Morgan Stanley - State Bank of India - Deterioration Unabated

F3Q14 PAT fell ~35% YoY. Higher credit costs led
core operating profit to fall 20% YoY. Impaired loan
formation was above our estimate at 1.4% of loans.
NII was in line. Fees/FX income picked up, but are
unlikely to be sustained. Weak trends at banking
subs lead us to trim estimates, PT to Rs1,150.
Pace of impaired loan formation still high – 1.4% of
loans (non-annualized). The mid-corporate and SME
segments (where collateral tends to be weak) contributed
to >75% of NPLs. The stock of impaired loans in this book
is ~17% and forms ~50% of overall impaired loans. The
recast pipeline remains high at ~Rs100bn (0.8% of loans)
– vs. ~Rs40bn of restructuring in F3Q14.
PPoP margin improved, but sustaining it will be
tough: This was driven by higher fees and volatile FX
income – unlikely to be sustained, as seen at other
banks. Margins were stable (given base rate hikes) – but
we expect them to trend lower as bad loan formation
remains high and the LD ratio moderates. Loan growth
(domestic) moderated to 15% yoy and will slow further.
Banking subs – even weaker trends: F3Q14 PAT was
down 55% YoY. Share in consolidated profits was lower
at 15% YTD from 18% in FY13 and 30% in FY11.
Impaired loans ratio increased to 11.5% vs. 10.9% last
quarter. Coverage was lower at ~40% vs. 43% last
quarter. These will need capital infusion by the parent.
Weak balance sheet and low profitability imply
continued dilution ahead – remain UW: Even after
the capital raising (9% dilution), F14 consolidated CET
Tier 1 at ~9.5% (by our estimate) is the lowest among
large Asian banks. Further, high impaired loans (9.1%)
with low coverage (~45%) will keep internal capital
generation low. Against the backdrop of Basel 3 and
D-SIB norms, this could lead to continued cash calls.

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Investment Thesis: Why UW
 Revenue progression (loan growth
plus fees) likely to be tepid given
slowdown in economic growth.
 Asset quality (9.1% impaired loans
ratio and 14% infrastructure
exposure) will likely remain under
pressure, given peak lending rates
and slowing growth.
 0.8x consolidated F2014e book value
is expensive in the context of a weak
balance sheet and ~6% underlying
ROE (average F2014-16e).
 Multiples will be under pressure as
revenue growth slows and asset
quality pressures increase.
Key Value Drivers
 Revenue – Margin progression, loan
growth and fee income progression.
 Credit costs.
 Life insurance valuation/ market
share.
Potential Catalysts
 System-wide loan/deposit growth
trends.
 Margin progression.
 Deposit rate trends in India.
 Impaired loan trends.
Key Upside Risks
 Stronger-than-expected loan growth.
 Less-than-expected margin
compression.
 Credit costs below expectations.
 Improvement in operating efficiency,
supporting ROA progression in the
long term.