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Despite macro risks – high inflation and tight liquidity – we expect banks to deliver strong earnings growth of 21%
in FY12E. Lower operating and credit costs are likely to offset the impact of lower NIMs, more so for state-owned
banks, as rising deposit rates flow through with a lag.
Our sector-specific bear and bull case analysis highlights the upside and downside risks for all stocks in our
coverage universe. We recommend SBI, Axis Bank, ICICI Bank, PNB, BoB, IndusInd Bank, Allahabad Bank,
M&M Finance and Shriram Transport. Among banks, we prefer those with strong deposit franchises, and among
non-bank financials, we prefer those operating in niche segments.
Restructured loans, the key drivers of NPLs over the past two years, have peaked, in our view. While the stress
on restructured loans is behind us, there could be upside risks to our bad loan forecasts from regulatory changes
in telecom, microfinance and real estate.
Investment summary
Though we expect a tough operating environment for India’s financial sector in FY12 – tight
liquidity and high inflation – we expect banks to post strong earnings growth driven by lower
credit costs and lower operating expenses. We estimate that the earnings of our coverage
universe would grow 22% yoy in FY12E and 23% yoy in FY13E (against 27% in FY11E and a
CAGR of 25% over FY08-FY10) despite pressure on NIMs (as the lagged impact of higher
deposit rates flow through margins) and slower NII growth.
NIMs to decline, NII growth to slow… We expect NIMs to decline given the lagged impact of
higher deposit rates on NIMs. We estimate NIMs to decline by an average of 7% or 22bps for all
state-owned banks. For private banks, NIMs are likely to decline much less given their lower base,
rapid network expansion and improving deposit mix. Given lower margins, we expect year-onyear
growth in net interest income to decelerate substantially for state-owned banks to 12% in
FY12E from 45% yoy in 9M FY11.
…but credit costs likely to fall… We expect credit costs, which were unusually high in FY09-
9M FY11, to moderate in FY12-13E driven by two factors: 1) Slippages on the restructured book
are close to peaking and 2) Most banks have already complied with the higher loan loss
provisioning cover of 70% mandated by the RBI in Nov ’09. For the sector, we expect loan loss
provisions to grow at a modest 3% yoy compared with 27% CAGR over FY09-FY11E. Possible
regulatory changes in the microfinance, telecom, and real estate sectors pose large upside risks
to our NPL forecasts.
…and operating expenses to moderate – Growth in operating expenses are likely to moderate
as pension charges for state-owned banks peak in 4Q FY11 and start declining in FY12E. As
banks have already started amortizing pension costs in 9M FY11 and are also likely to fully
provide for pension costs for retired employees in 4Q FY11E, we expect pension costs for stateowned
banks to decline year-on-year in FY12E. We expect operating expenses for our coverage
universe to grow at 12% yoy in FY12E down from 19% yoy in FY11E and 17% over FY08-FY10.
Prefer strong deposit franchises and niche NBFCs – After the correction over the past six
months, we believe the risk reward has turned positive for many financial stocks, especially those
that have strong deposit franchises among banks and those that operate in niche business
segments among non-bank finance companies (NBFCs). We also think capital is unlikely to be a
constraint for Indian banks. Among large caps, we rate ICICI Bank, Axis Bank, SBI, Bank of
Baroda and PNB as OUTPERFORM. Among mid caps, IndusInd Bank, Shriram Transport, M&M
Finance, Mannapuram and Allahabad Bank are rated OUTPERFORM. We have IN-LINE ratings
on Union Bank, IDFC and HDFC Bank and UNDERPERFORM ratings on Yes Bank, HDFC, LIC
Housing and Bank of India.
Our bear and bull case targets to analyse risk reward – We have worked out bear and bull
case targets to find the risk reward in stocks we track. SBI, Axis and ICICI Bank have more
upside risks than downside risks based on our bear and bull case targets. We have an
OUTPERFORM rating on these three stocks. In addition, we also rate M&M Finance, Shriram
Transport, IndusInd Bank, PNB, Allahabad and BoB as outperformers. We have INLINE/
UNDERPERFORM ratings on HDFC, IDFC, HDFC Bank, Bank of India, Union Bank, Yes Bank
and LIC Housing.
