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Sector outlook: Risks remain but some positives at the margin: Moderating
economic growth and sticky rates would continue to impact loan growth and
asset quality trend would remain volatile over the next two quarters, with some
more pain expected from SME/Agri portfolios. However, at the margins, NIMs
have bounced back and peaking rate cycle would be a sentiment positive. Also,
FY12 has seen a strong beginning for the much needed power sector reforms,
which over the next two years, will help address significant asset quality
concerns.
Asset quality: Analysing pain points: (1) SME asset quality remains weak, while
large corporates continue to remain robust. Stress sectors (excl. Infra) are ~18-
22% of PSU’s exposure v/s ~12-15% for private banks. (2) PSU’s Discom
exposure (3-5%) would need to be restructured but strong policy moves and
steep tariff increases would help bridge the gap and secure incremental funding
from banks/FIs (3) Fuel remains a risk for IPPs and our detailed analysis indicates
that ~16% of incremental projects could face significant challenges.
Valuations discounting some risks: Valuations at ~25-30% discount to historical
average do indicate asset quality risks being priced in. Impact on book value
factoring in write-offs of 10% in power fund and non-fund based exposure, 5% in
other Infra exposures and 2-4% inch-up in gross NPAs in other stress sectors, is
~9-13% for ICICI/Axis and 14-20% for PSU banks. Valuations adjusted for the
write-offs still remain ~15-20% lower than historic valuations for ICICI/Axis and
at par with historic valuations for PSU banks.
Top‐down strategy: Prefer ICICI/Axis over defensive private banks and PSU
names: With valuations at ~25-30% discount to average and no large negative
asset quality surprises expected in the near term, we prefer beaten down
private banks like ICICI/Axis reflected in our ‘BUY’ rating. We do not see any
cracks in the near-term retail asset quality. However, valuation premium for
defensives is already at 2009 levels and we expect no further outperformance
on sharp market declines reflected in our ‘Accumulate’ rating on HDFC Bank
(HDFCB)/HDFC. PSU banks’ valuations look interesting; however, we expect
near-term asset quality volatility to continue.
Bottom‐up stock Ideas: ICICI is our top pick as we believe market continues to
factor risks from lumpy Infra exposure but is ignoring offsets from high retail
exposure and sharp core ROE improvement which would narrow lending
business valuations gaps with peers. Among defensives, Kotak Bank (KMB) is
the least preferred because at par P/E valuations with HDFCB, it does not factor
in ROA compression under a normalised credit cost scenario which will not the
case with HDFCB/IIB. Among PSUs, SBI is our preferred pick as near-term
negative surprises are largely priced in but market is ignoring SBI’s low risk
power exposure and operating profit resilience due to high margins. We have an
‘Accumulate’ on Punjab National Bank (PNB)/Bank of Baroda (BOB) and
‘Reduce’ on Bank of India (BOI).
Investment Summary
Bank stocks have been underperforming over the last 12 months with negative
news-flows, starting with deposit rate increase in Oct-10, increase in NPAs, both
from the previous cycle (restructured book) and current book (high rates), soonerthan-
expected news on restructuring from the power book, regulatory pressure,
including SA de-regulation, and lately, slowdown fears. The near‐term macro
outlook continues to remain challenging but we believe Financials stocks are
pricing in large part of the negative news flow with valuations ~25‐30% below
average levels and valuations selectively looking attractive for private banks like
ICICI/Axis even after factoring some stress.
Though growth and asset quality is unlikely to turnaround in the next 1-2 quarters,
markets are ignoring some positives that are playing out at the margins. NIM
pressure is behind us and with a steep rate cut cycle unlikely, we expect margins to
remain robust. With the growth fears, RBI is likely to pursue a soft stance from
hereon. Also, though power sector reforms have a long way to go, FY12 marks a
strong beginning for the much needed SEB reforms.
We recommend adding some risks, through private banks like ICICI/Axis, which
have underperformed even PSU banks only in anticipation of infra/power asset
quality risks with current trend remaining robust. PSU banks’ valuations are
getting reasonable but we expect volatility in asset quality to remain in the nearterm.
Stable retail asset quality and negligible Infra exposure would aid
performance for defensives in the near‐term but valuation gap over ICICI/Axis have
significantly widened and we believe further out performance is unlikely.
Macro: Risks remain but some positives at the margin
Macro to remain challenging with GDP growth expected to remain at <7% for
the next two quarters – Expect loan growth to moderate to ~16% and low GDP
growth to continue to impact asset quality, especially SMEs.
Inflation to moderate over the next 3-4 months, but could move up again when
base impact fades - RBI pause almost certain, with slowing growth and
moderating inflation. Policy environment to get more conducive.
