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The current backdrop of slowing economic growth and a deadlock in the
investment cycle will impact banks' earnings through lower credit growth
and uptick in NPLs. However, we see asset quality trends being very
divergent among banks; private banks are better positioned due to lower
exposure to riskier segments, higher ROA and better coverage ratio. We
lower FY12-FY13 EPS by ~5%, but taking into account cyclical risks and
higher cost of equity, cut to price targets are much sharper. Sector leader
SBI remains U-PF and we downgrade most PSU banks. We believe that
private banks offer better risk-reward.
Credit growth to moderate
‰ Multiple domestic factors (investment slowdown, lower working capital demand
and slowdown in retail credit) are likely to limit credit growth to 17% for FY12
and ~18% for FY13.
‰ Deposit growth is likely to outpace credit growth, largely due to sharp rise in
rates, and hence will result in improvement in liquidity conditions.
‰ Margins have bottomed for most private banks and are likely to bottom for the
large PSU banks in 2Q; however tier 2 PSU banks may continue to see margin
contraction at least two more quarters.
Significant divergence in asset quality
‰ While banks will see rise in NPLs, asset quality trends will differ widely across
banks depending on (1) exposure to high risk sectors, (2) proportion of
restructured loans and (3) aggression in growth in past few years.
‰ Banks with high restructured loans and those with higher exposures to sectors
like infrastructure, real estate and textiles could report sharper rise in NPL.
‰ Private banks are better placed than PSUs due to lower exposure to risky
sectors like SME, textile, infrastructure and higher share of retail- led by
mortgage. Moreover, their superior profitability along with higher NPL coverage
will cushion earnings against the risk of rise in credit costs.
‰ Pressure would be manageable because (1) corporate leverage is manageable,
(2) capacity utilisation is still healthy, (3) loan growth has moderated after
2008, (4) book is diversified and (5) proportion of risky loans is not high.
‰ We are building in 140% rise in gross NPLs between FY11-14, which suggests
rise from 2.4% of loans to 3.3%- large scale restructuring seems unlikely.
‰ We believe our estimates are reasonable as (1) the slowdown has been quite
calibrated- driven by rate hikes by RBI and (2) asset quality of Indian banks
fared well during last crisis.
Lowering earnings to reflect the new outlook
‰ We have cut our earnings estimates for FY12-13 by ~5%, higher for tier II PSU
banks, reflecting the lower credit growth and higher loan loss provisioning.
‰ A 10% higher than expected NPL provisions would impact earnings impact by
1-5% (details in figure 48).
‰ Indian banks have corrected 12-49% from highs and are trading at close to/
below their 5 year average with some trading close to their 2008 lows.
‰ We are also lowering our price targets to reflect earnings cut and the higher
cost of equity.
‰ We prefer banks with strong liability franchise, seasoned loan portfolios, lower
proportion of restructured loan book and higher RoAs – mostly private banks.
‰ We don’t see significant asset quality pressures for ICICI Bank with ~40% of
loans being retail (well seasoned) and due to its low SME exposure. ICICI
Bank, HDFC Bank and HDFC are our preferred picks in the sector.
‰ We re-iterate U-PF on SBI due to higher share of stressed asset portfolio and
premium valuations; downgrading PNB, BOI, Canara Bank, Corporation Bank,
OBC, PFC and Union to U-PF largely due to their high exposure to risky sectors.
Credit growth to moderate
A slowdown in India’s economic activity- investment cycle and consumption
expenditure- along with falling demand for working capital loans will translate
into lower credit demand over FY12 and flow through is likely to be seen in
FY13 as well. RBI’s cautious stance against inflation has been key to the rate
hikes in India and this is playing a key role in moderation of credit demand.
On other hand, deposit inflows may trend-up due to (1) hike in rates (2) rise
in share of bank deposits within household savings (sale of insurance and
mutual funds have slowed) and (3) faster compounding of deposits. We
expect credit growth in FY12 to be 17% (lower than RBI’s projection of 18%)
and deposit growth to be 20% (higher than RBI projection of 17%)
Banks’ focus on margins will yield results in 2-3 quarters
Our analysis of interest rate cycles over the past eight years indicates that
there were four phases in the past interest rate cycle with strong inter-linkage
between level of credit and deposit growth, trend in loan deposit ratio and
interest rates. Combination of these determines spreads and margins. Please
see Appendix 3 for the diagrammatic representation of interest rate cycles in
the Indian banking sector.
In Phase II of the cycle banks raise deposit rates more than loan rates (to
push-up deposit mobilisation in a tight liquidity environment) and this puts
pressure on margins. In Phase III, as banks try to contain margin pressure
they raise loan rates more than deposit rates. While it helps to improve
margins, loan growth moderates whereas deposit growth remains buoyant
leading to overall improvement in liquidity conditions.
