India Banks 2Q12 Review: Better Margins, But Testing the Quality  Citi Research

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India Banks
2Q12 Review: Better Margins, But Testing the Quality
 2Q12 profits up 12%yoy (vs. 9% exp) on better NIMs — Indian banks’ 2Q12
earnings were better than expected (+12% yoy). Qualitatively, they were more mixed –
higher pre-provisioning profits ex-trading gains (+21% yoy vs. +15% exp), but higher
credit costs as well. Key operational drivers were: a) Better than expected NIMs
(+15bps QoQ) and b) Healthy loan growth (+20%). Private banks were better than
estimates (profits up 27% yoy), outperformed PSU banks (+3% yoy, ex-SBI: -3% yoy).
Asset quality was the key focus this quarter – slippages were high (mostly on migration
to automated NPL recognition), though there were signs of increased underlying stress.
 Healthy loan growth, but no balm for asset quality concerns — Asset quality stress
(apart from migration related slippages) has started to show up; PSU banks (especially
SBI) performed markedly worse and are likely to be impacted more going ahead as we
expect pressures to spread across peers – NPLs (for PSU banks) increased to 3% (vs.
2.5% in 1Q12, +22% qoq) and specific loan loss coverage dropped to 50% (-430bps
qoq). Loan growth remained healthy (+20% yoy), more corporate driven (SME, working
capital) than retail – should moderate. Funding mix (CASA ratio) is under pressure
higher rates for most banks (on higher rates) and costs likely to remain elevated.
 Margins ahead, partly offset by higher credit costs — Operationally, the P&L was
better than balance sheet –a) NIMs surprised on the upside (+15bps qoq, 343 bps
now) - close to historical peaks now, would expect gradual moderation hereon; b) Fee
incomes continued to lag asset growth (+10% yoy); c) Operating expenses were up 9%
yoy (cost-income ratio down 50bps qoq to 43%). These were however, partly offset by
higher credit costs (100bps overall), especially from PSU banks (120bps), while private
banks’ credit costs declined further to 60bps. We expect PSU banks’ credit costs to
remain elevated, should rise for private banks too (best historically), though with a lag.
 Sector view: Defensive near term — We remain cautious near term (high interest
rates, moderating growth, likely asset quality stress) – HDBK, Kotak most defensive.
Our top picks (Axis, SBI, ICICI) remain more leveraged to the economy – easier rates,
better growth and quality – should outperform when the outlook turns more benign.