>AXIS BANK (MORGAN STANLEY)

F1Q2010 – Treasury Drives Earnings; Remain UW

■ Axis Bank’s strong F1Q10 earnings were entirely driven by treasury: If we look at core earnings, they were weak. Volumes were down, NIMs were sluggish, fees were weak, and costs remained high. As a result, normalized earnings were under pressure. On our calculations, normalized earnings were around half of reported (adjusted for trading gains, write-backs and 10% provision on restructured loans), implying that the bank made single-digit normalized ROE in the quarter. Our view has been that the moment volume progression slows, earnings progression will decelerate, which appears to be happening.

■ Asset quality is under pressure: Despite the bank taking significant NPL provisioning, the coverage amount reduced, implying high charge-offs and a high level of new delinquencies. On our calculations, about 1.8% of loans are becoming NPLs annually. This is without accounting for the sharp spike in restructured loans. Including restructured loans, asset quality deterioration has intensified. The coverage for the bank on total impaired loans is about 20%.

■ Segmental earnings present little comfort: On segmental earnings, the bank made a loss on the retail banking business. The only segment that did well was treasury, which contributed about 50% of earnings. If we look at just trading gains, they were about 38% of PBT, suggesting earnings quality was weak.

■ Valuations are stretched, in our view: The stock is trading at 15x F10E earnings and 2.3x book. Moreover, core profitability is similar to the earnings profile at SOE banks. We believe that we can get better risk reward at SOE banks (trading at 5-6x PE and sub or around 1x book). We maintain UW.

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