Monday, October 12, 2009


Modest headline masks earning quality revival

After a sequential decline for the last two quarters, net interest income (NII) of banks is likely to improve modestly in 2QFY10, as loan spreads expand due to liability repricing and low incremental funding costs. However, high balance sheet liquidity will limit net interest margin (NIM) expansion. Headline earnings growth may take a breather after a stellar ride in the last three quarters, as tailwinds from capital gains and provision write-backs receded. We do not expect any surprises on asset quality news, with bulk of the restructuring completed in 1QFY10, except for some corporate debt restructuring (CDR) cases. Our top result picks are Axis Bank, Yes Bank and SBI.

Industry trends: Credit demand woes continue
Credit offtake continues to be subdued, coupled with ample liquidity in the financial system puts pressure on credit-deposit (CD) ratio. However, it is interesting to note that the incremental CD ratio has improved in 2QFY10 more as a function of slowing deposit accretion than higher credit growth. Subdued CD ratio has put pressure on pricing power, especially at the short end. Rate competition continues particularly in retail loan segments. However, the steep decline in lending yields witnessed in the last two quarters would be restricted as only few banks have lowered their PLR during 2QFY10.

Signs of improvement in earnings quality
2QFY10 headline profits for banks in our coverage universe are likely to increase 4% sequentially; YoY growth is expected to be 12%—slower than the run rate of 40% over the last three quarters. However, quality of earnings is likely to improve as expansion in loan spreads will drive a 6% sequential pick-up in NII after witnessing a decline in the last two quarters. Margin expansion will be modest as CD ratios have remained subdued. Earnings quality is expected to improve as dependence on capital gains and provision write-backs decline. Sectoral averages hide substantial difference in sequential earnings growth trajectory for private and public sector undertaking (PSU) banks. Boosted by margin expansion on account of liability repricing, continued low incremental funding costs and calibrated growth strategy, private banks should report healthy 11% QoQ PAT growth; PSU banks’ sequential PAT growth will likely be more modest at 1%.

Asset quality: No surprises expected
With a large part of restructuring completed in 1QFY10, we do not anticipate any negative surprises on asset quality, except for some CDR cases. Retail delinquencies across private banks are close to their peak and are expected to trend down 3QFY10 onwards.

To see full report: BANK EARNINGS PREVIEW