Yes Iifl Jan11s

8/2/2019 Yes Iifl Jan11s

1/14


2/14

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India - Banking

2

Headwind from moderation in growth and risinginterest rates

Moderation in FY12ii GDP grow th likelyIndias FY12ii economic growth rate is likely to moderate after a strongrebound witnessed in FY11. Many headwinds, including wider CAD,worsening outlook for inflation and rising interest rates are likely tohave a negative impact on the evolving growth outlook for FY12ii. A re-bound in growth during FY11 was led by strong growth in privateconsumption and an improvement in the investment cycle.

Figure3: GDPgrowthlikelytomoderateonslowerinvestmentcycle

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FY06 FY07 FY08 FY09 FY10 FY11ii FY12ii

(%)

Source:RBI,IIFLResearchWhile the tailwind of strong rural economic activity and privateconsumption continue to drive robust growth expectations for FY12, highinflation and volatile capital flows are beginning to emerge as key risks.Market expectations about levels of inflation would likely remain elevatedover the medium term, driven by higher commodity prices, includingthose of food and oil, and volatility in exchange rate. We believemonetary policy bias will shift to inflation management; marketexpectations of growth would likely moderate, owing to higher policy

rates.

Figure4: Highcommoditypricesarelikelytoaccelerateinflationfurther

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Jan06 Sep06 May07 Jan08 Sep08 May09 Jan10 Sep10

WPIinflationYoY(%)

Source:Bloomberg,IIFLResearchWith higher interest rates, we believe investment cycle would moderate,leading to our lower growth expectations for FY12ii GDP. We expectprivate consumption to sustain the growth momentum.

Upw ard bias to deposit and lending rates likely to remain

Figure5: IncreasesindepositandlendingratessinceJuly2010

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AXSB HDFCB SBIN BOB BOI ICICIBC PNB UNBK YES

PLR Depositrate(bps)

Source:IIFLResearch


3/14

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India - Banking

3

Deposit and lending rates have risen by 150-225bps and 75-150bps,respectively, since August 2010. A sharp decline in liquidity followed byan uptick in loan demand has driven rates higher much more quickly

than anticipated.

Figure6:BanksnetborrowingsfromRBIthroughrepowindow

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Netreverserepoo/s%ofbankingsystemdeposits(%)

Source:RBI,IIFLResearchFigure7: Loangrowthhasseenanaccelerationingrowthrateinrecentmonths

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Loan grow th Deposit grow th

(%)

Source:RBI

It is not unusual to see deposit and lending rates rising sharply whenliquidity conditions turn adverse. The sharp increase in deposit ratesshows banks recognition that liquidity is moving from excess to deficit

zone for the foreseeable future. The increase in lending rates is a signalof return of pricing power to banks, consistent with change in liquidityconditions. Banks seldom experience NIM contraction during risinginterest rates, save for asset-liability mismatches and strength ofdeposit franchise (mainly CASA deposit ratio).

Figure8: LendingratestendtolagdepositratechangeswhenincreasingaswellasdecreasingSBIPLRvs1yeartermdepositrates

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SBIPLR SBI1yrTD(%)

Source:Bloomberg,Company,IIFLResearchWe believe interest rates will retain an upward bias through CY11,driven by wider CAD and persistent higher inflationary pressures. CAD

has risen sharply since FY09; at FY11ii 3.5% of GDP, it will be ahistorical high. Dependence on volatile capital flows has been on therise to finance CAD of late. This raises concerns about sustainability ofsuch financing means over longer time horizons.

In the absence of adequate means to finance CAD from capital account,the RBI might have to resort to dipping into the official reserves to meetthe financing gap. In our view, wider CAD would likely pressure liquidityconditions and hence interest rates.


4/14

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India - Banking

4

Figure9: Currentaccountdeficitisnowatahistoricalhigh

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(0.7)(1.3)

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Source:RBI,IIFLResearchWhile the increase in deposit and lending rates suggests buoyancy indemand for loans, they are likely to peak much sooner than loangrowth, gaining significant momentum. In earlier cycles, interest rates

peaked much after loan growth, gaining significant traction.

Figure10:Inearliercycles,peakingofrateshastypicallylaggedpeakingofgrowthcycle

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16Loangrowth SBIPLR(RHS)(%) (%)

Source:RBI,Bloomberg,IIFLResearch

Loan growth likely to decelerate to 18% in FY12iiIn recent periods, project loans have become a significant driver of loangrowth. Thus, a moderation in investment cycle would likely lead to

slower pace of expansion of loans in FY12ii.

