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Banking
During 1QFY2012, banking stocks suffered on account of
uncertain domestic macro conditions, which have been plagued
by high inflation for over a year now. With margin compressions
and provisioning for pension expenses for retired employees in
case of PSU banks in 4QFY2011 results already having created
doubtful sentiments, the possibility of further aggressive rate
hikes by the RBI as inflation numbers continued to be much
outside the comfort zone led to a sharp correction in the Bankex
in the last week of April. An aggressive 50bp hike in key policy
rates in the May 3rd monetary policy was accompanied by the
increase in savings rate and shift to relatively stricter provisioning
norms, which further slid the Bankex down. Eventually, the
Bankex rallied along with the Sensex in the last week of June,
with increasing visibility that inflation may cool down from
2HFY2012.
By the end of the quarter, the Bankex was down by 3.6%
sequentially, underperforming the Sensex marginally by 0.5%.
Within our coverage universe, Federal Bank gave the highest
returns of 7.9% sequentially, followed by HDFC Bank and South
Indian Bank, with gains of 6.8% and 4.8%, respectively.
Credit demand sustains above 20%, deposit growth
crosses 18%
Prior to December 2010, broader deposit mobilisation was
inevitably lower in light of high inflation and deposit rates even
below NSS rates. Due to the resulting drying up of liquidity,
broader interest rates have already gone up by 200-225bp.
In 1QFY2012 alone, a cumulative repo rate hike of 75bp and
the more impactful 50bp hike in savings rate have led most
banks to pass on most of the burden to borrowers.
Further, the rise in interest rates during the quarter led
to a decline in credit demand from the highs of 23-24%
witnessed in 4QFY2011 to a more sustainable 20.7% (as of
June 17, 2011). However, on the positive side, it resulted in
higher and much-required deposit mobilisation.
With the sharp spike in lending rates, credit offtake has declined,
as evident from the incremental CD ratio in FY2012 YTD (up to
June 17) at just 44.9% compared to 247.1% during the same
period in FY2011. A like-to-like comparison between
March-end and mid-June of FY2011 vs. FY2012 indicates 11%
lower credit mobilisation vs. almost 5x higher deposit mobilisation.
The deposit growth rate for the first time since December 2009
crossed 18% (18.2% as of June 17, 2011), as the continual
increase in deposit rates by banks over the last six months led
to higher supply of funds. Consequently, the overall
credit-to-deposit ratio marginally fell to 74.9% from 75.7% at
the start of 1QFY2012.
The peak retail FD rates, currently hovering at 9-9.5% for major
banks, are well above the 8% rate that NSS offers and well
above the 10-year G-Sec yield (8.3%), reflecting that deposit
mobilisation has picked up significantly but only to be deployed
at a negative spread into government bonds. Accordingly,
we expect deposit rates as well as private sector lending rates
to not go up further even if the RBI hikes the repo rate a couple
of more times, as the demand-supply dynamics for the banking
sector dictate otherwise.
On the back of pick-up in deposit growth rates in 1QFY2012,
some of the banks reduced their term deposit rates. However,
on the advances side, banks raised their lending rates by ~50bp
on an average during the quarter. Amongst banks under our
coverage, Axis Bank had the highest average base rate change
(112bp), followed by HDFC Bank (97bp).
We expect most banks, especially the smaller banks with low
CASA ratios, to face NIM pressures during the quarter, as
1) further deposits reprice upwards, 2) CASA ratios decline as
rising interest rates are likely to have resulted in a shift from
savings to term deposits and 3) in most cases, CD ratios
deteriorate in line with sectoral trends. Overall, we expect large
private banks to post 25% yoy growth in net interest income,
while PSU banks are expected to register 20.6% yoy growth.
Liquidity relatively comfortable during 1QFY2012
Increasing deposit mobilisation and slowing credit offtake, apart
from seasonal factors, reflected in lower average LAF borrowings
for 1QFY2012 at ~`46,000cr, comfortably within the RBI's
comfort zone of +-1% of total NDTL.
The easing of liquidity pressures in 1QFY2012 post two quarters
of heavy liquidity crunch in the system (average LAF borrowings
for 3QFY2011 and 4QFY2011 at `92,300 and `83,800cr,
respectively) further suggests that banks may not increase deposit
rates any further even if there are further rate hikes by the RBI.
