2011 Outlook: Banking (Tier I fundamental strong, to make for rich valuations): ICICI Securities

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Banking (Tier I fundamental strong, to make for rich
valuations) Positive
The banking sector, a heavyweight in the BSE Sensex with a 17% share,
has emerged stronger in CY10 with the Bankex delivering 30% YoY returns
till date. We continue our positive stance on the sector even for FY12E
buoyed by stable economic growth, leading to 20-21% credit growth (on a
higher base) and 18% deposit growth in the system, thus supporting the NII
growth trend. Near term pressure on NIM persists but the effect of base rate
and BPLR hikes will come into play and FY12E NIM should not see any
further erosion. We do not foresee any risk to banks on the treasury side
since yields are expected to remain in the range of 7.5-8% for a major part
of next year.

The short-term outlook is overshadowed by corporate governance issues
post the bribery for loans scam but the recent price correction offers good
investment prospects.
⇒ NIM dip by 10-15 bps factored in, further erosion unlikely
Near term pressure on NIM persists but the effect of base rate and BPLR
hikes will come into play and FY12E NIM should not see any further
erosion. NIM reached its peak for most banks in Q2FY11 ranging
between 3% and 4%. We expect the RBI to tighten policy rates further
(50-100 bps) to tame inflationary expectations.
⇒ Easing pressure on asset quality to keep NPA provisions in check
We expect asset quality to remain stable with a step-up in recoveries.
Moreover, since most of the banks have reached the RBI mandated
70% PCR (provision coverage) and NPA scenario is comfortable, we do
not expect high provisions in FY12E like those in FY10 and FY11 on
account of agriculture and restructured assets to dent profits.
C/D ratio of banks reached 71% in FY06 after two decades in the 55% to
65% range, depicting credit growth rather than dependency on treasury
portfolio that also led to the BSE Bankex discount to Sensex narrowing
from 55% to 20% on a P/BV basis. We believe the same will continue.


Overall, we expect the NII and PAT to grow at 26% CAGR over FY10-12E for
the I-direct coverage universe. This is after achieving 18% and 26% CAGR
in NII and PAT, respectively, in FY06-10. We prefer banks with higher CASA
ratio and stable asset quality available at reasonable valuations like HDFC
Bank, Axis Bank. We also like certain large PSU banks that have corrected
like Bank of Baroda and SBI. Among mid-caps, we recommend DCB on
account of a sharp correction and growth expected on a lower base after
three years of losses and consolidation.