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Banks/Financial Institutions
India
Banking on the big picture: 3 reasons why. Our positive view of Indian banks looks
beyond near-term concerns to focus on earnings growth of 20% CAGR over FY2011-
13E resulting from (1) strong GDP growth that will drive loan growth and lower
slippages, (2) reasonable pricing power on account of liquidity conditions and
(3) improving operating leverage. We like banks with a strong retail liability franchise
and reasonable valuations. Our top picks are Axis Bank, ICICI Bank, PNB, Union Bank
and Federal Bank.
Earnings will remain strong; operating leverage to play out
We expect sector earnings to grow by 20% CAGR in FY2011-13E. While FY2011E earnings are
being driven by sharp margin improvement, FY2012E earnings will likely be driven by loan growth,
lower credit costs and lower operating expenditure growth. We expect revenue (net interest
income + other income) growth of 15% and PPoP growth of 16% CAGR for FY2011-13E.
Operating leverage will likely re-emerge as banks have started making provisions for retirement
costs in FY2011E.
Outlook for margins, loan growth positive given GDP growth and liquidity conditions
We reiterate our view that the current environment is resulting in a strong pricing power for
banks. We therefore expect margins to remain healthy, even as they moderate from current
elevated levels. Banks have been raising their lending rates and passing on the rising funding costs.
We expect loan growth to moderate to 18% CAGR for FY2011-13E (from current 24% growth)
on the back of 8% GDP growth and inflation at 6% levels. Loan book is getting more diversified
with retail, SME and non-infra contributions starting to increase. However, slowing order book on
long duration projects due to policy actions could be a key deterrent to loan growth in FY2013E.
Asset quality problems in the initial phase of the credit cycle likely to be lower
Our concerns regarding potential asset quality problems are tempered by (1) strong GDP growth,
(2) an improving global environment, which could result in recovery/upgrades of NPLs that have
slipped earlier, and (3) well-diversified loan book. Recent NPL trends suggest that 3Q saw a
slowdown in NPL formation while net NPLs for the whole sector declined sequentially. We expect
slippages to decline to about 1.6% levels in FY2012 from 2% levels in FY2008-10 and loan loss
provision as a proportion to assets to decline to 0.9% in FY2012E from 1.1% in FY2010 and 1%
in FY2011.
Tight liquidity concerns to ease; high inflation is a key risk
We expect the tight liquidity situation to improve over the next 2-3 months as higher government
spending and positive real rates influence deposit creation. The biggest risk to our thesis remains
high global inflation, especially rising crude prices that could keep domestic inflation high for a
sustained period. This could also jeopardize long-term, macro growth. We expect the RBI’s focus
to remain firmly on anchoring inflation expectations, which could impact growth in the medium
term.
EXPECT EARNINGS GROWTH OF 20% CAGR OVER FY2011-13E
We expect earnings to grow by 20% CAGR for FY2011-13E on the back of 18% CAGR loan growth, in turn
driven by strong GDP growth of 8%. An improving global environment will also lower slippages and credit
costs for banks. Even as margins moderate, we believe the tight liquidity conditions will give banks strong
pricing power. Operating leverage will also play out as FY2011E had huge cost increases due to retirement
benefits. Our top picks are Axis Bank, ICICI Bank and PNB among the large banks. We like Federal Bank and
Union Bank among the smaller ones.
Strong economic growth will ensure steady loan growth and asset quality
We expect a strong economic cycle ahead at 8% growth with inflation at about 6-7%,
implying 18% CAGR in loans for the banking sector in FY2011-13E. We factor loan growth
to nominal GDP growth at 1.3X against an average of 1.8X seen in the past decade. We
expect loan growth to be more diversified as retail and non-infrastructure segments pick up,
as against the current disproportionate share towards infrastructure. We expect lower
delinquency across product portfolios in the early stage of the credit cycle. Also, higher
recovery from slippages reported in previous years will result in lower credit costs.
Policy responses to anchor inflation expectations and moderate loan growth
We expect RBI to hike policy rates (repo and reverse repo) by 75-100 bps in FY2012E, as it
continues to rein in inflation and slow down loan growth from current levels. Loan growth is
at least 500 bps higher than deposit growth in FY2011E and RBI would like to narrow this.
