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Banking
Stock performance
During the first two months of 3QFY2011, banking stocks
performed in line with the broader markets on the back of good
2QFY2011 results and continuance of healthy credit demand.
However, in December 2010, banking stocks underperformed
the broader indices due to negative newsflows (related to the
bribes-for-loan scam, telecom-related and MFI exposures of a
few banks) as well as margin worries (expected NIM pressures
due to aggressive deposit rate hikes). Consequently, by the end
of the quarter, the BSE Bankex was down 4.6% sequentially,
underperforming the Sensex by 6.8%. Most banking stocks under
our coverage universe declined in line with the correction in
other banking stocks. Within our coverage universe, IOB gave
the highest returns of 10.8% sequentially, followed by Dena
Bank and ICICI Bank with gains of 9.6% and 3.1%, respectively.
Deposit growth yet to pick up meaningfully
As per the latest fortnightly data for credit and deposit, credit
growth jumped to 23.7% yoy compared to growth of 19.0%
yoy as of September 24, 2010. Banks have incrementally lent
close to `4,00,000cr YTD in FY2011, which is more than double
the amount lent during the same period last year. Deposit growth
has continuously lagged credit growth from April-December
2010. YTD credit growth has been healthy at ~12.3%, while
deposits have grown at ~6.0%, resulting in an incremental
credit-to-deposit ratio of 147.8%. Consequently, the overall
credit deposit ratio, which had bottomed out during 2QFY2010
at 68.8%, improved substantially to 75.8% in 3QFY2011.
From September 24, 2010 to December 17, 2010, the gap
between credit and deposit growth widened further, with credit
showing strong traction (6.4% qoq), while deposits growth not
picking up meaningfully (growing at just 2.0% qoq), resulting
in an incremental credit-to-deposit ratio of 235.2%.
Extremely tight liquidity position
The mismatch between credit and deposit growth exacerbated
the system liquidity situation with the Liquidity Adjustment Facility
(LAF) borrowings averaging more than `91,000cr during the
quarter. The liquidity situation worsened further with advance
tax outflows in December, taking the average LAF borrowings
for the last fortnight over `1,32,000cr. On December 22, 2010,
LAF borrowings hit a new record of `1,70,500cr.
Consequently, the short-term commercial paper (CP) and
certificate of deposit (CD) rates spiked up sharply by 195bp to
9.5% and 187bp to 9.0%, respectively, during the quarter.
The persistent tight liquidity situation and slower deposits growth
prompted many banks to raise their fixed deposit interest rates
aggressively across maturities. Most banks hiked deposit rates
by 50-150bp during the quarter. In spite of the aggressive rate
hikes, deposits growth as of now has not picked up meaningfully.
As a consequence of the FD rate hike and persistently tight
liquidity situation, lending rates were also raised by many banks.
Further, banks like SBI and ICICI Bank have hiked their base
rates with effect from January 3, 2011, by 40bp to 8.0% and
by 50bp to 8.25%, respectively.
Going forward, credit demand is expected to sustain at least
above the 19% level and central and state government
borrowings are also expected to kick in. Hence, to mobilise
sufficient deposits to meet the expected increase in credit, we
believe banks will have to continue increasing the deposit rates,
which will continue the upward pressure on lending rates.
Large banks better placed to sustain NIMs
NIMs are likely to be moderately affected in 3QFY2011.
Moreover, going forward over the next 4-6 quarters, we expect
rising retail and wholesale fixed deposit rates to lead to
substantial 40-60bps NIM compression of low-CASA mid-size
banks. Correspondingly, larger banks with high CASA ratios
and robust branch expansion such as SBI, ICICI Bank, HDFC
Bank and Axis Bank are better placed to sustain or improve
their NIMs going forward.
Higher G-sec yields might result in moderate MTM losses
During the quarter, yields also went up across the yield curve,
especially more so at the shorter end. The benchmark 10-year
G-sec yield went up marginally by 8bp to 7.9%, while the
one-year G-sec yield increased by 75bp and the three-year
G-sec yield went up by 21bp. Hence, we expect most of the
banks under our coverage to have moderate MTM losses
in 3QFY2011.
