Banks/Financial Institutions India 2QFY11 review:: Kotak Sec

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Banks/Financial Institutions
India
2QFY11 review - Margins improve further; slippages remain high. Key trends
observed during 2QFY11 (1) subdued loan growth adjusting for merger of BoR and SBI
Indore (2) NIMs beat estimates on better asset yields and stable costs (3) treasury profits
declined as interest rates moved up and (4) loan portfolio has witnessed higher
slippages, especially from agriculture, SME and restructured book (5) retirement
provisions made by select banks. NBFCs reported mixed trends in growth, provide
cautious guidance on margins. Retain positive bias for public banks with BOB, PNB and
Union Bank as our best picks. We remain underweight on NBFCs.





Loan growth traction weaker than expected; mergers help overall growth
Loan growth for the sector was subdued during 2Q, with a 4% qoq (22% yoy) for banks under
coverage; growth partly helped because of the merger of SBI Indore with SBI and Bank of
Rajasthan with ICICI Bank. Adjusted growth for the quarter was at 3% qoq. YTD loan growth is at
9% with private banks led by HDFC Bank and Yes Bank showing over 20% growth. ICICI Bank
and IOB have started expanding their balance sheets in line with industry, after being cautious over
past two years. Overall, we have tweaked our loan growth estimates downwards marginally at
close to 20% from 21% earlier.

Loan growth trends for NBFCs were mixed. IDFC, PFC and Mahindra Finance beat estimates while
the traction with REC and Shriram Transport declined qoq. Strong growth due to festive demand
especially in the auto finance segment will likely drive near-term growth.

Margins expand led by pricing and stable costs
NIMs for the industry expanded further led by better pricing and stable costs despite a decline in
CD ratio for the quarter. A mid-quarter increase in PLR, shedding of low yielding loans with the
introduction of base rate and better investment yields helped better pricing of assets. On the other
hand, rising cost of funds is slowly creeping into numbers with most banks witnessing an increase,
albeit very marginal increase qoq. However, few banks like OBC, Corporation Bank and Yes Bank
witnessed a sharp increase of about 40 bps qoq, banks where NIM vulnerability is the highest.

Overall, we have revised our NIM assumptions upwards on the back of strong performance.
Most NBFCs reported stable margins despite a rise in borrowings cost; large lending towards the
end of the quarter pulled down IDFC’s margins. However, NBFCs are guiding for pressure on
margins due to a sharp rise in borrowings cost. Most companies – HDFC, LICHF, Mahindra Finance
and Shriram Transport have already raised lending rates.

Slippages continue in public sector banks; no sharp deterioration from restructured loans
Despite headline gross NPL ratios being stable for most banks; slippages continued to increase for
the quarter, especially for public sector banks. Few banks showed higher NPLs because of agri
debt waiver, while slippages continued from corporate/SME portfolio. However, slippages from the
restructured book were lower than expected. Strong growth in operating income allowed banks to
write-off NPLs. We do not expect 1HFY11 slippages to repeat but remain higher than normalized
levels for PSU banks while private banks are likely to see lower slippages. Loan loss provisions will
decline partly as banks witness lower slippages and also reaching their regulatory limits.


Other operational highlights for the quarter
􀁠 Public sector banks have started making provision for retirement benefits (through the
employee expenses line or as a part of provisions). Liability is expected to be crystallized in
3QFY11 and is expected to be marginally higher than earlier estimates.
􀁠 Non interest income growth was subdued as treasury profits were substantially lower.
Core fee income growth was broadly muted compared to NII growth.


Muted non-interest income performance
Non interest income continued to decline yoy as the contribution of treasury profits
continued to fall sharply. Private banks saw pressure emerging from the wealth
management business while public sector banks saw pressure from their processing charges
emerging from fresh loan sanctions. ICICI Bank reported impressive growth partly driven by
balance sheet growth and international business. We have tempered our growth
expectations in fee income business for most banks.