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SBI: Margins beckon caution!
Jul 27, 2006

Performance summary
Banking behemoth SBI has clocked unenthusing numbers for 1QFY07, clearly manifesting the margin pressures and slowdown in credit cycle, as is well anticipated for the sector. Besides a 40 basis points fall in net interest margins, the impact of extraordinary earnings in 1QFY06 (due to income tax refunds and profit on stake sale in subsidiaries) has also bloated the year on year fall in bottomline. Excluding the one-time items, profits have grown by 20% YoY. Also, while the bank remains on track in terms of asset quality, incremental credit offtakes have certainly slowed down.

Rs (m) 1QFY06 1QFY07 Change
Income from operations 91,663 88,362 -3.6%
Other Income 15,766 17626 11.8%
Interest Expense 49,131 49,521 0.8%
Net Interest Income 42,532 38,841 -8.7%
NIM (%) 3.8% 3.4%  
Other Expense 23,903 28,102 17.6%
Provisions and contingencies 17,666 12,820 -27.4%
Profit before tax 16,729 15,545 -7.1%
Tax 4,500 7,559 68.0%
Profit after tax/ (loss) 12,229 7,986 -34.7%
Net profit margin (%) 13.8% 8.7%  
No. of shares (m) 526.3 526.3  
Diluted earnings per share (Rs)* 92.9 67.1  
P/E (x)   11.4  
* (12 months trailing)

The country’s largest banking entity
SBI is India's largest financial entity with an asset size of over Rs 4 trillion (Rs 4,000 bn). Although the bank's loan book is largely skewed towards corporate (63% of non-food advances), the retail side is also fast catching up. The bank has been a major beneficiary of the current upturn in investment cycle and has continued to witness substantial growth in both retail and corporate segments. It is also an active trader in forex and is the leader in cash management services. SBI has a network of over 9,000 branches and 5,590 ATMs across the country.

What has driven performance in 1QFY07?
Advances - Signs of slowdown: SBI, having 19% of the market share of non-food credit in the country, witnessed an extraordinary growth in incremental credit offtakes in FY05 and FY06, of 28% YoY and 29% YoY respectively. This was substantially higher than the average growth of 14.5% between FY00 to FY04. However, this trend of exponential growth now seems to have moderated and the early signs of the same are evident in the first quarter of FY07, wherein advances have grown by 21% YoY. Besides liquidity pressure (due to the redemption of IMDs in 3QFY06), slower deposit mobilisation and shortage of capital (CAR) seem to have taken a toll. While retail advances (26% of credit portfolio in 1QFY07) continue to remain buoyant despite the rise in interest rates, the bank seems to have been unsuccessful in passing on the rate hikes to its corporate customers (20% of advances are towards AAA rated corporates).

Comfortable CD ratio…
  1QFY06 % of total 1QFY07 % of total Change
Advances 2,206,090   2,678,220   21.4%
Retail 554,832 25.2% 707,050 26.4% 27.4%
Corporate 1,651,258 74.9% 1,971,170 73.6% 19.4%
Deposits 3,505,220   3,777,420   7.8%
CASA 1,342,499 38.3% 1,612,958 42.7%  
Credit/Deposit 62.9%   70.9%    

The lower deposit growth of 8% YoY, while on one hand was impacted on account of IMD redemption, is also not commensurate with the growth in advances. However, it is heartening to note that the bank continues to retain a high proportion of low cost deposits (43% in 1QFY07). Also, the credit to deposit ratio of 71% is well within our estimates. Nevertheless, the shortage of capital (CAR 11.9% in 1QFY07), especially in the wake of the upcoming Basel-II norms, compelled the bank to go in for subordinated Tier-II debt funding to the tune of Rs 23 bn in this quarter, which led a contraction of 40 basis points in NIMs, despite higher yield on advances. We have estimated NIMs at 3.1% by FY08.

Other income – Fees take a hit: The change in the computation of commission on government business (from value to volume based) has led to fall in fee income from the same by 13% YoY. While government business (collection of taxes) comprises 12% of SBI’s other income, total fee income comprise 17% of the bank’s total income. Also, the impact of higher base due to extraordinary gains on profit on sale of investments in 1QFY06 has muted the numbers in this quarter. Since the bank continues to have a considerable proportion of GSecs in the AFS basket (available for sale - approximately 55%), risks on the treasury side cannot be sidelined.

Costs scale up: SBI’s staff costs registered a growth of 18% YoY mainly due to wage revision and higher contribution to pension fund. The cost to income ratio thus, has inflated to 50% (one of the highest in the sector) from 41% in 1QFY06. While the bank does not see the same reducing going forward (as there are no VRS plans on the anvil), it hopes to derive the benefits of ‘employee-repositioning’ in the longer term. Also, the incidence of higher tax rates (effective tax rates increased from 27% in 1QFY06 to 49% in 1QFY07) led to further contraction in the bottomline.

NPAs - No surprises: The bank, however, saw no negative surprises emanating on the NPAs side with both gross and net NPAs reducing to 3.9% and 1.7% of advances respectively in 1QFY07, from 5.9% and 2.7% respectively in 1QFY06. It may also be noted that once the bank gets the approval to treat the stressed ‘Dabhol assets’ as standard assets (which is likely sometime later in FY06 or FY07), it may see the net NPAs come down to 1.5% of advances. The bank, despite writing back some provisions, has an adequate coverage ratio of 57% for NPAs, which adds to our comfort.

What to expect?
At the current price of Rs 764, the stock is trading 1.3 times our estimated FY08 adjusted book value. The bank had embarked upon inorganic growth initiatives in FY06, wherein its acquired stakes in 3 overseas banks, in Mauritius, Kenya and Indonesia. The bank had also cited that it will continue to pursue the inorganic growth route in the overseas markets to grow it international business (international business stood at US$ 7 m in 1HFY06) and the benefits of that will filter in, in the longer term. However, with the constraint on availability of capital and pressure on the bank’s margins, the bank now plans to concentrate on its domestic business in the coming quarters. While we anticipated lower growth and muted margins for the bank in the near term, the bank, given its balance sheet size, penetration and the possibility of merger with associates remains a preferred play for the long term.

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