Indian banks have finally started feeling the heat towards their cost of funds. With a rise in G-Sec yields, the deposit rates are under scrutiny. It is pertinent to note that, in contravention to the common perception that the hike in the lending rates is likely to augment the spreads, a hike in the deposit rate on the other side, is set to nullify this effect! To prevent a hit on the bottomline, the option most banks resort to is to go on a lending spree, with little heed to the quality of assets.
Most private and public sector banks that were basking under the retail story have now woken up to the sour fact that incessant lending has its own vices. Private banks, particularly UTI Bank, prefer the auto loans for their retail credit disbursals, because besides being high yielding, this class of asset has a shorter tenure with fixed rates – like 3-5 years, instead of 15-20 years as is the case with home loans.
With the auto majors contemplating a price revision and a hike in the auto lending rates, it devolves on the banks to exercise caution in maintaining their asset quality. UTI Bank, which has a 57% exposure in the auto loan segment (as a percentage of its total retail portfolio), has been particularly callous in this respect.
The bank reported a trading loss of Rs 949 m in 2QFY05 as compared to a trading profit of Rs 1,019 m in 2QFY04. This was a consequence of the accounting loss of Rs 1,145 m booked on account of the transfer of government securities amounting to Rs 3,377 m to the ‘Held to Maturity’ (HTM) category. To camouflage the losses, UTI Bank made relatively lower allocations for NPA provisioning in the quarter. Although this has helped the bank in improving its bottomline performance, net NPA to advances ratio rose to 1.2%, from 1% at the end of FY04. This outlines the bank’s concerns about showing a better bottomline picture at the cost of sacrificing the asset quality to an extent. However, in all fairness, the bank’s net NPA levels are still amongst the best in the industry.
With the government relaxing the norms for foreign equity holding in private banks, HSBC’s stake in UTI calls for an upward revision. According to the revised guidelines, foreign banks would be allowed to acquire up to 10% equity per year in a private bank and steadily take over the bank in three to four years. But it is not clear whether the transition will be as smooth as it sounds. As a prudent approach, to improve its valuations, the bank needs to tighten its lending norms and also keep a substantial margin on the loan amount, particularly in light of the inflationary environment.
Notwithstanding the slippage in the asset quality, the bank surely has the potential of improving on its operational performance. This can be substantiated by the fact that its core fee-based income has risen by 90% YoY in the September quarter. Also, falling cost of deposits (mainly due to rising proportion of demand deposits), have helped the bank improve further upon its net interest income and consequently its net interest margins (cost of funds declined to 4.7% in 2QFY05 compared to 5.7% in 2QFY04).
At the current price of Rs 178, the stock is trading at a price to book value of 3 times its FY05 expected numbers. Now, while valuations are among the top end of the spectrum, indicating that some part of the expected HSBC led positive is already in the price, we believe that the long-term future of the bank looks enthusing.