CLSA on Banks::: Cracking the code Secrets of annual reports revealed

Cracking the code
For more than six centuries, the world has struggled to decipher the smile of
Leonardo Da Vinci’s Mona Lisa. Thankfully, Indian banks’ annual reports are
not so mysterious. However, it would be naïve to regard them as artless. In
endeavouring to decode the cryptex of 13 such reports, we discover that
banks have reined in exposure to risky segments but asset quality between
public and private lenders is diverging. Further, current and savings accounts
growth has decelerated while the investment cycle slowdown has hurt fee
income. Our top picks are ICICI, Axis and HDFC Bank

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Our first discovery from the FY12 annual reports was reassuring. While no bank
escaped the slowdown in loan demand over the past year, all have tried to
contain the fallout. As a result, exposure to riskier sectors rose by just 12%, a
third of the pace in FY11 and the ratio of RWA/total assets was flat. Public-sector
undertakings (PSUs) have higher exposure to riskier segments than the private
lenders, making them more vulnerable to the current economic slowdown.
This was evident in the asset-quality pressures PSU banks faced in FY12 when
they saw stressed loans jump 62%, almost three times as fast as their private
counterparts. The concomitant rise in provisioning was a heavy drag on PSUs’
earnings growth, whereas private banks benefitted from low credit costs. Our
investigation also reveals that provisioning will continue to hurt profitability as few
have a sufficient buffer against the ageing of current NPLs and fresh slippages.
Current and savings accounts (Casa) are the banks’ lifeline for profitable growth,
but during FY12 high interest rates choked them of such deposits, slowing
expansion to a five-year low of 7%. Only small private lenders registered high
growth as they leveraged the deregulated interest-rate regime for savings
deposits to gain market share, albeit at a higher cost. Most banks carry a
mismatch in the maturity of assets and liabilities, but this could be a boon when
rates decline. But it’s not all good for private banks. The slowdown in the
investment cycle, as discussed in our recent Cyclical hurdles report, has hurt
their fee income. ICICI and Axis faced greater pressure due to their dependence
on such fees and are now increasingly focused on retail fees.
Even capitalisation needs to be examined closely and while banks’ tier-1 capital
adequacy ratios are comfortable at 8-13%, we argue that this is an
overstatement. Moreover, PSU banks’ pension assumptions are aggressive and
a revision could push net worth lower. For private lenders, fair-value accounting
of employee stock-ownership plans would reduce earnings by 3-7%. The gist of
all this analysis boils down to the differential in return on assets. It is hard to
ignore the fact that private banks generate 70bps more than PSUs, implying
that their return on equity could be 400-500bps higher. We recommend
investors BUY ICICI, Axis and HDFC Bank. Among PSU banks, we like SBI.