Capital infusion to aid credit growth
The government in December 2010 approved capital infusion
of `6,000cr in public sector banks to ensure tier-I CRAR of all
public sector banks in excess of 7% and to raise the government’s
holding in all public sector banks to 58%. The exact amount,
mode of capitalisation and other terms and conditions would
be decided in consultation with the banks at the time of infusion.
At present, we have factored in the proposed infusion only for
Union Bank of India and Dena Bank, as other banks have
indicated that they have neither been intimated by the
government nor does their own assessment indicate a need for
large capital infusion at present. In case of Uco Bank, although
it was earlier planning an FPO, it has now received the capital
it needed from the GoI itself, though in the form of preference
shares. Accordingly, we have factored the same in our estimates.
NPA concerns receding
Some of the PSU banks faced pressures on the asset-quality
front primarily due to switchover to CBS-based NPA recognition.
Within our coverage universe, Indian Bank and Union Bank of
India shifted to the CBS-based NPA recognition system during
1HFY2011, while Corporation Bank and PNB are expected to
complete major part of it in the 3QFY2011. Going forward,
such asset-quality pressures are likely for a few other PSU banks
as well. However, overall asset-quality pressures have evidently
moderated. Total asset-weighted (FY2010) net NPAs for the
sector have fallen from the peak of 1.15% in 3QFY2010 to
1.09% in 2QFY2011.
Only 11 out of the 39 listed banks had registered an increase
in net NPA ratio in 2QFY2011, compared to 23 banks witnessing
an increase in 3QFY2010. Especially private banks have
witnessed a substantial decline in net NPAs as well as
provisioning expenses over the same period.
Pension liabilities unlikely to impact profitability in a
major way
PSU banks had given the option to their employees to opt for
the pension scheme instead of the existing Provident Fund
scheme. As of now, most banks are working out the liabilities
as per the actuarial assumptions; however, initial estimates
indicate the liability to be ~`8lakhs-10lakhs per employee.
Some of the banks had proactively started making provisions
against the same in 1HFY2011 itself. Some of the banks have
directly provided the estimated liability amount, while others
have given the number of employees who have opted for the
pension option-in which case we have assumed a liability of
`10lakhs per employee. We expect that pension liabilities will
be allowed to be amortised over a five-year period.
Outlook
Back in August 2010 itself, we had cautioned that deposit rates
were set to rise in the coming quarters, possibly faster than the
consensus, which would signal margins of mid-size banks to
peak and contribute to their underperformance on the bourses.
Since then, the gap between deposit and credit growth has
widened further, prompting many banks to raise their fixed
deposit interest rates aggressively by 50-150bp during the
quarter. To mobilise sufficient deposits to meet an estimated
shortfall of about `50,000cr (post the `48,000cr RBI OMO) in
FY2011E and a further `1lakh crore estimated shortfall in
FY2012E as well, we believe banks will have to continue
increasing their deposit rates over the coming quarters.
Accordingly, going forward, we believe NIM progression rather
than asset quality will be the key monitorable parameter for the
banking sector, having the major impact on divergence in stock
returns across the banking space. NIMs are likely to see
moderate impact in 3QFY2010. The NIM compression is likely
to be especially front-ended in case of banks with higher reliance
on certificate of deposits (3-6 month tenure) as well as wholesale
deposits (6-12 month tenure). Moreover, in case of banks with
sub-30% CASA ratios, we expect NIM compression to be as
much as 40-60bp over the next 4-6 quarters. Correspondingly,
larger banks with high CASA ratios and robust branch expansion
such as SBI, ICICI Bank, HDFC Bank and Axis Bank are better
placed to sustain or improve their NIMs going forward.
Monitoring CASA market share trends will remain one of the
most important monitorables impacting earnings growth.
Hence, even post the sharp correction in most mid-sized banks,
we prefer to invest in the mid-cap banks which have stronger
CASA franchises such. Taking into account valuations, our top
picks among the private large-cap banks include ICICI Bank
and Axis Bank; SBI and Union Bank from the PSU large-cap
banking universe; and Dena Bank, IOB, J&K Bank and Federal
Bank among the mid-cap banks.
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