 54.86Total Capital Employed 6577.58 4290.87 6328.43 4485.12 3813.62

Source: CapitalineConsolidated Results Particulars Q3FY11 Q3FY10 % Chg Q2FY11 % Chg 9MFY11 9MFY10 % ChgInterest Earned 1653.80 1184.70 39.60 1449.27 14.11 4418.72 3353.41 31.77Interest/Discount on Advances 1277.60 904.40 41.26 1101.37 16.00 3365.26 2567.64 31.06Income on Investments 350.75 265.25 32.23 330.45 6.14 997.83 744.84 33.97Interest on bal with RBI 9.76 1.10 786.32 4.10 138.10 15.75 5.47 187.95Others 15.69 13.94 12.55 13.35 17.54 39.88 35.46 12.45Other Income 1014.67 1205.79 -15.85 1491.69 -31.98 3517.23 3687.18 -4.61


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Profit on sale of investments 14.93 106.05 -85.92 377.94 -96.05 490.66 768.66 -36.17Premium on Insurance Business 604.38 705.87 -14.38 726.30 -16.79 1876.92 1711.96 9.64Other income 395.36 393.87 0.38 387.45 2.04 1149.65 1206.57 -4.72Total Income 2668.47 2390.49 11.63 2940.96 -9.27 7935.94 7040.59 12.72Interest Expended 730.87 444.92 64.27 606.03 20.60 1860.19 1309.01 42.11Employee Expenses 396.72 312.27 27.04 373.22 6.30 1121.83 901.03 24.50Policy Holders expenses 536.99 663.20 -19.03 992.78 -45.91 2090.93 2145.89 -2.56Other Operating Expenses 407.97 363.51 12.23 400.42 1.89 1172.57 1012.04 15.86Operating Expenses 1341.68 1338.98 0.20 1766.42 -24.05 4385.33 4058.96 8.04Total Expenditure 2072.55 1783.89 16.18 2372.45 -12.64 6245.51 5367.97 16.35Net Interest Income 922.93 739.78 24.76 843.24 9.45 2558.53 2044.40 25.15Operating Profit before Prov & Cont 595.93 606.59 -1.76 568.51 4.82 1690.43 1672.62 1.06Prov & Cont 53.43 125.63 -57.47 47.44 12.64 156.17 388.96 -59.85PBT 542.49 480.97 12.79 521.07 4.11 1534.26 1283.66 19.52Tax 161.46 147.97 9.11 157.97 2.21 470.49 382.18 23.11PAT before minority interest 381.03 332.99 14.43 363.10 4.94 1063.77 901.48 18.00Less: Minority Interest 6.14 5.02 22.19 3.49 75.92 7.84 6.45 21.52Add: Share in Profits of Associates 8.67 3.43 152.97 4.53 91.43 19.43 -6.59 -395.06Net Profit 383.57 331.40 15.74 364.14 5.33 1075.36 888.45 21.04Equity 368.15 347.70 5.88 366.70 0.40 368.15 347.70 5.88EPS 5.21 4.77 9.31 4.97 4.92 14.60 12.78 14.31Gross NPA 863.70 1108.65 -22.09 904.32 -4.49 863.70 1108.65 -22.09Net NPA 274.72 572.54 -52.02 331.96 -17.24 274.72 572.54 -52.02Gross NPA% 2.12 -42.86 2.37 2.12 3.71Net NPA% 0.69 -64.62 0.88 0.69 1.95Return On Assets 0.60 -10.45 0.59 1.69 1.93

Source: CapitalineConsolidated P&L A/cParticulars FY08 FY09 FY10Interest Income 3648.39 4366.56 4601.16Interest Expenses 1816.48 1992.39 1772.86Net Interest Income 1831.91 2374.17 2828.30Other Income 4220.95 3662.81 5507.77Total Income 7869.34 8029.37 10108.93Operating Expenses 2367.72 2492.62 2405.34Staff Cost 1197.89 1192.51 1260.95

Other Operating Expenses 1169.83 1300.11 1144.39Total Expenditure 4184.20 4485.01 4178.20Operating Profit 3685.14 3544.36 5930.73Depreciation 98.67 125.93 142.92Provisions 2178.62 2402.32 3885.06Profit before Taxes 1407.85 1016.11 1902.75Taxes 449.12 363.44 575.39Profit after Taxes 958.73 652.67 1327.36Minority Interest -18.69 3.72 18.00P/L of Associate Company 13.81 3.44 -2.36Net Profit after Minority Interest 991.23 652.39 1307.00Extra ordinary items 0.62 -1.00 -2.97Adj. Net Profit after Tax 990.61 653.39 1309.97

Source: CapitalineConsolidated Balance SheetFinancial Year (Rs. In Crs) FY08 FY09 FY10LIABILITIESCapital 344.67 345.67 348.14Reserves & Surplus 5479.23 6176.88 7562.80Equity Application Money 58.21 91.91 54.80Minority Interest 51.23 62.86 80.86Deposits 13691.93 13821.84 21819.18Borrowings 12772.81 11979.02 13885.70Other Liabitlies 8199.09 7755.66 11363.33Total 40597.17 40233.84 55114.81ASSETSCash & Bank Balances with RBI & Others 1690.42 1007.03 2094.08


