Private Banks: Will M&A zing last?

Private banking stocks have rallied in the last three months and most of them are now trading near their 52-week highs. On the other hand, the Sensex declined by 3%, since the beginning of the current fiscal. Expectation of pick up in consolidation activity in the sector has injected buying interest in the sector. Old generation private banks have nearly doubled in the last three months. Opening up the sector by increasing foreign direct investment limit, spurred activity in these counters. Federal Bank was the prominent gainer. Vysya Bank and J&K Bank too witnessed a steep rise, as these banks were scouting for foreign partners. Bank of Punjab is the only loser over a period of one year due to instability in its financial performance.

Among the new generation private sector banks, Global Trust Bank (GTB) and ICICI Bank were the losers. GTB's alleged involvement in the stock market during the KP hey days cast a shadow on its business and resulted in deterioration of financial performance. Lack of confidence on the management impacted its valuations severely. Meanwhile, ICICI Bank's price dropped after it announced the merger with its parent. However, both these stocks rallied to record sharp gains in the last three months. IDBI Bank attracted buying interest after the parent IDBI decided against merging with it.

Interest income of the sector has been impacted severely due to a slowdown in credit off take resulting from downturn in the industrial activity. The Index of Industrial Production (IIP) grew by a mere 2.5% in the first 10 months of FY02. This was less than half the growth recorded in the comparable previous period. During the period April 2001 to February 2002, bank credit grew by just 13.6% as against 18.1% growth recorded a year ago. Industrial downturn is clearly reflected in this sluggish growth rates. During the same period, total deposits of banks grew at a lower rate of 14.4% on a YoY basis against 18.1% during the corresponding period of FY01.

Declining interest rates coupled with challenging environment pressurized interest margins of banks. As if this was not enough, escalation in non-performing assets due to subdued industrial activity contributed in lowering earnings growth. However, a cost reduction exercise (through VRS and implementation of IT plans) helped banks in maintaining their net profit growth.

Although, the sector has been banking on the immense growth potential in the retail finance segment, competition is likely to keep interest margins under pressure. Consequently, higher bottomline growth could come only from volumes and from fee based income (included in other income). Since the performance of the sector is directly related to GDP growth (which is forecasted to be about 5%), an improvement in economic growth and industrial activity could only bring improvement to the financial performance of the sector. The current high valuations of private banks are likely to be unsustainable in absence of stable financials.