Interest rate cycle over past eight years and recent changes in rates indicates
that banks could see margin expansion after 2-3 quarters as recent hike in
loan rates have been more than hike in deposit rates and quicker than in
previous cycle. Margins have bottomed for most private banks and are likely
to bottom for the large PSU banks in 2Q; however tier 2 PSU banks may
continue to see margin contraction at least two more quarters.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Continue to differentiate
The current backdrop of slowing economic growth and a deadlock in the
investment cycle will impact banks' earnings through lower credit growth
and uptick in NPLs. However, we see asset quality trends being very
divergent among banks; private banks are better positioned due to lower
exposure to riskier segments, higher ROA and better coverage ratio. We
lower FY12-FY13 EPS by ~5%, but taking into account cyclical risks and
higher cost of equity, cut to price targets are much sharper. Sector leader
SBI remains U-PF and we downgrade most PSU banks. We believe that
private banks offer better risk-reward.
Credit growth to moderate
‰ Multiple domestic factors (investment slowdown, lower working capital demand
and slowdown in retail credit) are likely to limit credit growth to 17% for FY12
and ~18% for FY13.
‰ Deposit growth is likely to outpace credit growth, largely due to sharp rise in
rates, and hence will result in improvement in liquidity conditions.
‰ Margins have bottomed for most private banks and are likely to bottom for the
large PSU banks in 2Q; however tier 2 PSU banks may continue to see margin
contraction at least two more quarters.
Significant divergence in asset quality
‰ While banks will see rise in NPLs, asset quality trends will differ widely across
banks depending on (1) exposure to high risk sectors, (2) proportion of
restructured loans and (3) aggression in growth in past few years.
‰ Banks with high restructured loans and those with higher exposures to sectors
like infrastructure, real estate and textiles could report sharper rise in NPL.
‰ Private banks are better placed than PSUs due to lower exposure to risky
sectors like SME, textile, infrastructure and higher share of retail- led by
mortgage. Moreover, their superior profitability along with higher NPL coverage
will cushion earnings against the risk of rise in credit costs.
‰ Pressure would be manageable because (1) corporate leverage is manageable,
(2) capacity utilisation is still healthy, (3) loan growth has moderated after
2008, (4) book is diversified and (5) proportion of risky loans is not high.
‰ We are building in 140% rise in gross NPLs between FY11-14, which suggests
rise from 2.4% of loans to 3.3%- large scale restructuring seems unlikely.
‰ We believe our estimates are reasonable as (1) the slowdown has been quite
calibrated- driven by rate hikes by RBI and (2) asset quality of Indian banks
fared well during last crisis.
Lowering earnings to reflect the new outlook
‰ We have cut our earnings estimates for FY12-13 by ~5%, higher for tier II PSU
banks, reflecting the lower credit growth and higher loan loss provisioning.
‰ A 10% higher than expected NPL provisions would impact earnings impact by
1-5% (details in figure 48).
‰ Indian banks have corrected 12-49% from highs and are trading at close to/
below their 5 year average with some trading close to their 2008 lows.
‰ We are also lowering our price targets to reflect earnings cut and the higher
cost of equity.
‰ We prefer banks with strong liability franchise, seasoned loan portfolios, lower
proportion of restructured loan book and higher RoAs – mostly private banks.
‰ We don’t see significant asset quality pressures for ICICI Bank with ~40% of
loans being retail (well seasoned) and due to its low SME exposure. ICICI
Bank, HDFC Bank and HDFC are our preferred picks in the sector.
‰ We re-iterate U-PF on SBI due to higher share of stressed asset portfolio and
premium valuations; downgrading PNB, BOI, Canara Bank, Corporation Bank,
OBC, PFC and Union to U-PF largely due to their high exposure to risky sectors.
Credit growth to moderate
A slowdown in India’s economic activity- investment cycle and consumption
expenditure- along with falling demand for working capital loans will translate
into lower credit demand over FY12 and flow through is likely to be seen in
FY13 as well. RBI’s cautious stance against inflation has been key to the rate
hikes in India and this is playing a key role in moderation of credit demand.
On other hand, deposit inflows may trend-up due to (1) hike in rates (2) rise
in share of bank deposits within household savings (sale of insurance and
mutual funds have slowed) and (3) faster compounding of deposits. We
expect credit growth in FY12 to be 17% (lower than RBI’s projection of 18%)
and deposit growth to be 20% (higher than RBI projection of 17%)
Banks’ focus on margins will yield results in 2-3 quarters
Our analysis of interest rate cycles over the past eight years indicates that
there were four phases in the past interest rate cycle with strong inter-linkage
between level of credit and deposit growth, trend in loan deposit ratio and
interest rates. Combination of these determines spreads and margins. Please
see Appendix 3 for the diagrammatic representation of interest rate cycles in
the Indian banking sector.
In Phase II of the cycle banks raise deposit rates more than loan rates (to
push-up deposit mobilisation in a tight liquidity environment) and this puts
pressure on margins. In Phase III, as banks try to contain margin pressure
they raise loan rates more than deposit rates. While it helps to improve
margins, loan growth moderates whereas deposit growth remains buoyant
leading to overall improvement in liquidity conditions.
Interest rate cycle over past eight years and recent changes in rates indicates
that banks could see margin expansion after 2-3 quarters as recent hike in
loan rates have been more than hike in deposit rates and quicker than in
previous cycle. Margins have bottomed for most private banks and are likely
to bottom for the large PSU banks in 2Q; however tier 2 PSU banks may
continue to see margin contraction at least two more quarters.
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