Banks have responded by hiking deposit rates aggressively by over 200 bps in the past
quarter. With real deposit rates turning positive, we expect deposit growth to pick up and
improve liquidity conditions.
However, we believe the markets are already anticipating this, and most of the actual hike is
already priced in. Thus, even as RBI increases its rates, we do not expect material changes in
the market rates on both deposits and loans hereon.
CRR (marginal hike in FY2013E) and SLR are expected to remain at current levels as policy
actions will likely keep interest rates higher and moderate liquidity (+/-1% NDTL)
environment, unless we see large foreign flows. The yield curve is likely to get steeper as
interest rates and easing liquidity conditions would release some of the current pressure at
the shorter end. We expect a 10-year G-Sec at close to 8-8.5% levels.
We expect earnings to grow at 20% CAGR in FY2011-13E
We expect the banking sector to deliver earnings growth of 20% CAGR in FY2011-13E on
the back of strong loan growth, stable costs structures and declining credit costs. Earnings
for private banks will likely remain strong at 24% CAGR while public sector banks would see
earnings growth of about 19% CAGR. Pre-provisioning operating profit will likely grow at
16% CAGR (private banks at 20% CAGR and public sector banks at 14% CAGR) while we
expect revenues to grow by 15% CAGR during this period.
Earnings drivers in place; constraints surmountable
Asset quality to remain comfortable on the back of better growth
A continuing growth environment provides us enough comfort on asset quality. We don’t
see any stress emerging for any specific sector in the near term. Banks have seen
delinquency rates increase post FY2008, but these have gradually been declining for public
sector banks over the past couple of quarters.
Macro perspective. The stress sectors of the previous cycle such as exports (textiles,
auto ancillaries and gems and jewelry) have seen demand revival while the domestic
consumption/investment story remains robust. Our interactions with banks indicate that
delinquency levels for most retail products are seeing historical lows.
Underwriting perspective. Emerging trends are encouraging with realistic growth
expectations and no big acquisitions/capex undertaken on high growth expectations.
Banks have been cautious too, as they are emerging from a crisis period of FY2008-09.
Unexpected negative news flow, events. In the past year, the banking sector was
singed by negative news flow on microfinance, the fallout of scams and lumpy
corporate slippages. Such risks remain but factoring such events would be difficult in
this phase of the cycle. Infrastructure could throw up some risks (fuel linkages,
inefficient pass through and lower-than-projected tariffs), especially for smaller PSUs,
as these projects become operational in FY2012-13E.
Tight liquidity will result in enough pricing power to sustain strong margins
Even as we assume some decline in margins, we believe that the current environment gives
enough pricing power to banks to reprice their loans faster. This has resulted in improving
margins for banks over the past few quarters. We expect deposit costs to catch up and
result in some moderation in NIMs, but we do not expect any sharp erosion in margins.
We also expect liquidity conditions to ease as expenditure by the government improves and
inflation eases. We expect margins to normalize from current levels by 10-20 bps as the
lending rates are already fully reflected and CD ratio declines but deposits reprice.
Stocks have corrected on inflation/liquidity fears
We believe that the recent correction in more than factors in the macro risks arising out of
higher interest rates. We highlight that the banks’ response to rising interest rates has been
quick, as they have raised lending rates by about 100-150 bps, which should result in
negligible margin impact.
We believe a strong price movement prior to the recent decline and high ownership in
financials accentuated the fall. However, given the strong fundamentals, we would be
buyers in the current decline, despite negative macro headwinds.
We remain positive on the growth prospects of Indian financials
We are optimistic on the growth prospects of Indian financials. We recognize the risks to
asset quality in the near term but do not see these as sustained or significant for FY2011-
2013. There are likely to be some near-term adjustments to margins/growth, but these are
largely factored in by the current decline in stock prices and we maintain that this does not
affect the long-term value of the business.