According to our bull and bear case analysis, M&M Finance, HDFC Bank, Union Bank and HDFC
have more downside risks than upside risks. We believe, for HDFC and HDFC Bank, this is
largely because of premium valuations. We have an IN-LINE recommendation on HDFC Bank
and UNDERPERFORM recommendation on HDFC.
M&M Finance also shows more downside risks than upside risks. Yet we have an
OUTPERFORM rating on the stock. The re-rating of M&M Finance has happened mainly over the
last one year driven by improving provisioning cover and strong volume growth, which is why the
analysis shows more downside risks than upside risks. While the re-rating is relatively recent, we
expect the premium to sustain throughout our forecast period backed by its strong and higherthan-
sector growth in loans and earnings. According to our calculations, IDFC shows higher
upside risks than downside risks, but we still have an IN-LINE recommendation on the stock
because it is more vulnerable to rising cost of wholesale deposits than banks. For all other stocks,
upside and downside risks are even.
We prefer strong deposit franchises, but low CASA banks could outperform if liquidity
eases in the near term – While we recommend being selective, it is likely that the sector will
see a short-term and short-lived rally, mainly driven by better liquidity between now and
May/Jun ’11, with low CASA banks and wholesale funded finance companies outperforming the
high CASA ones. Nevertheless, post May/Jun ’11 liquidity is likely to tighten with the RBI
launching the government’s borrowing program for FY12 and with corporate credit demand likely
to be strong. Although stock prices may react favourably for a short while, we take a long-term
view based on the outlook on rates and liquidity over the next 9-12 months and on the business
franchises of banks/fincos rather than on the very near-term liquidity outlook. We prefer banks
with strong deposit franchises.
Key sector risks – Faster-than-expected increase in policy rates; slowdown in economic growth
in response to higher interest rates; any increase in standard provisioning requirements by the
RBI; deregulation of the savings rate; and regulatory changes in the microfinance and telecom
sectors.
Valuations
We have derived our price targets using the Gordon Growth model. Our target P/BV multiples for
most financial stocks are higher than the five-year mean multiples.
We believe that state-owned banks deserve to trade at P/BVs that are higher than their past fiveyear
averages because:
Their bond portfolios now carry lower risks. The proportion of bonds held in AFS (available for
sale) has improved from 30% in FY06 to 70-80% in 9M FY11.
Their loan loss provisioning cover has improved from 50% to close to 70%.
Weak technology and weak customer service were the key disadvantages of state banks that
caused their stocks to trade at deep discounts to the private banks since FY97. The discount
has narrowed but still remain substantial. Large state-owned banks trade at 1.5-1.9x FY12E
P/BV while all large/mid cap private banks, excluding ICICI Bank, trade at 2.6x-3.8x FY12E
P/BV. ICICI Bank trades at 2.4x because of historical issues that have depressed its RoE.
They have computerized their operations. They now have centralized databases essential for
proper loan monitoring, especially for their retail loan portfolios. Computerization has also
enabled them to provide more efficient customer service. Banks have invested heavily in their
core banking solutions (CBS) over the past few years and have not yet fully reaped the
benefits in terms of fees and better productivity from these investments.
The government has demonstrated its commitment to ensure that state-owned banks are
adequately capitalized. Because the government’s stake in such banks cannot fall below 51%,
it has been providing adequate capital support to banks that cannot raise public funds due to
minimum government holding restrictions. As recently as in Mar ’11, the government infused
capital into the banks.
The Indian banking system is well regulated and the RBI has been proactive in introducing
counter cyclical measures from time to time over the past few years. High general provisions
on sensitive sector exposures, strict income and NPL recognition norms and adequate
capitalization reduce the risk of systemic shocks for Indian banks.
We believe most private banks should also trade above their five-year multiples given good
execution of business strategies over the past five years, leading to rapid growth in their
franchises and improving profitability
Target RoEs: To calculate sustainable RoEs, we have used NIMs that are lower than the
average of FY09-13E to reflect competitive pressures and the possible deregulation of interest
rates. We have used mid cycle credit costs.
