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UBS Investment Research
India Banking & Finance Sector
Entering the second stage of tightening
India in the second stage of tightening: tough macro environment ahead
We expect the near-term macro environment for banks to be difficult due to
elevated inflation. India is entering a second stage of tightening, which will likely
lead to margin pressure. While the Reserve Bank of India has the means to boost
banking liquidity, inflationary pressure necessitates tight liquidity.
Margins to dip in FY12E; falling LLP likely to support earnings
With the loan-to-deposit ratio at a peak and lending rates close to historical highs,
we expect NIMs to decline 10-20bp in FY12 from FY11. We estimate loan growth
of 18-20% in FY12-13, driven by 15% nominal GDP growth; however, risks to
growth are high. We expect asset quality trends to stabilise in FY12, and a decline
in loan loss provisions (LLP) to support earnings growth of 10-20%.
Near-term liquidity/rates to ease, but we are monitoring the FY12 fiscal deficit
We estimate the banking system liquidity deficit will ease from US$25bn to
US$8bn by end-March on government spending and RBI open market operations.
While we believe short-term rates will fall in the near term, the government’s
borrowing programme should be a key driver of liquidity/rates in FY12. We expect
liquidity and government borrowing announcements to be near-term catalysts.
We are structurally bullish but will be selective in the near term
We lower our price targets 4-8% to incorporate a rising cost of equity (a 25bp higher riskfree
rate). We believe stock selection is key, given the challenging outlook. We would be
more bullish if inflation (and inflation expectations) fall, or valuations become too
attractive to ignore. Our top picks are ICICI Bank, AXIS Bank, IndusInd Bank and
Shriram Transport Finance; our least-preferred are Bank of India and LIC Housing.
Entering the second stage of
tightening
In our report: Q-series ®: How do rising rates impact banks? 10 February 2010
we discussed in detail the first stage of tightening, which began in February
2010. The period thereafter was marked by fears that the tightening would erode
margins, growth and profitability in the banking sector—similar to the current
concerns. However, despite the Reserve Bank of India (RBI) tightening, the
banking sector outperformed the broader market by 25% and returned 54%
between February and October 2010 on stable margins and growing credit.
We believe the situation is different this time in more than one respect: 1) last
year was the first stage of interest rate tightening, which was good for banks’
profitability. However, FY12 will be the second stage of tightening and may not
be so good for margins; 2) liquidity last time was normal and short-term (3-
month) rates ranged between 5% and 6%, compared with 9% currently, 3)
inflation was on a downward trend in 2010 from around the 9% level, whereas
now there is uncertainty on inflation which we believe will stay above 7% for
most of FY12; 4) credit growth was sluggish at around 11% in December 2009
and at that time was expected to pick up in 2010, while credit growth now is at
24% and risks to growth are high; 5) asset quality risks were relatively higher in
2010 due to unseasoned restructured loans as compared to 2011; and 6) on the
last occasion, banking stocks were trading below their five-year averages, while
stocks are presently 10-15% higher than their five-year averages.
We believe the second stage of tightening will be characterised by tight liquidity,
policy rate hikes, high bank deposit rates, and negative investment spreads (10-
year bond yields minus 1-year term deposit rates). Please refer to the 19 January
2011 report by UBS Head of Asia Financial Institutions Research Andy Brown:
Asian financials—when does good inflation turn into bad inflation? for details
on this issue.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Banking & Finance Sector
Entering the second stage of tightening
India in the second stage of tightening: tough macro environment ahead
We expect the near-term macro environment for banks to be difficult due to
elevated inflation. India is entering a second stage of tightening, which will likely
lead to margin pressure. While the Reserve Bank of India has the means to boost
banking liquidity, inflationary pressure necessitates tight liquidity.
Margins to dip in FY12E; falling LLP likely to support earnings
With the loan-to-deposit ratio at a peak and lending rates close to historical highs,
we expect NIMs to decline 10-20bp in FY12 from FY11. We estimate loan growth
of 18-20% in FY12-13, driven by 15% nominal GDP growth; however, risks to
growth are high. We expect asset quality trends to stabilise in FY12, and a decline
in loan loss provisions (LLP) to support earnings growth of 10-20%.
Near-term liquidity/rates to ease, but we are monitoring the FY12 fiscal deficit
We estimate the banking system liquidity deficit will ease from US$25bn to
US$8bn by end-March on government spending and RBI open market operations.
While we believe short-term rates will fall in the near term, the government’s
borrowing programme should be a key driver of liquidity/rates in FY12. We expect
liquidity and government borrowing announcements to be near-term catalysts.
We are structurally bullish but will be selective in the near term
We lower our price targets 4-8% to incorporate a rising cost of equity (a 25bp higher riskfree
rate). We believe stock selection is key, given the challenging outlook. We would be
more bullish if inflation (and inflation expectations) fall, or valuations become too
attractive to ignore. Our top picks are ICICI Bank, AXIS Bank, IndusInd Bank and
Shriram Transport Finance; our least-preferred are Bank of India and LIC Housing.
Entering the second stage of
tightening
In our report: Q-series ®: How do rising rates impact banks? 10 February 2010
we discussed in detail the first stage of tightening, which began in February
2010. The period thereafter was marked by fears that the tightening would erode
margins, growth and profitability in the banking sector—similar to the current
concerns. However, despite the Reserve Bank of India (RBI) tightening, the
banking sector outperformed the broader market by 25% and returned 54%
between February and October 2010 on stable margins and growing credit.
We believe the situation is different this time in more than one respect: 1) last
year was the first stage of interest rate tightening, which was good for banks’
profitability. However, FY12 will be the second stage of tightening and may not
be so good for margins; 2) liquidity last time was normal and short-term (3-
month) rates ranged between 5% and 6%, compared with 9% currently, 3)
inflation was on a downward trend in 2010 from around the 9% level, whereas
now there is uncertainty on inflation which we believe will stay above 7% for
most of FY12; 4) credit growth was sluggish at around 11% in December 2009
and at that time was expected to pick up in 2010, while credit growth now is at
24% and risks to growth are high; 5) asset quality risks were relatively higher in
2010 due to unseasoned restructured loans as compared to 2011; and 6) on the
last occasion, banking stocks were trading below their five-year averages, while
stocks are presently 10-15% higher than their five-year averages.
We believe the second stage of tightening will be characterised by tight liquidity,
policy rate hikes, high bank deposit rates, and negative investment spreads (10-
year bond yields minus 1-year term deposit rates). Please refer to the 19 January
2011 report by UBS Head of Asia Financial Institutions Research Andy Brown:
Asian financials—when does good inflation turn into bad inflation? for details
on this issue.
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