Policy paralysis has impacted growth but policy initiatives, especially on power
reforms, finally moving – Incrementally positive, given high risk perception on
power exposures.
Sector Outlook: Growth to moderate
Loan growth to moderate to ~16% ‐ Sectors contributing ~45% of incremental
growth over the last 12 months, showing significant signs of slowing – Working
capital and retail credit to aid loan growth.
Margins outlook stable – No near-term pressure expected. Deposit re-pricing
done and we do not expect steep rate cut cycle currently and hence, see limited
risks to near-term margins. Impact of falling LDRs manageable.
Capital – PSU banks face capital risks but issues largely known and factored in.
News-flow on any likely capital infusion will be positive especially for SBI.
Regulatory environment – Significant policy actions were taken by RBI over the
last 12 months but the final outcome was not very unfavorable for banks. Apart
from new bank licenses and clarity on foreign banks, new PSL guidelines are
expected but we see limited incremental pressure as existing guidelines are
already very stringent.
Asset quality – Analyzing the pain points
Current depressed valuations for the sector is more a function of structural asset
quality problems expected and not cyclical growth/margin concerns. We analyse
every pain point in detail to identify likely outcomes and winners/losers.
Corporate asset quality, excl. Infra: Weak SME asset quality will continue over
the next 1-2 quarters as interest coverage (IC) continues to dip and the stress is
getting more widespread among SMEs. But the good news is large corporate IC
continues to remain robust. PSU banks will continue to be impacted relatively
more on SME asset quality, given origination issues.
SEB – Discoms: PSU’s Discom exposure would need to be restructured; at least
short-term loans to the loss-making SEBs, but strong policy moves and steep
tariff increases are positive. Incremental funding would be required till reforms
play out. With clear tariff and reform roadmaps, banks/FIs would start
incremental funding. Large PSU banks have ~3‐5% exposure, small PSUs worse
off, the big exception is SBI with <1% exposure to Discoms.
Private power: Fuel remains a concern for IPPs and we do expect some
restructuring, especially in Case I fixed tariff projects. We estimate ~10% of the
upcoming power capacities over FY11-15E could be under stress. ICICI/Axis have
~5‐6% exposure, PSU banks have ~5‐6% exposure with SBI’s exposure at ~3%.
Private banks’ exposure would have relatively better credit (structuring) but
higher unfunded exposure is an added risk.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Sector outlook: Risks remain but some positives at the margin: Moderating
economic growth and sticky rates would continue to impact loan growth and
asset quality trend would remain volatile over the next two quarters, with some
more pain expected from SME/Agri portfolios. However, at the margins, NIMs
have bounced back and peaking rate cycle would be a sentiment positive. Also,
FY12 has seen a strong beginning for the much needed power sector reforms,
which over the next two years, will help address significant asset quality
concerns.
Asset quality: Analysing pain points: (1) SME asset quality remains weak, while
large corporates continue to remain robust. Stress sectors (excl. Infra) are ~18-
22% of PSU’s exposure v/s ~12-15% for private banks. (2) PSU’s Discom
exposure (3-5%) would need to be restructured but strong policy moves and
steep tariff increases would help bridge the gap and secure incremental funding
from banks/FIs (3) Fuel remains a risk for IPPs and our detailed analysis indicates
that ~16% of incremental projects could face significant challenges.
Valuations discounting some risks: Valuations at ~25-30% discount to historical
average do indicate asset quality risks being priced in. Impact on book value
factoring in write-offs of 10% in power fund and non-fund based exposure, 5% in
other Infra exposures and 2-4% inch-up in gross NPAs in other stress sectors, is
~9-13% for ICICI/Axis and 14-20% for PSU banks. Valuations adjusted for the
write-offs still remain ~15-20% lower than historic valuations for ICICI/Axis and
at par with historic valuations for PSU banks.
Top‐down strategy: Prefer ICICI/Axis over defensive private banks and PSU
names: With valuations at ~25-30% discount to average and no large negative
asset quality surprises expected in the near term, we prefer beaten down
private banks like ICICI/Axis reflected in our ‘BUY’ rating. We do not see any
cracks in the near-term retail asset quality. However, valuation premium for
defensives is already at 2009 levels and we expect no further outperformance
on sharp market declines reflected in our ‘Accumulate’ rating on HDFC Bank
(HDFCB)/HDFC. PSU banks’ valuations look interesting; however, we expect
near-term asset quality volatility to continue.