We like strong retail franchises at reasonable valuations
In times of higher interest rates and tighter liquidity, strong retail liability franchises are likely
to trade at a premium. Post the recent correction; our best picks are Axis Bank, ICICI Bank,
PNB, Union Bank and Federal Bank. We also upgrade Federal Bank and Indian Bank to BUY
from ADD earlier. We also believe that for a 20% CAGR in earnings and near 20% RoEs,
valuations are attractive.
Key changes to our recommendations / rationale
Federal Bank (FB, CMP - `348, TP - `450, Upgrade to BUY)
Post a 23% correction in the past three months, valuations are attractive at 1.1X
FY2012E PBR and 8.0X PER, delivering RoEs of 14% and earnings growth of 24%
CAGR for FY2011-13E.
Slippages in key portfolios in retail and SME have exacerbated over the past three
quarters. The economic environment in the Emirates in the Middle East has improved—
this is positive for the bank as it has lent (primarily housing loans) to NRIs, a segment
where the bank has seen slippages over the past two years. Recoveries from these loans
will ease credit costs.
The management has initiated changes in process delivery – a hub and spoke model for
loan origination – and identified six key regions to focus on loan growth. We expect
loan growth to track the industry average from FY2012E.
The new management is focused on other segments like fee income. On a lower base,
growth is likely to remain high. The bank is undertaking an extensive training exercise
for most employees to improve contribution from this segment.
Indian Bank (FB, CMP - `214, TP - `320, Upgrade to BUY)
The stock has corrected by 26% in the past three months, the bank is currently trading
at 1.0X FY2012E PBR and 5X PER delivering RoEs of 22% and earnings growth of 18%
CAGR for FY2011-13E.
Slippages trends have been improving in the past three months. Slippages declined to
1.4% levels in 3Q from 5.3% in 1Q and 1.9% in 2Q. The bank expects net NPLs to be
at 0.5% by March 2011 (currently at 0.6%) and has a target of 0% by March 2012E.
Margins remain strong (3.8% in 3QFY11) and the bank has been fairly proactive in
increasing lending rates continuously. However, on the back of higher cost of deposits
we expect a 20 bps decline in our margin estimates in 4QFY11E and 30 bps yoy in
FY2012E.
Retirement costs are expected to increase from previous estimates.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Banks/Financial Institutions
India
Banking on the big picture: 3 reasons why. Our positive view of Indian banks looks
beyond near-term concerns to focus on earnings growth of 20% CAGR over FY2011-
13E resulting from (1) strong GDP growth that will drive loan growth and lower
slippages, (2) reasonable pricing power on account of liquidity conditions and
(3) improving operating leverage. We like banks with a strong retail liability franchise
and reasonable valuations. Our top picks are Axis Bank, ICICI Bank, PNB, Union Bank
and Federal Bank.
Earnings will remain strong; operating leverage to play out
We expect sector earnings to grow by 20% CAGR in FY2011-13E. While FY2011E earnings are
being driven by sharp margin improvement, FY2012E earnings will likely be driven by loan growth,
lower credit costs and lower operating expenditure growth. We expect revenue (net interest
income + other income) growth of 15% and PPoP growth of 16% CAGR for FY2011-13E.
Operating leverage will likely re-emerge as banks have started making provisions for retirement
costs in FY2011E.
Outlook for margins, loan growth positive given GDP growth and liquidity conditions
We reiterate our view that the current environment is resulting in a strong pricing power for
banks. We therefore expect margins to remain healthy, even as they moderate from current
elevated levels. Banks have been raising their lending rates and passing on the rising funding costs.
We expect loan growth to moderate to 18% CAGR for FY2011-13E (from current 24% growth)
on the back of 8% GDP growth and inflation at 6% levels. Loan book is getting more diversified
with retail, SME and non-infra contributions starting to increase. However, slowing order book on
long duration projects due to policy actions could be a key deterrent to loan growth in FY2013E.
Asset quality problems in the initial phase of the credit cycle likely to be lower
Our concerns regarding potential asset quality problems are tempered by (1) strong GDP growth,
(2) an improving global environment, which could result in recovery/upgrades of NPLs that have
slipped earlier, and (3) well-diversified loan book. Recent NPL trends suggest that 3Q saw a
slowdown in NPL formation while net NPLs for the whole sector declined sequentially. We expect
slippages to decline to about 1.6% levels in FY2012 from 2% levels in FY2008-10 and loan loss
provision as a proportion to assets to decline to 0.9% in FY2012E from 1.1% in FY2010 and 1%
in FY2011.
