>BANKING SECTOR (SYSTEMATIX RESEARCH)

Valuations to catch up with improving sector fundamentals……

We attribute an ‘ATTRACTIVE’ rating to the banking sector on the FY11 estimates as the Banking Sector is believed to be among the key benefactors to gain from the reviving economy. Earnings visibility of the sector has improved with superior outlook on credit, margins and asset quality of the banks. BSE BANKEX has registered 130% returns over the last 5 months, we however believe that the sector offers an upside as valuations are still 30‐40% lower from the peak valuations. An upward revision in earnings and expansion in valuations multiples is expected to underpin the stock prices further. In our view, the sector deserves better valuation multiples than assigned by the market currently.

Banks not to suffer large MTM hits in FY10 as most of them are hedged till 7.5‐8% yield
In our view, interest rates would remain in the range of 7‐7.3% levels in FY10.They are likely to inch upwards by 50‐100 bps from the fiscal year end FY10 in line with improvement in the business cycle, reversal of expansionary monetary policy, and rise in inflation. Banks, being hedged till 7.5‐8% yield, won’t suffer large MTM hits on their AFS book in the current fiscal, even if yields rises to the said rates. Going ahead, in our view, markets would assign better valuations multiples to the banks which are able to post sustainable earnings and are less volatile in nature.

Credit growth – momentum towards the year end
We expect the sectoral credit to grow at a healthy rate of 19‐20% in FY2010E assuming that GDP grows by 6%. We expect credit demand to rise in both the working and the term loans segment. CMIE data shows that the corporates have made investments into capacities of more than 5 trillion which translates into the credit growth of 18% from the industrial segment alone (whose share in the total credit is at 38%). We expect demand for the working capital loans to gain momentum with the upward movement in the commodity cycle and reversal in the economy.

Margins, which are at cyclical low levels currently are expected to improve
Q1FY10 margins across the sector have dropped which is a peculiar feature of the downward movement of interest rate cycle. In this cycle, margins get affected in the near term (3‐6 months) but they show signs of recovery as soon as liabilities start getting re‐priced. We are currently at the beginning of the phase where margins across the sector are expected to improve. An uptick in the credit demand will give the required pricing power to banks thereby capping the fall in their advances yields which would cushion the bank’s margins further.

Economic recovery to reduce NPA concerns
Over the last one year, with the economy entering the slower growth phase there have been looming concerns on astounding higher NPAs levels of banks. The concerns had triggered abrupt sector downgrades. In our view, economic growth would overturn to a recovery phase in the current fiscal which would narrow the NPA concerns to a large extent. Faster the economy recovery, shorter would be NPA cycle. The Q1FY10 performance of the assets which were restructured in Q4FY09 was encouraging as an insignificant amount of assets restructured under the special RBI dispensation slipped during Q1FY10

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