Figure11:InfrastructureloansemergedasasignificantcontributortogrowthinFY11

Infrastructure

(36%) Manufacturing

(19%)

Retail(17%)

Services

(27%)

Source:RBI,IIFLResearchFigure12:keepinginlinewiththetrendseeninFY10

Others

(18%)

Services

(18%) Retail

(5%)

Manufacturing

(33%)

Infrastructure(25%)

Source:RBI,IIFLResearch


5/14

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India - Banking

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We believe the slack in demand from infrastructure segment will bepicked by retail loans but would not be significant enough to offset thedeceleration in the pace of growth from infrastructure.

Figure13:Segmentwiseloangrowthforthesector

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Infrastructure Manufacturing Retail Services

Mar09 Mar10 Nov10

(%)

Source:RBI,IIFLResearchFigure14:Weforecastloangrowthwilldecelerateto18%inFY12ii

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FY07 FY08 FY09 FY10 FY11ii FY12ii

(%)

Source:RBI,IIFLResearch


6/14


7/14

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India - Banking

7

Figure17:SBINhastheleastandYesthemostdependenceonbulkdeposits

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20 20 2027

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SBIN UNBK BOI HDFCB PNB BOB ICICIBC AXSB YES

Bulk

deposits

%(%)

Source:Company,IIFLResearchThe gap arising from lower CASA deposit ratio and higher dependenceon bulk/wholesale deposits are structural disadvantages, in our view.The adverse impact on NIM arising from the above can only be negated

through better asset allocation. However, opportunities for suchefficiency improvements are insignificant through lending to segmentswhere pricing power of individual banks could be significant, but oftenresult in higher risk profile of loans.

Rising deposit rates would likely depress CASA deposit ratio and raisedependence on bulk/wholesale funded deposits. This would likelypressure NIM further, in addition to the adverse effect arising fromnegative gap and lower CASA deposit ratio.

We forecast NIM will compress by 10bps (HDFCB) to 33bps (YES). Thegap between deposit and lending rate increases suggests that NIMcontraction could be even sharper. However, all assets and liabilities donot re-price uniformly. We have assumed a moderation in the extent ofNIM contraction based on past experience, when interest rate reachedits peak in FY08-FY09.

Figure18:DifferencebetweenassumedandderivedNIMcontraction (FY12ii)

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HDFCB SBIN UNBK AXSB BOI ICICIBC BOB PNB YES

NIMcontractionbasedongapanal ysi s ForecastNIMcontraction

(bp)

Source:Company,IIFLResearchFigure19:ForecastedNIMdeclinecomparedtoearlierestimate

FY12ii(old) FY12ii(new) Change(bps)

AXSB 3.3 3.2 14HDFCB 4.6 4.5 10ICICIBC 2.5 2.3 17YES 2.7 2.4 33BOB 2.8 2.5 30BOI 2.6 2.4 24PNB 3.9 3.6 24SBIN 3.0 2.8 20UNBK 2.9 2.7 23Source:Company,IIFLResearch


8/14

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India - Banking

8

Significant improvement in asset quality unlikely during FY12iiWe believe banks are unlikely to show significant improvement in assetquality trends in FY12ii, given the high level of residual risks in their

balance sheetrestructured loans of state-owned banks still constitute3%-6.5% of loans as at end-2QFY11, and there are headwinds to debtservicing capacity of non-financial companies from rising interest rates.

Figure20:NPAlevelofbanksunlikelytoimprovesignificantlyinFY12ii

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12.0NPA+restructured%ofadvances GDPgrowth(%)(%)

Source:Company,IIFLResearchFigure21:Asof2QFY11restructuredassetscomprised36.5%ofassetsforstateownedbanks

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Restructuredassets% %Slippagefromrestructuredbook

Source:Company,IIFLResearch

Figure22:..and3065%ofthebanksnetworth

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Restructuredassets%ofnetworth

Source:Company,IIFLResearchFigure23:EBITDAmarginofnonfinancialcompaniescouldcomeunderpressureduetorisingcommodityprices

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EBIDTA

margin

(ex

real

estate/IT)

(%)

Source:CMIE,IIFLResearchNote: No of companies covered - 378


9/14

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India - Banking

9

Figure24:Risinginterestrateswouldexertpressureondebtservicingcapacity

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Interest/sales ratio(exIT)(%)


Figure25:InterestcoverageratiounlikelytoimprovesignificantlyinFY12ii

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Interestcoverageratio(ex(%)


Figure26:LoanstoMicroFinanceInstitutionsislikelytobecomedistressedasset

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MFIexposure%networth(2QFY11)(%)

