The Hindu Business Line : Banking on inherent resilience

Worries about the global credit crisis infecting Indian banks, apart from several other concerns, have made investors wary of the sector. But the sharp markdown in bank stock valuations suggests this may be a good time to accumulate selectively.

M. V. S. Santosh Kumar

Having outperformed the Sensex , from 2002-2007, the BSE Bankex, which represents the leading listed banks, has barely kept pace with it over the past year.

A steep increase in interest rates, tightening liquidity, higher reserve ratios, the farm loan waiver, controversies surrounding derivative structured products, depreciation of bond portfolios — the concerns over bank earnings have been many ove r the past year.

Worries about the global credit crisis infecting Indian banks too have contributed to investor wariness towards the sector. Yet the actual financials of leading banks for the past four quarters suggest that banks have weathered these challenges quite well, with a reasonable rate of profit growth on the back of robust credit growth.

What has driven profit growth?

For the trailing four quarters, the net profit of the BSE Bankex constituents increased by 17 per cent, year-on-year. This is despite median net interest income falling by 19 per cent. The increase in the cost of funds and a series of policy rate hikes weighed on net interest income. However, this has been more than offset by growth in ‘other income’ (median growth of 34 per cent).

Private sector banks have seen buoyancy in fee income, likely to be a sustainable source of income. For public sector banks, non-recurring income such as write-backs and treasury income have helped performance. And ongoing technology up-gradation promises to boost their fee income.

Banks’ operating expenses have grown 20 per cent year-on-year, with private banks reporting the biggest increases, mainly as a result of aggressive branch expansion. The operating expenses of public sector banks increased because of higher employee costs, provisions and technology upgrades.

Operating expenses may eventually moderate for both sets of banks — while the technology roll-out will help PSU banks peg up their fee income, branch expansion by private banks will help expand their low-cost deposit base.

Robust advances growth

Despite all the talk of tight credit, almost all banks posted advances growth of more than 25 per cent year-on-year to September.

This is despite banks hiking their prime lending rates (PLR) in the latest quarter. RBI data show overall credit growth at 29.4 per cent, but this appears partially attributable to the petroleum sector, to which credit has grown at 91 per cent.

Though there have been concerns about the steady increase in interest rates affecting credit growth, recent half-year results suggest that the overall demand for credit has not slowed, though the banks are turning more cautious in lending to some sectors. The most hit was retail lending, which contributed the least to incremental credit growth.

Higher advances growth can also be attributed to corporate borrowers turning back to loans within India, due to the non-availability of the funds through equity offers or external commercial borrowings (ECBs).

While appetite for corporate credit may remain high, concerns about credit risks and rising delinquencies in retail loans may prompt banks to be more cautious in lending to this segment.

Banks with higher proportion of retail assets (such as ICICI Bank, HDFC Bank and Kotak Mahindra Bank) may face slower growth in the coming quarters as a result.

Net interest margins stable

While credit growth has been consistently high, the net interest margins (NIMs) of banks saw mixed trends over the year, fluctuating mainly in line with PLR changes. Banks (especially PSU banks) saw NIM compression in the March and June quarters, because of the PLR cut in February. However, as banks reacted to the repo rate hike with a lag, the NIMs improved in the September quarter.

The banks best placed in terms of NIMs today are Kotak Mahindra Bank, HDFC Bank, Federal Bank, Indian Bank, Punjab National Bank (3.8- 6 per cent). Axis Bank and HDFC Bank are the exceptions to the rising trend in NIMs over the past quarter.

Current account and savings account balances, as a proportion of total deposits (CASA ratio), is one of the most important determinants of the cost of funds, which eventually decides a bank’s NIM.

The CASA for scheduled commercial banks has come down from 16.5 per cent to 14 per cent in six months. For one, term deposits have been driving deposit growth as mutual funds and retail customers shifted from demand to term deposits, given their more attractive rates.

SBI, PNB, HDFC Bank and Axis Bank have the highest absolute CASA. But ICICI Bank and Yes Bank saw an improvement in CASA over the one-year period. In recent months, bulk deposits (wholesale deposits) contributed significantly to higher cost of funds.

Non-performing assets (NPAs), a key point of concern as worries mount about asset quality, have increased in absolute terms year-on-year; but their levels are far from alarming. In ICICI Bank, HDFC Bank, Yes Bank, Kotak Mahindra Bank and IOB, NPAs as a proportion of advances increased, year-on-year.

The provisioning for NPAs was higher in the nationalised banks compared to the private banks, which indicates the former may have a higher margin of safety (compared to the RBI prescribed limits) to insulate themselves from any deterioration in asset quality going forward.

However, net NPAs are still quite low, with almost all the banks sporting ratios of less than one. Andhra Bank, Axis Bank, HDFC Bank, Yes Bank and Union Bank of India have the lowest NPA ratios, indicating good quality loan books.

While growth at the operating levels for most banks has been strong, a spike in provisioning (53 per cent up for the trailing 12 months) has resulted in net profit growth trailing income growth. Smaller banks have been particularly vulnerable to this trend. The higher provisioning may have been necessitated by higher slippages in advances, investment depreciation, derivatives provisioning and overseas exposure. In the coming quarters, profits for banks may actually be shored up as banks are expected to write back some of the provisions on their trading portfolios.

While growing advances spell strong growth for banks, capital adequacy is set to decline as the book size expands; which may force banks to raise more funds.

Therefore, further equity dilution may be on the cards for a few banks. Concerns remain for the public sector banks that have to raise funds in future, with the Government stake capped at 51 per cent.

The Government plans to provide additional capital to these banks, though the details are not known. Banks that have adopted Basel-II norms have started obtaining ratings for existing and new advances, thus presenting a more accurate picture on capital adequacies.

Related Stories:
Bank of India Q2 net rises 80% on robust credit growth
PNB’s net rises 21% in Q1
PSU banks promise additional capital market exposure

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Banking on inherent resilience

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