Provisioning for employee benefits
PSU banks had to provide fully for pension liabilities related to
retired employees in 4QFY2011, which led to a few
disappointments in 4QFY2011 results, particularly in case of
Central Bank of India, Vijaya Bank, Bank of India and Dena
Bank. However, with one-time costs related to pension expenses
for retired employees having been provided in 4QFY2011,
we expect most PSU banks under our coverage to report a
decline or negligible increase in staff costs in FY2012.
Barring a few banks, asset quality remains strong
Although a few banks surprised negatively on the asset-quality
front by reporting high slippages for 4QFY2011, the asset quality
of the sector on a whole especially for private banks continued
to improve in 4QFY2011, which is evident from the fact that
net NPA ratio for the entire sector has been on a declining
trend since 3QFY2010.
We expect moderation in asset-quality pressures for public sector
banks from the high base in the last few quarters; however,
further switchover to CBS-based recognition of NPAs during
this quarter as well as in 2QFY2012 is expected to lead to an
upsurge in gross NPAs for some PSU banks, especially including
those with larger proportion of rural branches. We expect asset
quality to remain healthy for private banks going forward,
although it is unlikely to improve materially from the already
low levels witnessed in the past couple of quarters. Overall,
incremental asset-quality pressures that could arise due to the
recent increase in interest rates pose risks to our asset quality
estimates for the sector.
Rate hikes by the RBI push up bond yields
The 10-year G-sec bond yields remained above 8% for most of
April as inflationary expectations continued to dominate
sentiments in the bond markets. The markets were expecting a
25bp hike in key policy rates in the annual monetary policy
meet on May 3, 2011; however, the RBI surprised mostly
everyone by announcing an aggressive 50bp hike. The RBI also
increased the savings deposit rate by 50bp to 4% and tightened
the provisioning norms for banks, which further dampened
sentiments in the bond markets, leading to a single-day increase
in bond yields by nearly 10bp to 8.24%.
Evidence of a slowdown in the economy coupled with high
reported inflation figures further hardened yields to as high as
8.41% during the quarter. The hardening of bond yields despite
higher deposit mobilisation (leading to higher SLR investments)
witnessed during the quarter (18.2% as of June 17, 2011) also
indicates higher demand of funds from the government's side.
With yields having hardened by ~22bp on an average in
1QFY2012 over the last quarter, we expect banks carrying a
high modified duration investment book to report some MTM
losses in 1QFY2012 results.
Hike in savings deposit rate; Provisioning norms
become stricter
The RBI hiked the savings bank rate by 50bp to 4.0% on May 3,
2011, the first hike in the past 19 years, to reduce the spread
between saving deposit and term deposit rates, which had
widened significantly in the recent period; this move by the RBI
is possibly a precursor to the deregulation.
The impact of the hike is expected to be more on banks with a
higher proportion of saving account deposits to total liabilities.
Assuming no interest burden had been passed on, the overall
negative impact would have been 0.4-9.3% on the net profit
level (FY2012E) and 1-8bp on the return on assets (FY2012E)
level. However, as expected, most banks have passed on the
increased burden of cost of deposits through lending rate hikes.
The RBI relaxed the 70% provisioning coverage norm for banks;
however, it increased the provisioning requirements across the
NPL bucket by 5-10%. Even in case of restructured advances,
provisioning requirements were hiked to 2.0% from the existing
0.25-1.0% (depending on the category of advances), which is expected
to add to the provisioning burden mainly for PSU banks in 1QFY2012.
Outlook and valuation
The trade-off between growth and inflation once again was the
key predicament faced by the RBI during the quarter.
With inflation not budging, the RBI was forced into further rate
hikes, which we feel was justified considering the generalisation
of inflationary pressures and the underlying strength in credit
demand remaining firm. Meanwhile, growth has suffered, as
pointed out by few of the growth indicators; however, with the
policy action in shape, we expect inflation to moderate in the
second half of FY2012.
Also, we expect deposit rates as well as private sector lending
rates to not go up further even if the RBI hikes the repo rate a
couple of more times, as the demand-supply dynamics for the
banking sector dictate otherwise.
In fact, we expect broader deposit and lending rates to decline
from 2HFY2012, once WPI inflation starts treading downwards
(the near-term uptick due to fuel prices is in our view already
factored in by the RBI and markets).
Accordingly, while we continue to like large banks with strong
deposit franchises, ICICI Bank and Axis Bank are our top picks
in this space as in our view they will also be bigger beneficiaries
of the eventual turn in the interest rate cycle. In the mid-cap
space, we prefer banks that have either already seen bulk of
the asset-quality pressures or have been relatively conservative
in the past couple of years. In this space, we like Corporation
Bank, Indian Bank, United Bank and Syndicate Bank.
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