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India banks
After the high, comes the hangover
Structural de-rating – return ratios to come down sharply
The eternal long-term optimism on Indian banks in our view is unfounded. What
gets neglected is the structurally lower growth, rising opacity of the quality of book
thanks to restructuring, grossly under-provisioned state relative to regional peers
and increasing burden in the form of priority sector/financial inclusion norms all of
which is going to exert pressure on earnings and return ratios over the longer
term. Leverage ratio is likely to be structurally lower due to Basel III
implementation and we expect a deluge of equity capital raising over the next five
years. Our earnings are ~15% below consensus for FY13E/FY14E and we expect
ROEs to come down from 18.1% in FY11 to 15.7% by FY14E. Our ROEs are
around 300bps lower than consensus for PSU banks. HDFC Bank is the only
Outperform in banks. Top Underperforms are PNB and SBI.
Gearing up for Basel III: Flood of capital raising in next 5yrs
As banks gear up for Basel III beginning 1stJan’2013 to achieve a common equity
ratio of 8% and a CAR of 11.5% over the next five years, assuming an 18% CAGR
of loan growth, we expect the banking system in India to raise a minimum of
US$30bn of equity capital, posing significant dilution risk. Capital required is more
for growth than meeting solvency requirements.
Socialistic attitude of Govt and regulators add to woes
We believe the socialistic mindset of regulators as well as the government is going
to exert more pressure on bank profitability. What is good for customers is not
necessarily good for shareholders. The tougher priority sector guidelines, financial
inclusion targets and a possible farm loan waiver over the next few years are only
going to worsen profitability dynamics. Our analysis suggests that the revised
priority sector guidelines could impact margins by c.30bps for private sector banks
on a ceterus paribus basis.
Asset quality – the pain hasn’t disappeared
While the government announcements with respect to greater coal supplies to
power projects do improve sentiment, their track record of implementation leaves
much to be desired. Nevertheless pains with respect to gas based power projects
and power projects where PPAs are fixed at low prices will continue to face stress
as renegotiation of PPAs is unlikely. Our analysis of independent power projects
(IPPs) suggests that close to 23,000MW of power projects or 16% of power
exposure of banks could be at risk of restructuring or default. Another 10–15%
could be contributed by SEBs. NPLs/restructuring related to SMEs, export
oriented sectors etc are unlikely to significantly abate. We are very worried over
the moral hazard issue in the agriculture sector. Our worry is also on the underprovisioned
state of Indian banks. We expect stressed assets, defined as net
NPLs plus restructured assets, to net-worth ratio for the system to increase to a
ten-year high of 57% (90% for PSU banks) by FY13. NPL coverage on stressed
assets stands at a dismal sub 40% vs. regional peers averaging at 150% plus.
Valuations – where is the comfort?
Stocks currently are trading above ten-year historical averages on the back of an
opaque book which is grossly inflated thanks to restructuring. The 20% re-rating
from the recent lows more than adequately factors a ~100bps cut in benchmark
rates and aggressive rate cuts are unlikely considering the fiscal and inflation
After the high, comes the hangover
Why do we continue to be bearish?
We expect a structural de-rating of the banking sector with ROEs expected to come down
sharply owing to lower ROAs as well as lower leverage ratios.
Our earnings estimates are 15–20% below consensus for PSU banks and ROEs around
300bps lower for FY13E/FY14E.
⇒ We expect ROEs to come down from a level of 18.1% in FY11 to 15.7% in FY14E
(c.250bps decline) driven by higher credit costs, operating cost ratios and lower
leverage.
⇒ The decline is even sharper at 400bps if we exclude private sector banks.
We believe market isn’t seriously factoring in the extent of equity dilution that can happen
due to Basel III and envisage closer to US$30bn of equity capital raising over the next five
years.
Asset quality pressures are unlikely to significantly abate and expect stressed assets as a
proportion of net-worth to rise to 50%+ by FY13 which will be a 12-year high. For PSU
banks this number will likely be closer towards 90%+.
Expect credit costs to remain at elevated levels and closer to ten-year high of 90bps for
PSU banks. For private banks also, we expect pick up in credit costs by 25bps over the
next two years.
⇒ NPL provisioning coverage ratios including stressed assets stand at abysmally low
levels of 23% for PSUs which is grossly inadequate.
⇒ Even on a reported basis, NPL coverage ratios are at 45% for PSUs compared to
regional peers whose coverage ratio on an average stand at 150%+.
The proposed draft priority sector guidelines and the continued thrust on financial inclusion
by the government are likely to exert pressure on margins, opex and asset quality over the
longer term. Private Banks get more impacted with respect to margins as they currently are
well below the proposed targets.
Valuations are now above 10yr historical averages for most banks on the back of a book
which is grossly inflated due to restructuring and inadequate provision levels.
Limited catalyst from interest rate cuts. We believe banking stocks are pricing in well a
100bps cut in interest rates over the next 12 months. Considering the inflation and fiscal
dynamics we believe it’s not possible for RBI to cut rates aggressively and don’t expect
more than 100bps cut in the next 12 months.