Cost of equity: We have used 10-year bond yield of 7.5% and market risk premium of 5%.
Sustainable growth rates: We have used growth rates of 6-8% for various banks.
We have valued the subsidiaries of diversified financials based on relevant market benchmarks.
We have used the Appraisal method for valuing life insurance companies and P/Es for other
financial businesses. To value non-strategic stakes in unlisted companies such as NSE (National
Stock Exchange), we have used the most recent stake sales as the benchmark.
Based on our price targets, we rate PNB, SBI, BoB, Allahabad Bank among state-owned banks
as OUTPERFORM. Among private banks, we rate ICICI Bank, Axis Bank and IndusInd Bank as
OUTPERFORM. ICICI Bank is our top pick among banks. Among finance companies, we rate
MMFS and Shriram as OUTPERFORM. We have an IN-LINE recommendation on HDFC Bank,
IDFC and Union Bank. We have an UNDERPERFORM rating on Yes Bank, HDFC, LIC Housing
and Bank of India.
Bull and bear case targets: We have worked out bear and bull case targets keeping in mind
sensitivities around margins, vulnerable exposures, loan growth and mark-to-market bond
portfolios.
Positive and negative risk returns based on our bear and bull targets: SBI, ICICI Bank, Axis
Bank have more upside risks than downside risks based on our bear and bull case targets. M&M
Finance, HDFC Bank, Union Bank and HDFC have more downside risks than upside risks. We
believe for HDFC and HDFC Bank, this is largely because of premium valuations. According to
our calculations, IDFC also shows higher upside risks than downside risks but we still have an INLINE
recommendation on the stock because it is more vulnerable to rising cost of wholesale
deposits than banks. We do not see any immediate triggers for IDFC to re-rate. For all other
stocks, upside and downside risks are even.
Bear case targets: Our bear case targets are based on the following assumptions:
25bps decline in NIM. We are already factoring in 20-25bps decline in NIMs over
FY11-13E. A decline of an additional 25bps will bring the overall decline to the levels of the
previous rising rate cycle.
25% peak loss in microfinance and 10% in telecom.
Impact of an increase of 50bps rise in rates on banks’ bond portfolios.
Impact on account of 100bps increase in rate on savings deposits.
Impact on account of 100bps decline in proportion of savings deposits to total deposits.
Our bear case target multiples are benchmarked to the low multiples for most stocks that have
consistent trading histories. For stocks with structural changes to business models, we have
used discount of 25-30% to base case multiples.
Bull case targets: Our bull case targets are based on the following assumptions:
Additional 5% loan growth in FY12. Given that the system loan multiplier is below the longterm
average, positive surprises on loan growth are possible in strong macro cycles.
Upside of 25bps in NIMs.
10bps decline in credit costs to average loans.
Impact of 50bps fall in bond yields on mark-to-market portfolios of banks.
Our bull case targets are benchmarked to the high multiples after adjusting for dilutions and
other one-off factors.
Key risks
Higher fiscal deficit – The government’s targeted fiscal deficit for FY12E is 4.6%, lower than the
5.1% target for FY11, which augurs well for bond yields and banking liquidity as a lower fiscal
deficit results in a decline in government borrowings. However, our economist believes that the
fiscal deficit for FY12E will likely be 4.8-5%, higher than the government’s target of 4.6% given
higher-than-budgeted subsidies and absence of the one-off 3G license fees recorded in FY11. A
higher-than-expected fiscal deficit is likely to result in higher borrowing by the government, putting
pressure on rates and liquidity.
Higher inflation – Our economist has forecast inflation of 7.75-8% by end Mar ’12, on an already
high RBI forecast of 8% for Mar ’11. We have used an average crude price of US$110/bbl to
arrive at our inflation forecast. Higher-than-expected international crude prices will pose upside
risks to our inflation forecast, which will likely put pressure on interest rates.
Economic slowdown – We expect GDP growth of 8.1% in FY12E. A slowdown in economic
growth in response to higher interest rates, higher inflation or global turmoil is likely to be a risk
for loan growth and asset quality. Restructured loans that account for 4-7% of loans for stateowned
banks will likely face more stress than other loans. There are no clear trends of a
slowdown yet, though rates have been rising since Jul ’10.