Source:Company,IIFLResearchFigure27:Highexposuretocommercialrealestateisalingeringconcern

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CRE%oftotalexposure(asofFY10)(%)

Source:Company,IIFLResearchHigh and sustained growth of the non-financial sector would enablebanks to reduce their stressed asset portfolio quickly. Moderation ingrowth rates and rising commodity prices are likely to exert pressure on

such improvements in the profitability of these companies. Rising


10/14


11/14

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India - Banking

11

Figure31:FY12EPSconsensusestimatesforbankshaveseen17%upgradesinlast6months

(2)

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BOI BOB AXSB HDFCB ICICIBC PNB UNBK SBIN YES

1m 3m 6m(%)

Figure32:andconsensusnowforecastsa2233%growthinFY12EPS

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YES

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Figure33:Wearenow040%belowconsensusFY12EPSestimatesforourcoverageuniverse;ForHDFCBweare2%ahead

FY11 FY12 FY13

BOI (19) (43) (41)BOB (3) (25) (28)UnionBank (15) (22) (23)ICICIBank (1) (17) (23)Yes 6 (15) (20)PNB (9) (13) (16)SBI 2 (8) (9)AxisBank 4 0 (1)HDFCBank 1 2 4Source:Bloomberg,IIFLResearch


12/14

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India - Banking

12

Repositioning based on earnings growth outlook andrisks

Bank stock prices have fallen by 1126% during the last three months.From the peak, the fall has been sharp. Valuations of banks havemoderated from their peaks and now trade at their mid-cycle multiples,in our view.

Figure34:3mpriceperformanceofbanksunderIIFLcoverageuniverse

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BOI

UNBK

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SBIN

Bankex

PNB

BOB

HDFCB

ICICIBC

Sensex


Figure35:EPSgrowthandFY12iiP/EX

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UNBK BOI BOB PNB ICICIBC SBIN AXSB YES HDFCB

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FY1012ii EPSCAGR P/E(RHS)

Source:Company,IIFLResearchFigure36:ROEandFY12iiP/BX

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ICI CIBC BOI SBI N UNBK BOB YES HDFCB AXSB PNB

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ROE P/B(RHS)

Source:Company,IIFLResearchWe believe earnings growth outlook and potentials risk to this outlookwould drive stock price performance over the next 12 months. Asdiscussed elsewhere in this note, earnings growth outlook for FY12ii is

likely to be driven by NIM contraction and higher credit costs vis--viscurrent expectations. As a corollary to the above, we believe banks that


13/14

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India - Banking

13

have strong deposit franchises and are less leveraged to improvementin credit quality outlook would likely outperform their peers. In ourview, HDFCB, Axis and SBI are best-positioned on the above metrics,

and we retain these banks as our best picks.

We believe HDFCB would sustain strong earnings growth momentum,on: a) strong retail lending franchise continuing to drive asset growthrobustly over the medium term; b) well-matched asset-liability profileand hence no significant concern about NIM contraction; and c) stableasset quality outlook.

We believe Axis Banks share price underperformed significantly owing

to concerns about significant NIM contraction arising from its highdependence on wholesale deposits. In our view, concerns aboutsignificant contraction of NIM is unlikely, given a well-matched balancesheet profile. We believe earnings growth for FY12ii would likely belower than the 30%+ CAGR delivered in the past. However, this doesnot alter the long-term growth outlook based on continued marketshare gains driven by an expanding franchise.

A strong deposit franchise and improving asset quality, albeit at amoderate pace, would place SBI in a better position vis--vis its peers.We believe SBI would likely deliver stronger revenue growth vis--viscurrent expectations, as its NIM contraction would be more modest,while credit costs would continue to show an improvement in FY12ii, aspressure on increase loan loss coverage ratio ease substantially.

We upgrade Yes Bank to Add from Reduce. While concerns about NIMcontraction are yet to play out, we believe the sharp fall in its share

price (32% from its peak) reflects potential concerns. We believeearnings growth would likely slow significantly in FY12ii. However, withthe stock trading at FY12ii P/B of 2x, we believe value is beginning toemerge.

We downgrade PNB from BUY to ADD, on concerns about NIMcontraction and lingering asset quality issueshigh exposure tocommercial real estate and large level of restructured assets wouldremain as an overhang to growth expectations in our view.

We downgrade BOB and UNBK from ADD to REDUCE. NIM contractionwould likely be more pronounced for these banks, causing significantchange to consensus earnings growth outlook of these banks.


14/14

Yes Iifl Jan11s

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