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Balances at short & call notices 1605.13 430.47 412.73Advances 21984.68 22497.62 29724.29Investments 12569.68 13313.03 19484.78Fixed Assets 336.45 341.76 613.83Other assets 2410.81 2643.93 2785.10Total Assets 40597.17 40233.84 55114.81

Source: CapitalineStandalone - Profit and Loss A/cParticulars FY08 FY09 FY10 FY11 FY12EInterest Income 2535.36 3065.14 3255.61 4142.12 5084.97Interest Expenses 1309.56 1546.60 1397.47 1908.74 2335.38Net Interest Income 1225.80 1518.54 1858.14 2233.38 2749.60Other Income 601.08 575.49 628.24 595.00 676.00Fee based Income 222.08 223.75 325.00 270.00 320.00Treasury Income 72.68 13.10 114.00 125.00 136.00Miscellaneous Income 306.32 338.64 189.24 200.00 220.00Operating Income 1826.88 2094.03 2486.38 2828.38 3425.60Operating Expenses 1156.35 1391.22 1189.39 1460.00 1700.45Staff Cost 519.23 583.63 555.79 715.00 843.70Other Operating Expenses 637.12 807.59 633.60 745.00 856.75Operating Profit 670.53 702.81 1296.99 1368.38 1725.15Provisions 272.79 276.78 485.89 200.00 300.00

Profit before Taxes 397.74 426.03 811.10 1168.38 1425.15Taxes 103.79 149.93 249.99 350.51 441.80Profit after Taxes 293.95 276.10 561.11 817.87 983.35

Source: Capitaline, HDFC Sec EstimatesStandalone - Balance SheetFinancial Year (Rs. In Crs) FY08 FY09 FY10 FY11 FY12ELIABILITIESCapital 344.67 345.67 348.14 366.7 366.7Reserves & Surplus 3249.03 3559.86 4191.80 6135.6 6713.0Deposits 16423.65 15644.93 23886.46 31891.0 43168.5Borrowings 5119.25 5904.07 6140.50 7100.5 8230.2Other Liabitlies 3178.71 3257.34 2869.41 3206.0 3627.0Total 28315.31 28711.87 37436.31 48699.8 62105.4ASSETS

Cash & Bank Balances with RBI & Others 1683.49 995.35 2085.67 2708.5 3296.3Balances at short & call notices 439.18 145.32 214.59 321.9 482.8Advances 15552.22 16625.34 20775.05 27717.6 36558.7Investments 9141.99 9110.18 12513.04 14610.9 17201.4Fixed Assets 210.25 213.35 427.64 748.4 860.6Other assets 1288.18 1622.33 1420.38 2592.6 3705.5Total Assets 28315.31 28711.87 37436.37 48699.8 62105.5

Source: Capitaline, HDFC Sec EstimatesKey Financials and Ratios (Standalone)Particulars FY08 FY09 FY10 FY11 FY12ENet Interest Income 1225.80 1518.54 1858.14 2233.38 2749.60% Growth 0.00 23.88 22.36 20.19 23.11PBT 397.74 426.03 811.10 1138.38 1365.15% Growth 0.00 7.11 90.39 40.35 19.92PAT 293.95 276.10 561.11 796.87 941.95% Growth 0.00 -6.07 103.23 42.02 18.21EPS 4.26 3.99 8.06 10.87 12.84% Growth 0.00 -6.34 101.79 34.83 18.21BV 104.26 110.33 130.41 88.38 95.97% Growth 0.00 5.82 18.20 -32.23 8.59Adj BV 76.65 79.73 94.38 39.38 43.97% Growth 0.00 4.02 18.38 -58.28 11.66CASA % 28.43 32.72 26.74 29.05 31.77% Growth 0.00 15.07 -18.29 8.66 9.34Cost Income Ratio % 63.30 66.44 47.84 52.17 50.52% Growth 0.00 4.96 -28.00 9.07 -3.16Credit Deposit Ratio % 94.69 106.27 86.97 86.91 84.69


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% Growth 0.00 12.22 -18.15 -0.07 -2.56NIM % 5.08 5.33 5.62 5.19 4.97% Growth 0.00 4.78 5.49 -7.67 -4.27

Source: Capitaline, HDFC Sec Estimates

One Year Forward PABV

0100200300400500600700

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Daily Closing Price - LHS PABV - 2 - LHS PABV - 2.5 - LHS PABV - 3- LHS PABV - 3.5- LHS Actual P/ABV-RHS

Technical supports/resistances

Analyst: Tiju K Samuel ( [email protected] )

RETAIL RESEARCH Fax: (022) 3075 3435Corporate Office : HDFC Securities Limited, I Think Techno Campus, Bulding B. Alpha, Office Floor 8, Near Kanjurmarg Station, Opp. CromptonGreaves, Kanjurmarg (East), Mumbai 400 042 Fax: (022) 30753435 Website: www.hdfcsec.com Email: [email protected]

Disclaimer: This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. Thisdocument is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buyany security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not berelied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to timesolicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for Retail Clientsonly and not for any other category of clients, including, but not limited to, Institutional Clients

hdfcsec - research report march 11, 2011

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