While growth in bank credit remains strong, growth in industrial production as measured by the
IIP (index of industrial production) has been volatile over the past three months. IIP came in at
3.6% in Feb ’11, lower than market expectations of 5%. Growth in capital goods was negative for
the third month in succession driven by higher inflation, higher rates and more importantly
slowdown in government approval for key projects due to recent scams. We have not seen a
major slowdown in bank loans yet. As on 25 Mar ’11, bank credit has grown 21% yoy and 5% qoq.
The qoq growth in 4Q FY11 is slower than 10% seen in 3Q FY11, but still strong. Commercial
vehicle and car sales by auto manufacturers remain strong and the growth in home loans has not
slowed, according to banks. Loans to the infrastructure and other manufacturing sectors have
slowed qoq largely because of delays in environmental and other government clearances.
However, we do need to keep a close watch on IIP data releases to see if the slowdown in the
last three months was temporary or is likely to sustain. If IIP continues to be lower than expected
for the next 2-3 months, it will likely be a key risk for financial stocks.
Deregulation of savings rate – The RBI is likely to deregulate the rate on savings deposits,
which is currently fixed by the RBI at 3.5%. Deregulation of the savings rate will likely increase
the cost of funds for banks in the short term, more so in a tight liquidity environment.
Exposure to vulnerable sectors – Banks’ exposure to telecom and microfinance could be at
risk if there are tough regulatory changes in these sectors. A 10% slippage in telecom loans will
cause their earnings to decline by 2-16% for FY12E. For Yes Bank, the impact will be higher than
the average sector range. Similarly, potential losses in microfinance will lead to a decline of 2-7%
of earnings for FY12E.
Pension liabilities – All state-owned banks now provide pensions to their employees. Changes
in discount rates and expected yields can likely lead to under-funding, requiring banks to provide
more for pensions. Fluctuation in pension costs has been a key driver of volatility in SBI’s
earnings over the past few years.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Despite macro risks – high inflation and tight liquidity – we expect banks to deliver strong earnings growth of 21%
in FY12E. Lower operating and credit costs are likely to offset the impact of lower NIMs, more so for state-owned
banks, as rising deposit rates flow through with a lag.
Our sector-specific bear and bull case analysis highlights the upside and downside risks for all stocks in our
coverage universe. We recommend SBI, Axis Bank, ICICI Bank, PNB, BoB, IndusInd Bank, Allahabad Bank,
M&M Finance and Shriram Transport. Among banks, we prefer those with strong deposit franchises, and among
non-bank financials, we prefer those operating in niche segments.
Restructured loans, the key drivers of NPLs over the past two years, have peaked, in our view. While the stress
on restructured loans is behind us, there could be upside risks to our bad loan forecasts from regulatory changes
in telecom, microfinance and real estate.
Investment summary
Though we expect a tough operating environment for India’s financial sector in FY12 – tight
liquidity and high inflation – we expect banks to post strong earnings growth driven by lower
credit costs and lower operating expenses. We estimate that the earnings of our coverage
universe would grow 22% yoy in FY12E and 23% yoy in FY13E (against 27% in FY11E and a
CAGR of 25% over FY08-FY10) despite pressure on NIMs (as the lagged impact of higher
deposit rates flow through margins) and slower NII growth.
NIMs to decline, NII growth to slow… We expect NIMs to decline given the lagged impact of
higher deposit rates on NIMs. We estimate NIMs to decline by an average of 7% or 22bps for all
state-owned banks. For private banks, NIMs are likely to decline much less given their lower base,
rapid network expansion and improving deposit mix. Given lower margins, we expect year-onyear
growth in net interest income to decelerate substantially for state-owned banks to 12% in
FY12E from 45% yoy in 9M FY11.
