After a sharp rally, banking stocks seem to offer a limited upside from current levels.
While the BSE Sensex has given a return of 45 per cent in the past year, the BSE Bankex has gained about 58 per cent led by both large and small banks.
The robust credit growth of 30 per cent for three years till FY07 on the back of an 8 per cent GDP growth and foreign investments chasing reasonable valued stocks have led to the huge demand for banking stocks.
The recent rate cut of 50 basis points by the US Federal Reserve has revived hopes that the rising interest rate regime of the past few years may come to an end in India as well, which augurs well for the economy and for banks too.
Besides macro factors, there are also fundamental reasons for the stocks to shoot up. The banking industry has witnessed one of the most challenging times this year and yet exhibited good financial performance partly due to robust growth of non-interest income for many players.
Banks have weathered various storms such as rising interest rates, inflationary concerns due to high oil prices and constant pressure from the Reserve Bank of India (RBI) to reduce their exposure to lucrative but risky sectors like capital markets and real estate. What lies ahead?
| Credit growth is slowing down... RBI’s earlier measures of hiking key rates like repo, reserve repo and cash reserve ratio (CRR) in the past and its objective to protect banks from riskier assets seems to have worked. Interest rates in India have risen by 400 basis points since 2006. |
| As a result, credit growth has come down to 23 per cent y-o-y as on September 14 from the earlier 30 per cent. Deposit growth, which was lagging behind the blistering advance growth in the past, is growing at the same rate. |
| While this may look healthy, the credit growth between April and September 2007, traditionally a lean season, looks disappointing. While deposits grew at 7 per cent, advances have risen at less than half the rate of 3 per cent. |
| Last year, advances had increased by 7.4 per cent in the same period. With SLR (statutory liquidity ratio) investments at near stipulated levels of 25 per cent, banks have to fund their credit growth through deposits, which has led to a higher growth in deposits than advances. |
| Says an analyst, “This will become a normal business cycle in future as banks will garner huge deposits in the lean season, which will be utilised in the next half or busy season.” |
| Is this just a blip? Says Tarun Bhatia, head-financial sector, ratings, Crisil, “Credit growth will pick up in the next two quarters though the overall growth in 2007-08 will be lesser than what we are used to in the past few years.” |
| Adds Hitesh Kuvelkar, associate director, research, First Global, “Bank credit has to grow at more than 20 per cent if India has to achieve its targeted GDP growth of 8-9 per cent.” Even if credit growth drops to 23 per cent for FY08, nobody is complaining as it comes on a higher base. |
| How will margins shape up? Due to lacklustre credit market, players have started resorting to rate cuts or discounts. Some banks have also started lending to corporates at sub-PLR rates. |
| According to Rupa Rege, chief economist, Bank of Baroda, effective yield on advances have come down by 50-100 basis points. However, interest rates on deposits still remain high levels at over 8 per cent. |
| Thus, net interest margins (NIMs) will vary from bank to bank depending on magnitude of cut in the deposit rates. |
| Adds Rege, “Margins may contract by 20 basis points in Q2 FY08 as deposit rates continue to remain high and advances growth has been lacklustre.” |
| Crisil’s Bhatia also agrees and adds that profitability will be impacted marginally. |
| He adds that the net profitability margin, a parameter used by Crisil, which considers interest income from interest bearing assets, fee-based income, interest cost on borrowings and operating expenses is likely to decline by 10-15 basis points. |
| However, margin contraction will be supported by higher fee based income, treasury gains both from equities (Sensex at new high) and bonds (with yields declining from 8.15 per cent in May-June to the current 7.8 per cent) and robust recoveries. |
| But net profit growth will vary from bank to bank depending on the provisions. But the situation will not be all that bad. |
| Strategy: accumulate or hold After a steep rally, investors will have to be patient while putting money in private banks, which have appreciated more than their public sector counterparts. |
| Analysts advise investors to have a horizon beyond 2010 while investing at the current levels. |
| Says Ajit Dange, analyst, Pinc Research, “Valuations seem to factor in FY09 growth in business.” |
| Kuvelkar of First Global prefers to wait till Q2 results before recommending stocks and revising price targets even though he is bullish over the long term. Existing investors with a medium term view may even liquidate their holdings and enter again on dips. |
| Mid-caps vs large-caps Stock prices of mid-cap banks such as Yes Bank, Centurion Bank and Federal Bank have zoomed. |
| Explains an analyst, “Stock prices of mid-cap banks are going up on hopes of an imminent consolidation as shareholders of acquired banks gain more than that of the acquiring bank due to better price offered.” |
| As a result, most of them are quoting at comparable valuations of large-cap banks. Analysts prefer large-cap banks in the long term as they believe that banking in India is eventually a market share game. Here are some banks worth looking at: |
| Allahabad Bank: The bank’s valuation of around one time estimated price to book multiple for FY09 makes it attractive. |
| According to analysts, the bank is unlikely to give any negative surprises on the key financial indicators like net interest income, margins, non-performing assets (NPAs) and net profits in the next few quarters. |
| Union Bank of India: UBI’s renewed focus on areas like maintaining NIMs, improving CASA (current and savings accounts) ratio further, bringing down NPAs and shift to retail and SME segments have already started yielding results. The bank looks attractive at 1.4 times estimated price to book for FY09. |
| Indian Overseas Bank: IOB trades at a price-book multiple of 1.4 FY09 estimates and looks promising given its high NIM (3.5-4 per cent), return on equity (25 per cent) and return on assets (1.4 per cent). |
| Though the bank continues to have higher gross NPAs, they are declining and net NPAs of less than one per cent look encouraging. Analysts are hopeful that the bank will maintain the strong financial performance. |