BANKING- Higher margins, lower credit costs, keep earnings afloat: Edelweiss,

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BANKING
Higher margins, lower credit costs, keep earnings afloat


In Q3FY11, earnings of our coverage group grew 24% Y-o-Y and 14% Q-o-Q, ahead of
our estimate. The spurt was supported by strong NII growth (36% Y-o-Y, 9% Q-o-Q)
and decline in credit costs (25bps sequential contraction). While both private banks
and public sector banks (PSBs) posted strong loan book growth, the latter surprised
positively on margins front and former on faster-than-expected decline in credit costs.

􀂄 Margins surprise positively on back of stretched LDR and asset re-pricing
NIMs (cal) continued to surprise positively for third consecutive quarter,
expanding sequentially by 8bps for PSBs and 6bps for private banks against our
expectation of 8-9bps decline. During the quarter, while PSBs benefited largely
from asset re-pricing, private banks drew upon both CD ratio expansion and asset
re-pricing. Since August 2010, deposit rate hikes have been in tandem with
lending rate increases, reflecting the pricing power wielded by banks. Given the
sluggish deposit mobilization (lagging advances growth by 5% pts YTD), a further
deposit rate hike cannot be ruled out. We believe higher-than-expected deposit
rate increase, coupled with higher LDR, will spill over to negative bias on margins.
􀂄 Strong advances growth; LDR peaked
Both private banks and PSBs grew advances by 7% Q-o-Q - ahead of our estimate
(4%). However, deposit growth continued to lag (2.9% Q-o-Q, private banks flat,
PSBs up 4.6% Q-o-Q) advances growth. The credit-deposit ratio stands stretched
at 80% (private: 79%, PSBs: 85%) necessitating raising deposits to fund further
advances growth, especially in the fourth quarter, when growing advances is
indispensable given that banks have to meet their priority sector lending targets.
CASA deposits grew sequentially ~3%, lower than 6% in Q2FY11.
􀂄 Declining credit costs drive earnings
In Q3FY11, PSBs’ incremental slippages declined sequentially to 1.6% from 2.8%
(2.1% excl. one offs). Their credit costs came off 20bps (to 112bps), even though
they (barring OBC) maintained/ improved their provision cover; we expect credit
costs for PSBs to decline further to 80bps by FY12E. On account of improvement
in retail asset quality, private banks reported a sharp 44bps decline in credit costs
to 106bps, faster than our expectation; we expect their credit costs to stabilize at
~90bps in FY12E.
􀂄 Limited clarity on assumptions gone in SPO estimates
Most banks have indicated overall pension liability along with their Q3FY11
results, albeit 15-20% below our expectation. We believe the variance is due to
difference in our assumption of employees opting for pension and wage revision
catch up for existing employees (built into our estimates). RBI has recently
allowed banks to amortise the second pension option as well as increased gratuity
limit liability over a period of five years.
􀂄 Outlook and valuations: Getting cautiously optimistic
Over the past three months, banking stocks across the board have corrected
around 16%, underperforming broader markets by 6% reflecting broader macro
headwinds. Though we believe macro headwinds will prevail in the near term, the
recent correction has led to valuation moderating for stocks and they are trading
closer or below their five year trading averages. Hence, we believe stronger
liabilities franchises like ICICI Bank, Axis Bank, Punjab National Bank, and Bank of
Baroda are attractive from a risk-return perspective.