Capital constraints, asset quality drag Union Bank

Pick-up in growth and infusion of equity funds imperative for lifting bank's fortunes

Despite the recent run-up, Union Bank of India’s scrip is trading cheaper (0.9 times FY15 estimated book) compared to peers which are trading at 1-1.4 FY15 estimated price/book. There are reasons for it.

In sync with weak macro and banking trends, Union Bank is also facing high asset quality pressures. The bank’s gross non-performing assets stood high at 4.1 per cent (Rs 9,564 crore) of advances in FY14. These, along with a total loan restructuring book of Rs 15,433 crore, indicate  stressed assets form close to 11 per cent of advances. These asset quality pressures, however, could ease marginally in the second half of this financial year, driven by a potential pick-up in the economy and private investments.

Apart from economic revival, the key factor for Union Bank’s fortunes is capital. The bank’s Tier-I capital adequacy ratio of 7.5 per cent is weaker versus 9-9.7 per cent for peers such as SBI and Bank of Baroda, and marginally above the minimum mandated level of six per cent. However, Union Bank is looking to raise funds via QIP in July 2014,  likely to push up its Tier-I capital by 50 basis points, estimate analysts. But, to fund its loan growth (annual  growth of 17 per cent each in FY12 and FY13, 10 per cent in FY14), the bank will have to raise funds repeatedly.

“Union Bank’s return on retained earnings over FY10-FY14 (-5 per cent) ranks close to the bottom among banks, necessitating repeated infusions of capital. Hybrid instruments, which form close to 60 basis points of Tier-I capital, are yet another headwind in the transition to Basel-III norms. We expect RoAs and RoEs (return and assets and equity) to remain stifled at 0.5 per cent and 10 per cent, respectively, over FY15-16,” says Abhinesh Vijayaraj, analyst at Spark Capital. Profitability will also be hit from wage revisions and higher pension obligations, he adds. While the actual equity dilution is contingent upon the price at which funds are raised, as well as quantum of fund raising, most analysts estimate  Union Bank could witness the highest dilution among the top six-seven public sector banks.

This might come in the way of any significant increase in its stock price. While the loan growth moderated to 10 per cent in FY14, analysts peg this figure at 12-14 per cent in FY15 and FY16 each. Its sizeable restructuring pipeline of Rs 1,700 crore in the June 2014 quarter signifies that asset quality woes will continue in the near term for the bank. If the economic recovery happens as anticipated, it would help ease some stress on asset quality and overall financials. But, that is still some time away.