…but credit costs likely to fall… We expect credit costs, which were unusually high in FY09-
9M FY11, to moderate in FY12-13E driven by two factors: 1) Slippages on the restructured book
are close to peaking and 2) Most banks have already complied with the higher loan loss
provisioning cover of 70% mandated by the RBI in Nov ’09. For the sector, we expect loan loss
provisions to grow at a modest 3% yoy compared with 27% CAGR over FY09-FY11E. Possible
regulatory changes in the microfinance, telecom, and real estate sectors pose large upside risks
to our NPL forecasts.
…and operating expenses to moderate – Growth in operating expenses are likely to moderate
as pension charges for state-owned banks peak in 4Q FY11 and start declining in FY12E. As
banks have already started amortizing pension costs in 9M FY11 and are also likely to fully
provide for pension costs for retired employees in 4Q FY11E, we expect pension costs for stateowned
banks to decline year-on-year in FY12E. We expect operating expenses for our coverage
universe to grow at 12% yoy in FY12E down from 19% yoy in FY11E and 17% over FY08-FY10.
Prefer strong deposit franchises and niche NBFCs – After the correction over the past six
months, we believe the risk reward has turned positive for many financial stocks, especially those
that have strong deposit franchises among banks and those that operate in niche business
segments among non-bank finance companies (NBFCs). We also think capital is unlikely to be a
constraint for Indian banks. Among large caps, we rate ICICI Bank, Axis Bank, SBI, Bank of
Baroda and PNB as OUTPERFORM. Among mid caps, IndusInd Bank, Shriram Transport, M&M
Finance, Mannapuram and Allahabad Bank are rated OUTPERFORM. We have IN-LINE ratings
on Union Bank, IDFC and HDFC Bank and UNDERPERFORM ratings on Yes Bank, HDFC, LIC
Housing and Bank of India.
Our bear and bull case targets to analyse risk reward – We have worked out bear and bull
case targets to find the risk reward in stocks we track. SBI, Axis and ICICI Bank have more
upside risks than downside risks based on our bear and bull case targets. We have an
OUTPERFORM rating on these three stocks. In addition, we also rate M&M Finance, Shriram
Transport, IndusInd Bank, PNB, Allahabad and BoB as outperformers. We have INLINE/
UNDERPERFORM ratings on HDFC, IDFC, HDFC Bank, Bank of India, Union Bank, Yes Bank
and LIC Housing.
According to our bull and bear case analysis, M&M Finance, HDFC Bank, Union Bank and HDFC
have more downside risks than upside risks. We believe, for HDFC and HDFC Bank, this is
largely because of premium valuations. We have an IN-LINE recommendation on HDFC Bank
and UNDERPERFORM recommendation on HDFC.
M&M Finance also shows more downside risks than upside risks. Yet we have an
OUTPERFORM rating on the stock. The re-rating of M&M Finance has happened mainly over the
last one year driven by improving provisioning cover and strong volume growth, which is why the
analysis shows more downside risks than upside risks. While the re-rating is relatively recent, we
expect the premium to sustain throughout our forecast period backed by its strong and higherthan-
sector growth in loans and earnings. According to our calculations, IDFC shows higher
upside risks than downside risks, but we still have an IN-LINE recommendation on the stock
because it is more vulnerable to rising cost of wholesale deposits than banks. For all other stocks,
upside and downside risks are even.
We prefer strong deposit franchises, but low CASA banks could outperform if liquidity
eases in the near term – While we recommend being selective, it is likely that the sector will
see a short-term and short-lived rally, mainly driven by better liquidity between now and
May/Jun ’11, with low CASA banks and wholesale funded finance companies outperforming the
high CASA ones. Nevertheless, post May/Jun ’11 liquidity is likely to tighten with the RBI
launching the government’s borrowing program for FY12 and with corporate credit demand likely
to be strong. Although stock prices may react favourably for a short while, we take a long-term
view based on the outlook on rates and liquidity over the next 9-12 months and on the business
franchises of banks/fincos rather than on the very near-term liquidity outlook. We prefer banks
with strong deposit franchises.
Key sector risks – Faster-than-expected increase in policy rates; slowdown in economic growth
in response to higher interest rates; any increase in standard provisioning requirements by the
RBI; deregulation of the savings rate; and regulatory changes in the microfinance and telecom
sectors.