Tight liquidity concerns to ease; high inflation is a key risk
We expect the tight liquidity situation to improve over the next 2-3 months as higher government
spending and positive real rates influence deposit creation. The biggest risk to our thesis remains
high global inflation, especially rising crude prices that could keep domestic inflation high for a
sustained period. This could also jeopardize long-term, macro growth. We expect the RBI’s focus
to remain firmly on anchoring inflation expectations, which could impact growth in the medium
term.
EXPECT EARNINGS GROWTH OF 20% CAGR OVER FY2011-13E
We expect earnings to grow by 20% CAGR for FY2011-13E on the back of 18% CAGR loan growth, in turn
driven by strong GDP growth of 8%. An improving global environment will also lower slippages and credit
costs for banks. Even as margins moderate, we believe the tight liquidity conditions will give banks strong
pricing power. Operating leverage will also play out as FY2011E had huge cost increases due to retirement
benefits. Our top picks are Axis Bank, ICICI Bank and PNB among the large banks. We like Federal Bank and
Union Bank among the smaller ones.
Strong economic growth will ensure steady loan growth and asset quality
We expect a strong economic cycle ahead at 8% growth with inflation at about 6-7%,
implying 18% CAGR in loans for the banking sector in FY2011-13E. We factor loan growth
to nominal GDP growth at 1.3X against an average of 1.8X seen in the past decade. We
expect loan growth to be more diversified as retail and non-infrastructure segments pick up,
as against the current disproportionate share towards infrastructure. We expect lower
delinquency across product portfolios in the early stage of the credit cycle. Also, higher
recovery from slippages reported in previous years will result in lower credit costs.
Policy responses to anchor inflation expectations and moderate loan growth
We expect RBI to hike policy rates (repo and reverse repo) by 75-100 bps in FY2012E, as it
continues to rein in inflation and slow down loan growth from current levels. Loan growth is
at least 500 bps higher than deposit growth in FY2011E and RBI would like to narrow this.
Banks have responded by hiking deposit rates aggressively by over 200 bps in the past
quarter. With real deposit rates turning positive, we expect deposit growth to pick up and
improve liquidity conditions.
However, we believe the markets are already anticipating this, and most of the actual hike is
already priced in. Thus, even as RBI increases its rates, we do not expect material changes in
the market rates on both deposits and loans hereon.
CRR (marginal hike in FY2013E) and SLR are expected to remain at current levels as policy
actions will likely keep interest rates higher and moderate liquidity (+/-1% NDTL)
environment, unless we see large foreign flows. The yield curve is likely to get steeper as
interest rates and easing liquidity conditions would release some of the current pressure at
the shorter end. We expect a 10-year G-Sec at close to 8-8.5% levels.
We expect earnings to grow at 20% CAGR in FY2011-13E
We expect the banking sector to deliver earnings growth of 20% CAGR in FY2011-13E on
the back of strong loan growth, stable costs structures and declining credit costs. Earnings
for private banks will likely remain strong at 24% CAGR while public sector banks would see
earnings growth of about 19% CAGR. Pre-provisioning operating profit will likely grow at
16% CAGR (private banks at 20% CAGR and public sector banks at 14% CAGR) while we
expect revenues to grow by 15% CAGR during this period.
Earnings drivers in place; constraints surmountable
Asset quality to remain comfortable on the back of better growth
A continuing growth environment provides us enough comfort on asset quality. We don’t
see any stress emerging for any specific sector in the near term. Banks have seen
delinquency rates increase post FY2008, but these have gradually been declining for public
sector banks over the past couple of quarters.
Macro perspective. The stress sectors of the previous cycle such as exports (textiles,
auto ancillaries and gems and jewelry) have seen demand revival while the domestic
consumption/investment story remains robust. Our interactions with banks indicate that
delinquency levels for most retail products are seeing historical lows.
Underwriting perspective. Emerging trends are encouraging with realistic growth
expectations and no big acquisitions/capex undertaken on high growth expectations.
