It has been pouring in this fiscal and will continue for some time! We are referring to the downpour of issuances in the equity markets. Besides the flurry of IPOs in the primary issuances, markets will be witness to secondary issuances including ADRs, GDRs and QIPs (qualified institutional placements).
Equity issuances in FY08E
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The need...
Sustenance and growth of market share: There is no precedent for such large issuances. The aggregate issue of new equity by these banking entities, over the preceding decade, is estimated to be less than Rs 180 bn. However, Indian banks that have been more active in issuing additional equity have, naturally, been more successful in expanding their market share. In the past five years, ICICI Bank, HDFC Bank and Axis Bank (erstwhile UTI Bank) have added a combined 4% to their market share of non-food credit, raising it to 15.1%. They also raised Rs 137 bn of fresh equity, leading to dilution of 13% to 47% in their equity books, over the last five years.
The growth history created by the said banks in the last two fiscals is also unprecedented and will be a challenge to sustain across interest rate cycles. Besides their own growth, financial conglomerates like HDFC, SBI and ICICI Bank also need capital to fund the growth of their subsidiaries before separating them to unlock value. In fact, a large part of the funds raised in the equity issuances this fiscal will be routed to subsidiaries.
Capital Adequacy Ratio in FY07
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The impact...
The classical explanation for a decline in return on equity (ROE) would be the lag between the inflow of new equity and the time when it is fully geared. In the interim, the bank may be relatively under leveraged, which could depress the ROE temporarily. The 11-year trend in ROE of HDFC Bank depicts such peaks and troughs. The long-term trend of decline may be explained by a secular decline in profitability. We believe the strongest influence on this trend is the sustained competition that tends to drive down all elements of revenue.
Banks that are expanding market share do not seem to be spared from the broader trend of declining asset profitability. There are two opposing forces that act on the return on asset (ROA) of a bank that is expanding market share by leveraging new equity. An aggressive chase of new business could depress margins and the ROA. Substitution of high-cost deposits by equity could, in the near term, shall improve margins.
Whether valuations justify?
The equity issuance would definitely poise the banking stocks attractively on the price to book value parameter due to addition to their net worth. Having said that, this should not be the sole guidance of their future prospects. There has been considerable convergence between the operations of the state-owned banks and new private sector banks on four important dimensions - loan growth, cost of intermediation, asset quality and profitability.
A logical approach to estimation of fair values would therefore need to be based on most of these parameters. Also, sustenance of higher margins (NIMs), higher profitability (with fee income support) and retention of market share in fund as well as non-fund based income streams are imperative factors that should guide investors' evaluation of banking sector stocks.
BANK OF MAHARASHTRA share price is trading up by 5% and its current market price is Rs 16. The BSE BANKEX is up by 0.9%. The top gainers in the BSE BANKEX Index is BANK OF MAHARASHTRA (up 5.2%). The top losers is HDFC BANK (down 0.2%).
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