Valuations
We have derived our price targets using the Gordon Growth model. Our target P/BV multiples for
most financial stocks are higher than the five-year mean multiples.
We believe that state-owned banks deserve to trade at P/BVs that are higher than their past fiveyear
averages because:
Their bond portfolios now carry lower risks. The proportion of bonds held in AFS (available for
sale) has improved from 30% in FY06 to 70-80% in 9M FY11.
Their loan loss provisioning cover has improved from 50% to close to 70%.
Weak technology and weak customer service were the key disadvantages of state banks that
caused their stocks to trade at deep discounts to the private banks since FY97. The discount
has narrowed but still remain substantial. Large state-owned banks trade at 1.5-1.9x FY12E
P/BV while all large/mid cap private banks, excluding ICICI Bank, trade at 2.6x-3.8x FY12E
P/BV. ICICI Bank trades at 2.4x because of historical issues that have depressed its RoE.
They have computerized their operations. They now have centralized databases essential for
proper loan monitoring, especially for their retail loan portfolios. Computerization has also
enabled them to provide more efficient customer service. Banks have invested heavily in their
core banking solutions (CBS) over the past few years and have not yet fully reaped the
benefits in terms of fees and better productivity from these investments.
The government has demonstrated its commitment to ensure that state-owned banks are
adequately capitalized. Because the government’s stake in such banks cannot fall below 51%,
it has been providing adequate capital support to banks that cannot raise public funds due to
minimum government holding restrictions. As recently as in Mar ’11, the government infused
capital into the banks.
The Indian banking system is well regulated and the RBI has been proactive in introducing
counter cyclical measures from time to time over the past few years. High general provisions
on sensitive sector exposures, strict income and NPL recognition norms and adequate
capitalization reduce the risk of systemic shocks for Indian banks.
We believe most private banks should also trade above their five-year multiples given good
execution of business strategies over the past five years, leading to rapid growth in their
franchises and improving profitability
Target RoEs: To calculate sustainable RoEs, we have used NIMs that are lower than the
average of FY09-13E to reflect competitive pressures and the possible deregulation of interest
rates. We have used mid cycle credit costs.
Cost of equity: We have used 10-year bond yield of 7.5% and market risk premium of 5%.
Sustainable growth rates: We have used growth rates of 6-8% for various banks.
We have valued the subsidiaries of diversified financials based on relevant market benchmarks.
We have used the Appraisal method for valuing life insurance companies and P/Es for other
financial businesses. To value non-strategic stakes in unlisted companies such as NSE (National
Stock Exchange), we have used the most recent stake sales as the benchmark.
Based on our price targets, we rate PNB, SBI, BoB, Allahabad Bank among state-owned banks
as OUTPERFORM. Among private banks, we rate ICICI Bank, Axis Bank and IndusInd Bank as
OUTPERFORM. ICICI Bank is our top pick among banks. Among finance companies, we rate
MMFS and Shriram as OUTPERFORM. We have an IN-LINE recommendation on HDFC Bank,
IDFC and Union Bank. We have an UNDERPERFORM rating on Yes Bank, HDFC, LIC Housing
and Bank of India.
Bull and bear case targets: We have worked out bear and bull case targets keeping in mind
sensitivities around margins, vulnerable exposures, loan growth and mark-to-market bond
portfolios.
Positive and negative risk returns based on our bear and bull targets: SBI, ICICI Bank, Axis
Bank have more upside risks than downside risks based on our bear and bull case targets. M&M
Finance, HDFC Bank, Union Bank and HDFC have more downside risks than upside risks. We
believe for HDFC and HDFC Bank, this is largely because of premium valuations. According to
our calculations, IDFC also shows higher upside risks than downside risks but we still have an INLINE
recommendation on the stock because it is more vulnerable to rising cost of wholesale
deposits than banks. We do not see any immediate triggers for IDFC to re-rate. For all other
stocks, upside and downside risks are even.
Bear case targets: Our bear case targets are based on the following assumptions:
25bps decline in NIM. We are already factoring in 20-25bps decline in NIMs over
FY11-13E. A decline of an additional 25bps will bring the overall decline to the levels of the
previous rising rate cycle.
