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Banks/Financial Institutions
India
3QFY11 preview: Strong operating performance; moderate earnings growth. We
expect core performance of banks to remain strong aided by impressive loan growth
(24% yoy) and higher yoy margins. However, lower treasury gains and higher provisions
will put pressure on reported earnings. Asset quality should hold up well and we expect
better trends compared to 2QFY11. NBFCs will likely report some moderation in
margins even as loan growth continues to remain strong. Valuations are comfortable,
and our top picks are PNB, BoB and Axis Bank.
Core earnings will remain strong; net earnings to moderate due to lower treasury gains
We expect core earnings to remain strong on the back of strong loan growth and higher margins
yoy. Non-interest income growth will remain subdued, as treasury gains will be limited. However,
earnings growth is expected to slow down on the back of higher base and higher loan loss
provisions. Overall profit growth is expected to be at 14% yoy, private banks would grow by 27%
compared to 9% for public sector banks. NBFCs will likely report 20-30% core earnings growth
primarily on the back of strong loan growth even as margins moderate. We expect BoI, IOB and
OBC in public sector and most private sector banks to show earnings growth over 25% yoy aided
by lower base earnings.
NIMs to moderate marginally qoq; loan growth has picked up further during 3QFY11
We expect NIMs to report marginal pressure sequentially as banks have been refocusing on
deposit growth to counter the tight liquidity environment. However, we believe that the increase
in lending rates, especially in late 2Q/3Q and expansion in CD ratio of about 350 bps qoq, should
cushion the sharp increase in deposit costs. Loan growth is expected to be more broad-based,
having grown impressively by about 6% qoq and 24% yoy. Margins for NBFCs have likely peaked
and we expected some moderation in 3QFY11. The current liquidity scenario poses a challenge for
bulk borrowers and we would be selective in playing NBFCs.
Asset quality appears comfortable; provisions to remain at 2QFY11 levels
We expect slippages to trend better than previous quarters, even as we expect some slippages for
public banks, especially emanating from the mid-market/SME segment. Amongst larger banks, we
expect slippages to remain at elevated levels for SBI and Union Bank. However, discussions with
banks indicate that recoveries have improved, cushioning a sharp rise in overall NPLs. We expect
provisions to remain high during the quarter and largely in line with 2Q levels for public sector
while private sector will see further decline from previous quarter, as their slippages are likely to be
lower sequentially.
Reported earnings to slow down due to higher base
We expect reported earnings growth to moderate for the quarter, primarily on the back of lower
treasury gains/ improvement in margins in 3QFY10 and higher loan loss provisions compared to
the corresponding quarter. Core earnings will remain strong—NII growth at 26% and margins will
remain strong. Better pricing and expansion in CD ratio will cushion the impact of rising cost of
funds for the quarter. We expect earning to grow by 14% yoy for the sector with public sector
banks growing by 10% and private banks growing by 27%. BoI, IOB and OBC in public sector
while HDFC Bank, ICICI Bank, Yes Bank and Federal Bank in private sector would be few banks to
show earnings growth over 25%. We see higher loan loss provisions and lower treasury income to
impact earnings growth for Canara Bank and Indian Bank.
NBFCs: Signs of margin pressure
` We believe that NBFCs will report 20% to 30% core earnings growth primarily driven by
higher business volumes.
` All asset classes are currently in a sweet spot—festive season is driving auto sales, growth
in housing and infrastructure remains strong.
` Marginal borrowing cost at the shorter end has increased by about 2%+ over the last
quarter—CP rates were up 4% between April and December 2010. We expect margins to
shrink in the current scenario given the time-lag between the rise in borrowings cost and
lending rates. Select companies were in sweet spot due to favorable asset re-pricing
(HDFC, Shriram Transport) while most other companies (REC, IDFC etc) will report yoy
margin contraction. While the reported margins may not report significant contraction in
3QFY11, we expect management’s guidance on margins to be conservative in light of
sharp liquidity pressure in the past few weeks and significant rise in base rates by the
banking sector.
` We do not expect any severe movements on asset quality performance during the
quarters.
Loan growth impressive at over 6% qoq; CD ratio expands by about 350 bps
Loan growth for the quarter witnessed a sharp rebound (was almost flat in 2QFY11),
expanding 6% qoq as of December 17, 2010. Yoy growth continues to remain strong at
24% despite the negative base impact. Deposit growth has been slower with sequential
growth of over 2% with yoy growth remaining well below credit growth at 14.8%. CD ratio
for the quarter improved by about 350 bps as banks continued to draw down their surplus
SLR investments to fund loan growth.
Banks’ investments in commercial paper declined by 25% qoq to `326 bn while investments
in corporate debentures have increased by about 8% qoq to `760 bn. We believe that some
portion of credit which was channelized through commercial papers in the previous quarters
on the back of surplus liquidity has come back to banks, resulting in a sharp increase in
loans qoq. However, borrowings through external credit/short-term credit from abroad
continued to remain strong.
NII growth to remain over 25%; NIMs to witness marginal pressure
We expect overall NII growth to remain over 25% yoy in the current quarter as the
expansion in CD ratio and hikes in their lending rates (late 2QFY11 and two phases in
3QFY11) should offset the sharp rise in deposit rates, especially for shorter tenors.
Sequentially, we expect NIMs to come off marginally for most banks between 5 and 10 bps.
Public sector banks will continue to drive growth in NII at about 30% yoy as margins are
comparatively higher compared to 3QFY10 while private banks would see NII growth of
17% yoy. Union Bank, SBI, Canara, Andhra, BoB and PNB amongst public sector banks and
Yes Bank amongst private banks will report NII growth of over 30%. Federal Bank and ICICI
Bank will report weak NII growth largely on back of slower balance sheet growth. We expect
margins to decline further in 4QFY11E as deposit rates have increased by over 100 bps in
various tenors (would be cushioned by the 50-75 bps increase in lending rates in December).
Subdued non-interest income; limited treasury gains
Fee income growth likely to remain steady on the back of improved loan book activity while
income from off balance sheet activities (LC/BG/Forex) should remain healthy due to a lower
base and improvement in economic environment.
There have been limited opportunities for banks to have made gains on their investment
portfolio during the quarter. During the quarter, the yield curve flattened further with the
10-year and 5-year increasing by 11 bps and 19 bps qoq while the 2-year has increased by
about 50 bps and 1-year G-Sec increased by 70 bps. The 10-year rallied by nearly 25 bps
from the peak in the current quarter. A flatter yield curve might also entail some provisions.
Asset quality appears comfortable; provisions to remain high
We believe asset quality is unlikely to surprise negatively (but expect overall NPL level to rise
further). We expect slippages to continue at higher levels, especially from SME portfolio in
the current quarter. Movement towards system recognized NPLs could result in higher
slippages for select banks. Slippages from the restructured portfolio will continue during the
quarter but we don’t expect any sharp deterioration. We would also shift focus towards
recoveries and upgradations given the underlying environment. We see almost negligible
impact from microfinance in the current quarter.
Provisions would continue at high levels seen in 2QFY11 for public sector banks while large
private banks would see a decline sequentially. Sharp improvement in recoveries/
upgradations would result in lower NPL provisions for the quarter.
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