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Banks/Financial Institutions
India
Overstated concerns; opportunity to BUY. We retain our positive stance on banks
and find little merit in arguments for a sharp deterioration in the operating
environment. We believe margins will moderate only marginally from 2Q’s elevated
levels, but remain very healthy nevertheless. Most banks, including PSU banks, have
been hiking their lending rates and hence, current concerns on margins due to severe
liquidity crunch are clearly overstated. We remain positively biased towards high CASA
banks – SBI, PNB, BoB as our best picks amongst public banks. Like ICICI and Axis Bank
amongst private.
Opportunity to BUY from recent price correction
Banking stocks have corrected sharply on the back of heightened concerns on tight liquidity that
could result in margin pressures, increasing NPL risk due to telecom / real estate exposures and
probably this having some impact on growth.
` We are not overly concerned about margins and believe that margins for the banking sector
have always remained strong in a tighter liquidity environment.
` Further, while the NPL risk always remains in all forms of lending and recent news flows do not
seem very positive – likely telecom exposure of banking sector is 2% of loans and real estate is
another about 3%, with reasonable collaterals.
` Further, loan growth is always a function of the overall GDP growth and at 8.5-9% real GDP
growth 18-20% growth is unlikely to pose a challenge. We reiterate our positive view on the
sector and are buyers at current levels.
Valuations very comforting to BUY
Valuations have become very comforting, post a 20-25% correction from peak levels. We do not
see big risks to our earnings on back of tight liquidity or some bit of higher NPLs. PSU Banks now
trade at 1-1.6XFY2012E with compelling RoEs of 17-23%. We also like private banks which have
reasonable high levels of CASA – 40-50%. Our top picks are SBI, PNB, and BOB amongst public
banks and ICICI Bank, and Axis Bank amongst private banks. Owing to the tighter liquidity
conditions which may persist, we remain negatively biased on NBFCs.
Margins remain strong in tighter liquidity environment; Banks have been increasing base rates
Liquidity in the system has consistently remained tight over the past six months and the situation
has accentuated in the month of December (a seasonally tight month). The environment may
continue to remain tight for some time, but we expect some respite from January as government
spending improves. In times of tight liquidity, banks will raise deposit rates, but pricing power
remains with banks, resulting in higher lending rates as well. We concede that SBI’s deposit rate
hike was steep at one go, but the bank had not hiked its rates earlier and the measure appeared
largely an exercise to align deposit rates to market rates. Further, we strongly believe that over
time, all banks including SBI will also raise lending rates. With RBI having introduced a base rate,
banks would be forced to revisit their respective lending rates as deposit costs have gone up. A
high CASA bank has a natural advantage as its deposit costs do not rise as much as some of the
wholesale focused banks.
Many banks have already raised lending rates
Over the last week, many banks like HDFC Bank, ICICI, Axis, PNB, Andhra Bank, BoB etc
have already raised their lending rates. We expect all other banks to also hike rates – base
rates have to go up in any case, as they are calculated on stated formula linked to the
deposit rates (1 year deposit rate in most cases). Thus, we expect base rates for all banks to
rise by December end of first week of January.
NPL risk – blown out of proportion
On asset quality, the exposure of the banking sector to perceived high risk sectors currently
– telecom is about 1.8% and about 3% for real estate. Within telecom, larger companies
have a very high share and thus this should not be very worrying. Further, on real estate, our
discussions with bankers suggests that the collateral levels are comfortable and over the past
couple of years, incremental funds have largely gone for residential projects and not for
commercial projects. Thus, we do not see any large scale defaults in this portfolio. Also, we
capture some of the delinquencies through our earnings and do not believe our expectations
on delinquencies are at a higher risk.
Credit growth – expect 20% growth in FY2011E
We expect credit growth to at 20% for FY2011E, on the back of a strong GDP growth of
8.5-9%. YTD during the fiscal, we have achieved 10% so far. Bankers do highlight that
credit growth is getting somewhat diversified and are seeing early signs of capex revival.
Working capital demand across industries remains very strong. Heightened concerns /
negative news flows may have some temporary impact (difficult to quantify), but do not
change the overall growth picture.
NBFCs – margin pressure likely
Niche auto finance NBFCs well placed in the current environment
We find accelerating loan growth traction for most NBFCs a positive earnings driver while
margins have peaked for most players.
Sharp rise in short-term rates in the past six months
Declining bulk borrowings rates on the back of surplus liquidity in the system buoyed
margins for most NBFCs in FY2010. A sharp liquidity squeeze post April 2010 put pressure
on short-term rates in the system, thereby impacting the borrowings of NBFCs. Most
companies highlighted that they reduced dependence on short-term borrowings and
corrected their ALM mismatches from 1QFY11, as such the impact was less pronounced.
Housing finance companies: The recent rate hike will support near-term margins
This may affect demand over the medium term. Housing finance companies have held on to
their margins albeit seasonal trends. Competition from banks (primarily SBI) ensured that
home loan rates for new customers move up marginally; hike in interest rates for existing
customers / PLR, developer loans have helped these companies to report stable margins.
Housing finance companies have now (December 2010) raised home loan rates for new
customers by 50-75 bps, this will likely support near-term margins though such a rise will
impact volumes over the longer-term. While most banks have raised home loan rates, SBI
will review its teaser rate home loan scheme in January 2011.
Auto finance: Passing on the rate hikes, well placed in the current environment
Auto finance companies typically report high margin pressures in a rising interest rate
environment as all auto finance assets carry a fixed rate while borrowings may be linked to
bank PLR. Over the past four quarters, Shriram Transport and Mahindra Finance reduced
their dependence on variable rate borrowings to less that 25% of total borrowings. Both
companies increased lending rates by 50-100 bps for new loans and will likely report
marginal spread compression over the next few quarters. Both players operate in a niche
segment, charge lending rates of 18-21% and hence are well placed to pass on any 50-100
bps rate hike.
Infrastructure finance: Margins at peak
We believe margins of infrastructure finance companies are close to peak. IDFC and PFC
have already reported a margin qoq decline in 2QFY11. Recent capital issuance has
supported REC’s margins even as its reported spreads have declined. Infrastructure finance is
a low spreads business and the ability of these companies to pass on rate hikes is crucial. We
are cautious on the margin trends in this segment.
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