25% peak loss in microfinance and 10% in telecom.
Impact of an increase of 50bps rise in rates on banks’ bond portfolios.
Impact on account of 100bps increase in rate on savings deposits.
Impact on account of 100bps decline in proportion of savings deposits to total deposits.
Our bear case target multiples are benchmarked to the low multiples for most stocks that have
consistent trading histories. For stocks with structural changes to business models, we have
used discount of 25-30% to base case multiples.
Bull case targets: Our bull case targets are based on the following assumptions:
Additional 5% loan growth in FY12. Given that the system loan multiplier is below the longterm
average, positive surprises on loan growth are possible in strong macro cycles.
Upside of 25bps in NIMs.
10bps decline in credit costs to average loans.
Impact of 50bps fall in bond yields on mark-to-market portfolios of banks.
Our bull case targets are benchmarked to the high multiples after adjusting for dilutions and
other one-off factors.
Key risks
Higher fiscal deficit – The government’s targeted fiscal deficit for FY12E is 4.6%, lower than the
5.1% target for FY11, which augurs well for bond yields and banking liquidity as a lower fiscal
deficit results in a decline in government borrowings. However, our economist believes that the
fiscal deficit for FY12E will likely be 4.8-5%, higher than the government’s target of 4.6% given
higher-than-budgeted subsidies and absence of the one-off 3G license fees recorded in FY11. A
higher-than-expected fiscal deficit is likely to result in higher borrowing by the government, putting
pressure on rates and liquidity.
Higher inflation – Our economist has forecast inflation of 7.75-8% by end Mar ’12, on an already
high RBI forecast of 8% for Mar ’11. We have used an average crude price of US$110/bbl to
arrive at our inflation forecast. Higher-than-expected international crude prices will pose upside
risks to our inflation forecast, which will likely put pressure on interest rates.
Economic slowdown – We expect GDP growth of 8.1% in FY12E. A slowdown in economic
growth in response to higher interest rates, higher inflation or global turmoil is likely to be a risk
for loan growth and asset quality. Restructured loans that account for 4-7% of loans for stateowned
banks will likely face more stress than other loans. There are no clear trends of a
slowdown yet, though rates have been rising since Jul ’10.
While growth in bank credit remains strong, growth in industrial production as measured by the
IIP (index of industrial production) has been volatile over the past three months. IIP came in at
3.6% in Feb ’11, lower than market expectations of 5%. Growth in capital goods was negative for
the third month in succession driven by higher inflation, higher rates and more importantly
slowdown in government approval for key projects due to recent scams. We have not seen a
major slowdown in bank loans yet. As on 25 Mar ’11, bank credit has grown 21% yoy and 5% qoq.
The qoq growth in 4Q FY11 is slower than 10% seen in 3Q FY11, but still strong. Commercial
vehicle and car sales by auto manufacturers remain strong and the growth in home loans has not
slowed, according to banks. Loans to the infrastructure and other manufacturing sectors have
slowed qoq largely because of delays in environmental and other government clearances.
However, we do need to keep a close watch on IIP data releases to see if the slowdown in the
last three months was temporary or is likely to sustain. If IIP continues to be lower than expected
for the next 2-3 months, it will likely be a key risk for financial stocks.
Deregulation of savings rate – The RBI is likely to deregulate the rate on savings deposits,
which is currently fixed by the RBI at 3.5%. Deregulation of the savings rate will likely increase
the cost of funds for banks in the short term, more so in a tight liquidity environment.
Exposure to vulnerable sectors – Banks’ exposure to telecom and microfinance could be at
risk if there are tough regulatory changes in these sectors. A 10% slippage in telecom loans will
cause their earnings to decline by 2-16% for FY12E. For Yes Bank, the impact will be higher than
the average sector range. Similarly, potential losses in microfinance will lead to a decline of 2-7%
of earnings for FY12E.
Pension liabilities – All state-owned banks now provide pensions to their employees. Changes
in discount rates and expected yields can likely lead to under-funding, requiring banks to provide
more for pensions. Fluctuation in pension costs has been a key driver of volatility in SBI’s
earnings over the past few years.
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