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Banks: Good times ahead? - Views on News from Equitymaster
 
 
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  • Oct 6, 2006

    Banks: Good times ahead?

    After a brief period of skepticism about sustenance of credit growth, roll back in PLR hikes and chances of further liquidity tightening, banking stocks are back in the reckoning. Reasons being no visible signs of slowdown in credit offtake and stability in interest rates. In fact, the banks' treasury portfolios that were so long a cause of anguish to investors (because of the mark-to-market losses) have of late caught their fancy. This is due to the benign excess provisioning on the AFS (available for sale) basket and possible gains with the softening of interest rates. We believe that the fundamentals of the sector will continue to remain on a strong footing in the coming quarters due to several factors.

    • Margins to sustain: The lending rate hikes that the banks effected earlier this year enabled loan spreads to improve. However, the impact of the same on the bottomline, which usually lags by 3 to 4 months, will start filtering this quarter onwards. While we do not see any immediate softening in borrowing costs, the pressure on net interest margins will certainly get mitigated. Also, with the yield on G-Sec issues having cooled off, the downward pressure on bond spreads has also reduced. Given this, despite the fact that the banks have been deprived of interest on cash balances with the Reserve Bank of India (RBI), the overall NIMs should be fairly stable.

    • Provision write backs in the offing: With the surplus SLR portfolio of banks having dried up, the demand for G-Secs has led to the benchmark 10-year bond yield dip to less than 7.6% (down 80 basis points from the high of 8.4%). Since most banks had marked their bond books (floating provisions) above 8% on an average (10-year G-Sec yield), in the event of the interest rates remaining soft, a number of banks are likely see substantial provision write backs in the ensuing quarters.

    • Lesser sensitivity to interest rates: The sector's sensitivity to interest rates will only diminish in the future considering that there has been a marked reduction in the treasury exposure, the higher cost of borrowing has already been factored in and the provisioning requirements have largely been taken care of.

    • Visible impairment in asset quality not foreseen: The fact that despite the run up in interest rates, the overall asset quality of the sector has not been visibly impaired vindicates the fact that the risk assessment systems are in place. Also, the RBI's proactiveness in terms of raising the provisioning requirements on mortgage and real estate loans stands in good stead. Going forward, therefore, we believe that there is little possibility of negative surprises on this front.

    Dormant risks lingering...
    In the midst of this optimism, it is important to point out that the near-term risks to stocks from the banking sector could be in terms of valuations and structural issues. These are in the form of high employee costs to PSU banks (due to high pension liabilities and burden of excess employees), restriction on new branch licenses for a year (because of some operational transgressions) and uncertainty over capital costs on Basel II implementation.

    What's the upside?
    This is a very important question to ask. While the downside is limited and the odds are heavily in favour of the sector, any factor impacting their ability to grow could well become an overhang on the banks' valuations. This could be by way of inability to fund credit growth, restriction on franchise expansion and raising capital (especially for PSU banks). Thus, investors need to understand that although the prospects for the sector remain buoyant from a long-term perspective, they need to be selective in terms of the risk reward scale. After all, the upside in the stock price needs to adequately cover your risks!

     

     

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    S&P BSE BANKEX


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