Banks have been cautious too, as they are emerging from a crisis period of FY2008-09.
Unexpected negative news flow, events. In the past year, the banking sector was
singed by negative news flow on microfinance, the fallout of scams and lumpy
corporate slippages. Such risks remain but factoring such events would be difficult in
this phase of the cycle. Infrastructure could throw up some risks (fuel linkages,
inefficient pass through and lower-than-projected tariffs), especially for smaller PSUs,
as these projects become operational in FY2012-13E.
Tight liquidity will result in enough pricing power to sustain strong margins
Even as we assume some decline in margins, we believe that the current environment gives
enough pricing power to banks to reprice their loans faster. This has resulted in improving
margins for banks over the past few quarters. We expect deposit costs to catch up and
result in some moderation in NIMs, but we do not expect any sharp erosion in margins.
We also expect liquidity conditions to ease as expenditure by the government improves and
inflation eases. We expect margins to normalize from current levels by 10-20 bps as the
lending rates are already fully reflected and CD ratio declines but deposits reprice.
Stocks have corrected on inflation/liquidity fears
We believe that the recent correction in more than factors in the macro risks arising out of
higher interest rates. We highlight that the banks’ response to rising interest rates has been
quick, as they have raised lending rates by about 100-150 bps, which should result in
negligible margin impact.
We believe a strong price movement prior to the recent decline and high ownership in
financials accentuated the fall. However, given the strong fundamentals, we would be
buyers in the current decline, despite negative macro headwinds.
We remain positive on the growth prospects of Indian financials
We are optimistic on the growth prospects of Indian financials. We recognize the risks to
asset quality in the near term but do not see these as sustained or significant for FY2011-
2013. There are likely to be some near-term adjustments to margins/growth, but these are
largely factored in by the current decline in stock prices and we maintain that this does not
affect the long-term value of the business.
We like strong retail franchises at reasonable valuations
In times of higher interest rates and tighter liquidity, strong retail liability franchises are likely
to trade at a premium. Post the recent correction; our best picks are Axis Bank, ICICI Bank,
PNB, Union Bank and Federal Bank. We also upgrade Federal Bank and Indian Bank to BUY
from ADD earlier. We also believe that for a 20% CAGR in earnings and near 20% RoEs,
valuations are attractive.
Key changes to our recommendations / rationale
Federal Bank (FB, CMP - `348, TP - `450, Upgrade to BUY)
Post a 23% correction in the past three months, valuations are attractive at 1.1X
FY2012E PBR and 8.0X PER, delivering RoEs of 14% and earnings growth of 24%
CAGR for FY2011-13E.
Slippages in key portfolios in retail and SME have exacerbated over the past three
quarters. The economic environment in the Emirates in the Middle East has improved—
this is positive for the bank as it has lent (primarily housing loans) to NRIs, a segment
where the bank has seen slippages over the past two years. Recoveries from these loans
will ease credit costs.
The management has initiated changes in process delivery – a hub and spoke model for
loan origination – and identified six key regions to focus on loan growth. We expect
loan growth to track the industry average from FY2012E.
The new management is focused on other segments like fee income. On a lower base,
growth is likely to remain high. The bank is undertaking an extensive training exercise
for most employees to improve contribution from this segment.
Indian Bank (FB, CMP - `214, TP - `320, Upgrade to BUY)
The stock has corrected by 26% in the past three months, the bank is currently trading
at 1.0X FY2012E PBR and 5X PER delivering RoEs of 22% and earnings growth of 18%
CAGR for FY2011-13E.
Slippages trends have been improving in the past three months. Slippages declined to
1.4% levels in 3Q from 5.3% in 1Q and 1.9% in 2Q. The bank expects net NPLs to be
at 0.5% by March 2011 (currently at 0.6%) and has a target of 0% by March 2012E.
Margins remain strong (3.8% in 3QFY11) and the bank has been fairly proactive in
increasing lending rates continuously. However, on the back of higher cost of deposits
we expect a 20 bps decline in our margin estimates in 4QFY11E and 30 bps yoy in
FY2012E.
Retirement costs are expected to increase from previous estimates.
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