BANKS - Pipeline capital raising :: CLSA

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Over the next 12-18 months Indian banks may raise up to US$16bn in
equity to meet tighter regulatory requirements and healthy credit demand.
Leverage for some banks is above 25x while the sector average is near
15x. Many state-owned banks are levered up to 17-20x and would see
their ROE compress as they raise equity. We prefer banks with high ROA
and low leverage as they should see ROE expansion, leading to a possible
re-rating. We rate ICICI and HDFC Bank as BUYs.
Indian banks have high leverage. Even though the Indian financial
system has been a tightly and well regulated market, the leverage ratio of
many banks is reasonably high. As at March 2010, the average asset-toequity
ratio for the sector was 15x with some banks at 25x or higher.
Reported ROEs overstate profitability for banks that make sub 1% ROA
and have high leverage. Reported capital adequacy ratios don’t reflect high
leverage as 22% of bank balance sheets are in government bonds, which
carry a zero risk weight.
Capital of US$16bn needed. For a 20% Cagr in assets over 10-12CL, we
estimate that banks (with sub 10% tier I ratio as at March 2010) may
need to raise up to US$16bn by March 2012 to maintain a comfortable
capital adequacy. Additionally, even private banks that are currently well
capitalised, may need to raise capital in 12-13CL. The Central bank’s
recent move to disallow banks from recognising unaudited profits in tier I
capital may require higher margins of safety. Tighter norms under new
Basel (higher risk weight, exclusion of hybrids) may also bump up the
need for core equity. Unfunded pension liability is estimated at 6-14% of
net worth, which would dilute the capital base further if provided upfront.
ROA and not ROE may drive valuations. As regulators globally clamp
down on leverage, we prefer banks with high ROA. Banks with higher ROA
(+1.4%) and high Tier I capital are ICICI Bank (ICICIBC IB - Rs1,099.3 -
BUY) and HDFC Bank (HDFCB IB - Rs2,306.7 - BUY). We expect these
firms to see ROE expansion of 500bps or more, driving re-rating. Banks
with low ROA (<1%) and low tier 1 (<7%) are IDBI Bank, Central Bank
and Uco Bank (none of which are covered) and will need to raise equity
and should report ROE compression. We also like IDFC (IDFC IB - Rs156.8
- BUY) and HDFC (HDFC IB - Rs682.8 - BUY), which generate +3% ROA.