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SBI: Going strong and steady - Views on News from Equitymaster
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SBI: Going strong and steady
Jun 23, 2005

Post declaration of SBIís FY05 audited figures, we re-visited our earlier projections for the bank. While we continue to stand by our estimates on the assets side (advances), those on the funding side (capital and borrowings that are required to grow advances) needs a revisit. Here are our key assumptions for the next two years. Advances:† The bank is envisaging a growth of 25% in its loan book for the next 2 to 3 years. For this, it will be leveraging on the mid-corporate segment for which the bank has set up a dedicated SBU in FY05. The mid corporate segment accounted for 18% of the bankís credit portfolio in FY05 and this, coupled with the funds from international operations (21% of loan book in FY05), are expected to propel the net interest income (NII) growth over the next couple of years. However, taking into consideration the possibility of shortage in money supply (with the possibility of interest rates going up and execution of the governmentís borrowing programme), we have assumed a CAGR of 22% over the next 3 fiscals. The credit to deposit ratio is maintained at an average of 67% for the next 2 years. But it needs to be noted that the bank has average asset duration of 3 years (higher as compared to peers), which might prove to be detrimental for its net interest margins (NIMs), if interest rate inch upwards. As per our assumptions, the current NIMs (3.4% in FY05) are expected to taper down to 3% by FY07.

Deposits:† The India Millennium Deposits (IMDs) (US$ 5 bn raised @ 7.7% p.a. in FY01) that are due for redemption in 3QFY06 pose the highest threat of liquidity crunch for the bank. On redemption, the deposits are expected to get re-priced at lower cost. Although the bank is confident of being able to retain 35% to 40% of the deposits through its overseas branches, inability to do so will force the bank to garner deposits at higher rates. Nevertheless, going forward, the higher quantum of deposits will give the bank economies of scale and help control its deposit costs. We have assumed average cost of deposits of 4.8% for the next two years (5% in FY05).

Borrowings:† SBI is embarking on a major overseas expansion drive, which will be executed through the inorganic route. This will enable the bank to achieve the desired reach within a shorter span of time. It acquired a Mauritian Bank for Rs 0.4 bn in FY05, as the first step on this direction. Also, the bank, in its analyst meet, has given guidance of raising Rs 40 bn borrowings in FY06 to fund the acquisition plans that will henceforth be of much larger ticket sizes. Tier II borrowings are also inevitable for raising the bankís CAR (capital adequacy ratio) and meet the funding needs (as the public issue route is not accessible). We have therefore assumed a lower deposit to borrowing ratio of 14 times (19 times in FY05) and average cost of borrowings of 6.5% over the next two years (5.5% in FY05). Factoring in the above assumptions, the total costs of funds are expected to reduce to 3.9% in FY07 from 4.9% in FY05.

Provisioning:† With lower incremental slippages and higher coverage ratio (provisions to gross NPAs) over the years, not only has SBIís asset quality improved over the years but also its provisioning liability has considerably reduced. Assuming that the bank brings down its net NPA levels to 1.5% of advances (from 2.7% in FY05) the incremental provisioning will reduce by approximately 60% over the next 2 years. This will add buoyancy to its bottomline growth.

What to expect?
At the current price of Rs 666, SBI is trading 1.2 times its FY07E adjusted book value, making it the cheapest play amongst the banking stocks under our research coverage. But what is more attractive is the fact that SBIís consolidated adjusted book value in FY05 is Rs 497 as against the standalone adjusted book value of Rs 356. Thus, if one were to consider the consolidated figures, the FY07E valuation comes to 1 times adjusted book value. Given the fact that the bankís plan to merge its associate banks is in pipeline, investors will stand to considerably gain from the same.

We had given a HOLD on SBI in April 2005. Given the above rationale, we continue to stand by our view from a two to three year perspective and reiterate the fact that SBI is entailed to be one of the highest beneficiaries of economic buoyancy and consolidation in Indian banking industry. But at the same time, unlike the last five years, growth is likely to come at the cost of margins, which investors have to bear in mind.

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