>Indian Financial Sector (GLOBAL MARKET RESEARCH)

Fundamental, Industry, Thematic, Thought-leading
Deutsche Bank Company Research's Investment Policy Committee has deemed this work FITT for investors seeking differentiated ideas. While credit quality risks in Indian banks are undoubtedly on the rise, we remain below-consensus on the extent of the likely NPL increase. Our analyses suggest that stock prices now offer compelling selective investment opportunity across the India financial sector. This includes paired or hedged ideas as the credit quality impact is likely to be materially different across the sector.

Fundamental: Strong headwinds, but corporate preparedness generally high We estimate our coverage universe will report a ~50% increase in NPLs in year to Mar’10E over Mar’09E. This is significantly lower than consensus that expects closer to a doubling in NPLs. Sharp credit controls and portfolio seasoning should result in NPLs peaking sooner and less severely than most think. We also derive comfort from sizeable unrealized gains, lesser global dependence of the economy, comparatively modest GDP deceleration and subsequent lower risk of job losses.

Industry: Favourable regulatory regime, but transparency risk increases Institutional frameworks such as the foreclosure law work not just as postdelinquency tools, but also as a deterrent to willful defaults. Prudential exposure guidelines and transition to Basel II function as effective self-control mechanisms. We are concerned, however, that aggressive bank restructuring – an otherwise necessary and positive trend – could make bank balance sheets more opaque and evoke investor skepticism over reported NPLs.

Thematic: Sensitivity analysis reveals primacy of private banks Detailed scenario analyses of rising NPL conditions reveal that private sector banks hold a clear advantage over PSU banks and underscore the importance of adequate capitalization levels. Valuation analysis suggests that the market has already priced in 50% higher than our increased NPL estimates, with many banks now trading at valuations closer to periods when NPLs were 3-4x higher.

Thought leading: Rising default risks but retail seasoning data positive Our detailed analysis of corporate India’s conventional default risk indicator ratios, Altman Z scores across sectors and Merton’s methodology indicate rising default probabilities in general with expectedly greater degree of stress in export-oriented sectors. We conclude that the ‘tail risk’ is still increasing, but our seasoning analysis also reveals lesser-known, positive aspects of retail loans.

To see full report: INDIAN FINANCIAL SECTOR