Earnings estimates and ROE below consensus
Our earnings estimates and ROE are significantly below consensus especially for PSU banks
as they face significant dilution risk owing to higher capital requirements and also have more
issues with respect to asset quality.
We are 14% and 20% below consensus on EPS terms with respect to PSU banks for
FY13E and FY14E respectively.
If we look at PAT the corresponding numbers are 9% and 10% respectively. The difference
in EPS and PAT is on account of equity dilution that we expect to happen over the course
of next two years.
In terms of ROE we are around 300bps lower than consensus ROE for FY13/FY14E for
PSU banks. We expect leverage ratios to come down for PSU banks which are currently
very high.
Top picks – buys and sells
Our top pick is HDFC Bank. We don’t have any other Outperform in the banking space. We
downgrade ICICI Bank, Kotak and YES to Neutral from Outperform on account of valuations.
We have now all Underperforms in the PSU banking space. We downgrade BOB and Union
Bank to Underperform.
Top Buy- HDFC Bank (HDFCB IN, OP, CMP Rs528, TP Rs625)
Least concern on asset quality. Retail expected to do well and credit costs expected to
remain at low levels.
NPL coverage one of the highest in the sector. Also restructuring of assets is expected to
be the least in the sector.
Stellar deposit franchise should help it to deliver sector beating margins and high ROAs.
High capital levels. We don’t envisage any equity dilution for the next 12–18 months.
Top Sells
SBI (SBIN IN, UP, CMP Rs2,355, TP Rs1,700)
Asset quality continues to be the bane. Expect NPLs to remain high driven by agriculture
and SME sectors. We don’t envisage any significant recoveries in the agri sector.
Expect frequent equity dilution. We don’t think the current Rs79bn equity capital infusion
from government would suffice and expect SBI will soon be raising capital again in the next
12 months.
We expect the wage revision expected in Nov-12 will put pressure on opex ratios for FY14
due to higher salary costs and pensions which are linked to wage hikes.
The stock trades at a 10–15% premium to large cap peers despite having ROEs inferior to
them.
PNB (PNB IN, UP, CMP Rs1,027, TP Rs790)
NPLs have been stubbornly high and we don’t expect any reduction in slippages or
restructured assets.
ROA is expected to be under pressure. Current high level of margins is unsustainable and
opex increases should exert pressure on ROA. PNB historically has had a bad track record
of large employee cost increases due to wage revision compared to other PSU banks.
Expect ROEs to come down from 22% levels in FY11 to 17% over the next three years.
That could drive de-rating of the stock.-
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India banks
After the high, comes the hangover
Structural de-rating – return ratios to come down sharply
The eternal long-term optimism on Indian banks in our view is unfounded. What
gets neglected is the structurally lower growth, rising opacity of the quality of book
thanks to restructuring, grossly under-provisioned state relative to regional peers
and increasing burden in the form of priority sector/financial inclusion norms all of
which is going to exert pressure on earnings and return ratios over the longer
term. Leverage ratio is likely to be structurally lower due to Basel III
implementation and we expect a deluge of equity capital raising over the next five
years. Our earnings are ~15% below consensus for FY13E/FY14E and we expect
ROEs to come down from 18.1% in FY11 to 15.7% by FY14E. Our ROEs are
around 300bps lower than consensus for PSU banks. HDFC Bank is the only
Outperform in banks. Top Underperforms are PNB and SBI.
Gearing up for Basel III: Flood of capital raising in next 5yrs
As banks gear up for Basel III beginning 1stJan’2013 to achieve a common equity
ratio of 8% and a CAR of 11.5% over the next five years, assuming an 18% CAGR
of loan growth, we expect the banking system in India to raise a minimum of
US$30bn of equity capital, posing significant dilution risk. Capital required is more
for growth than meeting solvency requirements.
Socialistic attitude of Govt and regulators add to woes
We believe the socialistic mindset of regulators as well as the government is going
to exert more pressure on bank profitability. What is good for customers is not
necessarily good for shareholders. The tougher priority sector guidelines, financial
inclusion targets and a possible farm loan waiver over the next few years are only
going to worsen profitability dynamics. Our analysis suggests that the revised
priority sector guidelines could impact margins by c.30bps for private sector banks
on a ceterus paribus basis.
Asset quality – the pain hasn’t disappeared
While the government announcements with respect to greater coal supplies to
power projects do improve sentiment, their track record of implementation leaves
much to be desired. Nevertheless pains with respect to gas based power projects
and power projects where PPAs are fixed at low prices will continue to face stress
as renegotiation of PPAs is unlikely. Our analysis of independent power projects
(IPPs) suggests that close to 23,000MW of power projects or 16% of power
exposure of banks could be at risk of restructuring or default. Another 10–15%
could be contributed by SEBs. NPLs/restructuring related to SMEs, export
oriented sectors etc are unlikely to significantly abate. We are very worried over
the moral hazard issue in the agriculture sector. Our worry is also on the underprovisioned
state of Indian banks. We expect stressed assets, defined as net
NPLs plus restructured assets, to net-worth ratio for the system to increase to a
ten-year high of 57% (90% for PSU banks) by FY13. NPL coverage on stressed
assets stands at a dismal sub 40% vs. regional peers averaging at 150% plus.
