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BANKING SECTOR: CONCERNS OVERSTATED
Banking stocks have corrected sharply in last one month (BSE Bankex is
down by 11.5%) on back of certain key investor concerns. To certain extent
this is justified; however, we believe that, the correction is overdone and
investors should use this opportunity to enter into stocks having strong
liability franchise.
We like banks with strong liability franchise (CASA mix) as they are better
placed to protect their margins in a relatively tight liquidity environment/
rising interest rate environment. We retain Axis Bank, ICICI Bank, PNB and
SBI as our preferred picks in our banking coverage universe.
The objective of this update is to assuage certain key investor concerns and uncertainty that have been surrounding the banking sector in recent times. We are trying
to dismantle each investor concern one by one along with suggesting our clients to
use this opportunity to enter into fundamentally good stocks.
Investor Concern 1: NIM Compression
There is a growing feeling amongst investors that banks are likely to witness sharp
NIM compression, going forward. The recent statements by RBI governor for banks
to charge lower NIM from customers by hiking deposit rates along with lowering
lending rates has also raised concerns about the margins of banks, going forward.
Our view: This is not a surprise to us. We have modelled compression in NIM for
majority of banks under our coverage. In the backdrop of tighter liquidity environment and slow pace of deposit mobilization (YTD deposit growth 8.1%; YTD loan
growth 9.8%), banks are likely to witness some compression of their margins. However, the impact would vary across banks, we opine, with relatively weaker CASA
banks getting impacted more.
We believe banks will have to mobilise more deposits by offering higher interest
rates on term deposits as C/D ratio is near its high (73.4% at November 19, 2010;
incremental C/D ratio at ~100% in last 2 fortnights).
Few banks like SBI, BOI, PNB and ICICI Bank have already raised their deposit rates
without hiking the lending rates (ICICI Bank did hike the lending rate as well). We
expect they will raise their lending rates later to protect their margins.
SBI has hiked the deposit rates by 50-150 bps across various buckets. It is currently
offering 8.5% for 555 days deposits, which is higher than those (1-2 years maturity)
offered by its peers. With the leader setting the tone, other banks are also likely to
follow the suit.
Earlier, SBI was slow in raising deposit rates as it had surplus liquidity sitting on its
balance sheet (Rs.970 bn at the end of Q1FY10 which came down to Rs.281 bn at
the end of Q1FY11). Its aggressive hike in deposit rates on shorter duration bucket
indicates that they expect tighter liquidity scenario to be temporary in nature.
Moreover, we understand that, some liquidity has likely been sucked out of the system because of the large equity issuances and some more liquidity will be drained
out due to the impending advance tax payments by December 15th.
However, we feel that, these are temporary anomalies, which are expected to be
set right in the medium term.
Loan growth has also started picking up in last couple of fortnights which also suggests return of some pricing power in the hands of banks. However, we do not expect banks to pass on the increased costs completely, leading to some compression
in their margins. We believe this would be more aggravated for banks having weak
liability franchise; hence our preference for banks with strong CASA mix.
Investor Concern 2: Tight liquidity environment further likely to
get aggravated with advance tax payment
Another concern amongst the investors is tight liquidity environment which is likely
to be further aggravated by ~550 bn advance tax outflow (on December 15, 2010).
Our view: Liquidity situation has been tight in the banking system as is visible from
~Rs.1000 bn daily average borrowing under LAF window in recent month. Despite
2% temporary cut in SLR by RBI, wholesale rates have moved up sharply (see 1 Yr
PSU CD rate)
This situation is likely to further get aggravated with ~Rs.550 bn of advance tax (to
be payable by December 15, 2010) and redemption of Rs.1.1-1.3 trillion worth of
CDs (market estimates) expected by the end of Q3FY11.
This tight liquidity has also led to spike in 10-Year government bond yield which
touched 8.21% on December 06, 2010, highest in recent times. The rise in 10-Year
yield is negative for banking stocks as they have to take MTM hit on their AFS/HFT
book, thus negatively impacting their earnings
However, we believe there is enough cushion in the system as banks are holding
30.4% (as on November 19, 2010) of their NDTL in SLR investment. Apart from
temporary SLR cut of 2% (applicable till January 28, 2010), banks have more than
5% of excess SLR against which they can borrow from RBI under LAF window.
We believe, tight liquidity environment would continue till Q3FY11 and it is likely to
improve in Q4FY11 when government's spending would start bringing back money
into the system. Apart from this we also believe that RBI would not let growth to
suffer on account of liquidity crunch. It might resort to Open Market Operations
(OMO) by buying back its own paper, resulting into decline in bond yield. It can
even resort to CRR cut (although chances are bleak!!) thus releasing the money
parked by banks with RBI.
Investor Concern 3: Exposure to Telecom sector / MFI / commercial real estate might lead to deterioration on asset quality
Exposure by banks to these sectors is another concern of the investors. AP ordinance
on MFI has elongated the payment cycle of the MFIs. There are also some expectations of loan waivers (similar to farm loan waiver done by the govt) which is impacting the collections of MFI. Alleged 2G scam has raised some concerns over operations of new 2G operators. Similarly, there are expectations that, the recent bank
bribery case might slow down the flow of credit to real estate sectors and thus impacting their loan growth.
Our view: The MFI exposure issue is related to AP only. The total banking exposure to MFI is Rs.300 bn (0.8% of total loan book). Even if direct exposure to Self
help Groups is included, it would come at 1.0-1.5% of banks loan book. Out of this
AP exposure is only 30-35%.
It is likely that MFIs would face some cash flow problems as payment cycle has elongated in AP and therefore we expect them to come up for rescheduling. More clarity would come when Malegam committee is likely to submit its recommendation in
January 2011. Other than AP, MFI are functioning normally elsewhere.
Axis bank has the exposure of Rs.13 bn (1.2% of loan book) with no direct exposure
to SHG. Similarly, ICICI bank and Yes bank have MFI exposure at 1% each of their
loan book. SBI has small exposure of Rs.8 bn (0.12% of loan book) with only Rs.3 bn
with AP.
Investigations into the 2G licenses issue is related to the new 2G operators. Many of
them have little or no debt or have parent guarantees. We believe monetary penalties are likely to be enforced. However, is the licenses are cancelled, it may be a
point of concern for banks. In our opinion, it is less likely that their licenses would be
cancelled.
SBI has Rs.5-10 bn (0.1% of loan book) of exposure to new 2G players. ICICI bank
has no direct exposure to 3G companies and their exposure to 2G was mainly working capital (non-fund). HDFC bank has not taken exposure to new 2G players.
We like banks with high CASA mix as they are better placed to protect their margins in a relatively tight liquidity environment. We retain Axis Bank, ICICI Bank, PNB
and SBI as our preferred picks under our banking coverage universe.
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