Bottom‐up stock Ideas: ICICI is our top pick as we believe market continues to
factor risks from lumpy Infra exposure but is ignoring offsets from high retail
exposure and sharp core ROE improvement which would narrow lending
business valuations gaps with peers. Among defensives, Kotak Bank (KMB) is
the least preferred because at par P/E valuations with HDFCB, it does not factor
in ROA compression under a normalised credit cost scenario which will not the
case with HDFCB/IIB. Among PSUs, SBI is our preferred pick as near-term
negative surprises are largely priced in but market is ignoring SBI’s low risk
power exposure and operating profit resilience due to high margins. We have an
‘Accumulate’ on Punjab National Bank (PNB)/Bank of Baroda (BOB) and
‘Reduce’ on Bank of India (BOI).
Investment Summary
Bank stocks have been underperforming over the last 12 months with negative
news-flows, starting with deposit rate increase in Oct-10, increase in NPAs, both
from the previous cycle (restructured book) and current book (high rates), soonerthan-
expected news on restructuring from the power book, regulatory pressure,
including SA de-regulation, and lately, slowdown fears. The near‐term macro
outlook continues to remain challenging but we believe Financials stocks are
pricing in large part of the negative news flow with valuations ~25‐30% below
average levels and valuations selectively looking attractive for private banks like
ICICI/Axis even after factoring some stress.
Though growth and asset quality is unlikely to turnaround in the next 1-2 quarters,
markets are ignoring some positives that are playing out at the margins. NIM
pressure is behind us and with a steep rate cut cycle unlikely, we expect margins to
remain robust. With the growth fears, RBI is likely to pursue a soft stance from
hereon. Also, though power sector reforms have a long way to go, FY12 marks a
strong beginning for the much needed SEB reforms.
We recommend adding some risks, through private banks like ICICI/Axis, which
have underperformed even PSU banks only in anticipation of infra/power asset
quality risks with current trend remaining robust. PSU banks’ valuations are
getting reasonable but we expect volatility in asset quality to remain in the nearterm.
Stable retail asset quality and negligible Infra exposure would aid
performance for defensives in the near‐term but valuation gap over ICICI/Axis have
significantly widened and we believe further out performance is unlikely.
Macro: Risks remain but some positives at the margin
Macro to remain challenging with GDP growth expected to remain at <7% for
the next two quarters – Expect loan growth to moderate to ~16% and low GDP
growth to continue to impact asset quality, especially SMEs.
Inflation to moderate over the next 3-4 months, but could move up again when
base impact fades - RBI pause almost certain, with slowing growth and
moderating inflation. Policy environment to get more conducive.
Policy paralysis has impacted growth but policy initiatives, especially on power
reforms, finally moving – Incrementally positive, given high risk perception on
power exposures.
Sector Outlook: Growth to moderate
Loan growth to moderate to ~16% ‐ Sectors contributing ~45% of incremental
growth over the last 12 months, showing significant signs of slowing – Working
capital and retail credit to aid loan growth.
Margins outlook stable – No near-term pressure expected. Deposit re-pricing
done and we do not expect steep rate cut cycle currently and hence, see limited
risks to near-term margins. Impact of falling LDRs manageable.
Capital – PSU banks face capital risks but issues largely known and factored in.
News-flow on any likely capital infusion will be positive especially for SBI.
Regulatory environment – Significant policy actions were taken by RBI over the
last 12 months but the final outcome was not very unfavorable for banks. Apart
from new bank licenses and clarity on foreign banks, new PSL guidelines are
expected but we see limited incremental pressure as existing guidelines are
already very stringent.
Asset quality – Analyzing the pain points
Current depressed valuations for the sector is more a function of structural asset
quality problems expected and not cyclical growth/margin concerns. We analyse
every pain point in detail to identify likely outcomes and winners/losers.
Corporate asset quality, excl. Infra: Weak SME asset quality will continue over
the next 1-2 quarters as interest coverage (IC) continues to dip and the stress is
getting more widespread among SMEs. But the good news is large corporate IC
continues to remain robust. PSU banks will continue to be impacted relatively
more on SME asset quality, given origination issues.
SEB – Discoms: PSU’s Discom exposure would need to be restructured; at least
short-term loans to the loss-making SEBs, but strong policy moves and steep
tariff increases are positive. Incremental funding would be required till reforms
play out. With clear tariff and reform roadmaps, banks/FIs would start
incremental funding. Large PSU banks have ~3‐5% exposure, small PSUs worse
off, the big exception is SBI with <1% exposure to Discoms.
Private power: Fuel remains a concern for IPPs and we do expect some
restructuring, especially in Case I fixed tariff projects. We estimate ~10% of the
upcoming power capacities over FY11-15E could be under stress. ICICI/Axis have
~5‐6% exposure, PSU banks have ~5‐6% exposure with SBI’s exposure at ~3%.
Private banks’ exposure would have relatively better credit (structuring) but
higher unfunded exposure is an added risk.
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