Valuations – where is the comfort?
Stocks currently are trading above ten-year historical averages on the back of an
opaque book which is grossly inflated thanks to restructuring. The 20% re-rating
from the recent lows more than adequately factors a ~100bps cut in benchmark
rates and aggressive rate cuts are unlikely considering the fiscal and inflation
After the high, comes the hangover
Why do we continue to be bearish?
We expect a structural de-rating of the banking sector with ROEs expected to come down
sharply owing to lower ROAs as well as lower leverage ratios.
Our earnings estimates are 15–20% below consensus for PSU banks and ROEs around
300bps lower for FY13E/FY14E.
⇒ We expect ROEs to come down from a level of 18.1% in FY11 to 15.7% in FY14E
(c.250bps decline) driven by higher credit costs, operating cost ratios and lower
leverage.
⇒ The decline is even sharper at 400bps if we exclude private sector banks.
We believe market isn’t seriously factoring in the extent of equity dilution that can happen
due to Basel III and envisage closer to US$30bn of equity capital raising over the next five
years.
Asset quality pressures are unlikely to significantly abate and expect stressed assets as a
proportion of net-worth to rise to 50%+ by FY13 which will be a 12-year high. For PSU
banks this number will likely be closer towards 90%+.
Expect credit costs to remain at elevated levels and closer to ten-year high of 90bps for
PSU banks. For private banks also, we expect pick up in credit costs by 25bps over the
next two years.
⇒ NPL provisioning coverage ratios including stressed assets stand at abysmally low
levels of 23% for PSUs which is grossly inadequate.
⇒ Even on a reported basis, NPL coverage ratios are at 45% for PSUs compared to
regional peers whose coverage ratio on an average stand at 150%+.
The proposed draft priority sector guidelines and the continued thrust on financial inclusion
by the government are likely to exert pressure on margins, opex and asset quality over the
longer term. Private Banks get more impacted with respect to margins as they currently are
well below the proposed targets.
Valuations are now above 10yr historical averages for most banks on the back of a book
which is grossly inflated due to restructuring and inadequate provision levels.
Limited catalyst from interest rate cuts. We believe banking stocks are pricing in well a
100bps cut in interest rates over the next 12 months. Considering the inflation and fiscal
dynamics we believe it’s not possible for RBI to cut rates aggressively and don’t expect
more than 100bps cut in the next 12 months.
Earnings estimates and ROE below consensus
Our earnings estimates and ROE are significantly below consensus especially for PSU banks
as they face significant dilution risk owing to higher capital requirements and also have more
issues with respect to asset quality.
We are 14% and 20% below consensus on EPS terms with respect to PSU banks for
FY13E and FY14E respectively.
If we look at PAT the corresponding numbers are 9% and 10% respectively. The difference
in EPS and PAT is on account of equity dilution that we expect to happen over the course
of next two years.
In terms of ROE we are around 300bps lower than consensus ROE for FY13/FY14E for
PSU banks. We expect leverage ratios to come down for PSU banks which are currently
very high.
Top picks – buys and sells
Our top pick is HDFC Bank. We don’t have any other Outperform in the banking space. We
downgrade ICICI Bank, Kotak and YES to Neutral from Outperform on account of valuations.
We have now all Underperforms in the PSU banking space. We downgrade BOB and Union
Bank to Underperform.
Top Buy- HDFC Bank (HDFCB IN, OP, CMP Rs528, TP Rs625)
Least concern on asset quality. Retail expected to do well and credit costs expected to
remain at low levels.
NPL coverage one of the highest in the sector. Also restructuring of assets is expected to
be the least in the sector.
Stellar deposit franchise should help it to deliver sector beating margins and high ROAs.
High capital levels. We don’t envisage any equity dilution for the next 12–18 months.
Top Sells
SBI (SBIN IN, UP, CMP Rs2,355, TP Rs1,700)
Asset quality continues to be the bane. Expect NPLs to remain high driven by agriculture
and SME sectors. We don’t envisage any significant recoveries in the agri sector.
Expect frequent equity dilution. We don’t think the current Rs79bn equity capital infusion
from government would suffice and expect SBI will soon be raising capital again in the next
12 months.
We expect the wage revision expected in Nov-12 will put pressure on opex ratios for FY14
due to higher salary costs and pensions which are linked to wage hikes.
The stock trades at a 10–15% premium to large cap peers despite having ROEs inferior to
them.
PNB (PNB IN, UP, CMP Rs1,027, TP Rs790)
NPLs have been stubbornly high and we don’t expect any reduction in slippages or
restructured assets.
ROA is expected to be under pressure. Current high level of margins is unsustainable and
opex increases should exert pressure on ROA. PNB historically has had a bad track record
of large employee cost increases due to wage revision compared to other PSU banks.
Expect ROEs to come down from 22% levels in FY11 to 17% over the next three years.
That could drive de-rating of the stock.-
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