BFSI - Turning Interest Tables: Looking Beyond Obvious; Sector Update :: Edelweiss

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Over the past few days a flurry of statements from different quarters has been building expectations of a rate cut in the upcoming monetary policy- leading to a rally in the bond market. However, the moot question is the implication for the banking system, more so for the PSU banks. While markets seem to give banks the benefit on their investment book, they seem to overlook the hit that may come due to change in pension assumptions and thus limit the gains. For most large cap banks BoB, PNB and SBI investment gains will to an extent be offset by pension assumption changes. However, banks with larger AFS book, higher duration, conservative discount rate assumptions and more wholesale dependence stand to gain, among them being Canara Bank, OBC and Allahabad Bank (ALBK). Moreover, in the early part of the rate cut cycle, NIMs can come under pressure due to the time lag in assets vis-à-vis deposit repricing. As a culmination of these and the annual report analysis done we see Canara and OBC best geared to play on interest rate cycle.   Overall, we continue to reiterate, SBI as our long term preferred pick in the overall PSU banks - on better capital, relatively lower stressed pool.

Investment gain aids but pension assumption change raids

Banks record investment gains on AFS portfolio (benefitting P&L) when G-sec yield falls is well known (seen in Q2FY15 performance and to an extent in ensuing quarters with 10-year G-Secs further rallying post September), however the banks also benefit from notional gain on the HTM portfolio. Our sensitivity analysis suggests 4-24% impact on FY15 earnings of banks (AFS portfolio), with BoB at the lower end and Canara at the upper end of the curve and notional gains of 6-10% on FY15 net-worth of banks (HTM portfolio). However, while investors seem to give banks this benefit, they seem to miss likely changes in critical pension assumptions (particularly discount rate), which may limit these gains. In FY14, most banks increased their discount rate assumption by 50-75bps (average being 9.0-9.2%) to offset the impact following shift in mortality table. SBI, Canara and Union are the most aggressive in terms of discount rate assumption, while BoB is the most conservative. Our analysis (accounting for both FVA and PVO) suggests earnings impact of 2% to 11% for PSU banks with ALBK at the lower end and Union Bank at upper end of the curve. Thus, net earnings impact will be positive for Canara, OBC and ALBK, whereas investment gains to an extent will be offset for BoB, PNB, SBI and Union.

Turning interest rates to exert pressure on NIMs

Early in the rate cut cycle, NIMs come under pressure due to time lag in assets vis-à-vis deposit repricing. In backdrop of softening interest rates we expect 50bps cut in benchmark rate starting towards end of this fiscal. Factoring these we believe, wholesale deposit funded banks like Yes, IndusInd and OBC will have greater leeway for tweaking base rate without impacting NIMs vis-a- vis banks with stable (CASA + retail liabilities) franchise which are not majorly impacted by rate cycles -for them improvement is more gradual.

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https://www.edelweiss.in/research/BFSI--Turning-Interest-Tables-Looking-Beyond-Obvious;-Sector-Update/27649.html