Jun 3, 2005|
A couple of reforms later and with wide coverage in the pink papers, banking stocks continue to figure amongst the favorite picks in an investor's portfolio. This includes stocks across the sector that includes large as well as midcaps. Nevertheless, one needs to note the fact that even with all 'reforms' factored in, the dynamics of the sector have not radically changed. Although the government has in a way taken a liberal stance, the reins firmly rest in the hands of the RBI. Also, the opening up of the sector to foreign investors implicates that the domestic entities need to be made globally competitive.
** includes SBI, Corp Bank, BOI, ICICI Bank, HDFC Bank and UTI Bank
|Income from operations
|Net Interest Income
|Provisions and contingencies
|Profit before tax
|Profit after tax/ (loss)
|Net profit margin (%)
While we do not doubt the competence of Indian banks, unfortunately the same cannot be said for all entities, across the sector. Treasury profits that the banks feasted on during the falling interest regime are now a thing of the past and it will be proficiency in core banking that will see the entities sail through the competitive era. This will not only necessitate adequate capital but also sufficient customer base to profitably deploy the same. It is in this regard that the large caps (with well distributed franchise) stand to enjoy the comfort factor. An analysis of their 4QFY05 performance also seems to suggest the same.
What drove performance in FY05?
Asset growth-the topline trigger: The sector witnessed an asset growth of 27% in FY05 (one of the highest in the last 3 decades). This was primarily driven by the retail segment (comprising 40% of the asset book). Thus an extended franchise of branches and healthy capital adequacy ratio were paramount to achieve the same. Not to mention the access to low cost deposits also aided the banks' incremental credit offtake. A healthy topline growth (7% YoY) coupled with lower interest expense (dropped by 2% YoY) also helped amplify the net interest margins (NIMs). Going forward, however, deposit mobilization seems to be posing a problem. With no tax incentives on bank deposits and interest rates keeping an upward bias, garnering a higher proportion of low cost deposits (as a % of total funds), to sustain the current level of NIMs, may not be feasible in the medium term. We therefore anticipate the sector to face margin pressures, although the smaller entities that cannot pass on the higher cost to borrowers will take the maximum hit.
Treasury-not profitable: Higher investment in government securities (G-Secs), which the banks resorted to (beyond the SLR requirements) in a sluggish credit growth period have obviously taken the backseat with demands from both corporate and retail segments being robust. However, one also needs to note the fact that with interest rates rising, the market value of such G-Secs gets eroded. Thus, most large banks have taken the advantage of one time shift to held-to-maturity (HTM) category (allowed by Reserve Bank of India (RBI) in September'04) and booked the depreciation for the same in FY05. This explains the rise in other expenses. Nevertheless, due to this, these entities have reasonably insulated their bottomlines against treasury losses. On the other hand, smaller banks that could not take such a hit continue to hold a major portion of their investment portfolio in the available-for-sale (AFS) category (which needs to be marked to market) and are dangerously exposed to the risk of treasury losses. The possibility of such treasury losses converting into negative bottomlines looms large.
Fee income-renewed focus: To reduce the reliance on treasury income, banks have also endeavored to improve the share of fee-based income to their other income. For this, initiatives have been taken for third party cross selling of products as well as technology-based services. It thus goes without saying that banks which have a larger component of other income emanating from fee income will be better off if interest rates were to rise.
Asset quality-promising prospects: As against the earlier trend of banks acquiring higher quantum of assets at the cost of asset quality, they have now awoken to the fact that maintenance of asset quality is pertinent to garner attractive valuations. Thus, besides aggressive provisioning and securitisation of doubtful assets, the screening of incoming assets has also been a focus area. Strict credit appraisal norms have been put in place to arrest the incremental slippages. Here again, the larger banks have been more proactive.
What to expect?
While we do not intend to be the doomsayers for smaller banks, all we intend to highlight is that mere treasury gains will no more help banks paint a rosy picture of their financials. They thus need to have the steam to withstand competition in their core business, not only from their domestic counterparts but also from international ones. It thus needs to be kept in mind that strong fundamentals and suitable valuations will be the drivers of their future growth. Even in case of smaller entities, it will be these parameters that will make them attractive acquisition targets and give them the requisite dimensions. So, the next time you wish to invest in a banking stock choose a 'stronger' one rather than a 'hot' one!
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