>STATE BANK OF INDIA (MERRILL LYNCH)

■ Operating earnings in line; asset quality disappoints
SBI’s 2QFY10 earnings at Rs24.9bn, up 10.2% yoy, were about 3-4% below estimates owing to slightly weak (2% yoy) topline. The bigger disappointment was the 3-fold jump qoq in NPL formation (~Rs50bn). Operationally, margins were up 25bps qoq, CASA rose to 41% and loan growth was at 16.4% yoy. Further, SBI has made the necessary wage provisions. Hence, it appears well positioned to show strong operational growth in ensuing quarters; NPL is the key challenge. Maintain Buy and PO of Rs2575 given core RoE of 19% and our SOTP at Rs693.

■ NPL formation up 3x qoq; but likely to have peaked
SBI’s 2QFY10 topline was weak owing to the sustained flow of deposits (up 25% yoy) despite rate cuts. LDR has begun to rise now due to infra and mortgage loans. Fee growth strong at +50%, driven partly due to surge in forex. NPL accretion due to overseas (15% of new NPLs) due to FDIC norms, rural (drought) and SME. SBI, however, confident that NPL formation has peaked and gross NPL’s to be greater than 3% of loans by year end (3% as of Sep’09).

■ Earnings cut by 4-5%; to still grow +14-15%; RoE at 16-17%
We have cut our earnings by 4-5% to capture weaker topline and higher credit costs. Still foresee earnings growth of 14% in FY10 and +22% in FY11. RoEs est. at 18% in FY11. We are building in NPL formation at Rs135bn (Rs67bn in H1) and gross NPL’s at 3.2% of loans; net at 1.7%. Maintain value of SOTP (assoc. banks, life insurance and asset mgmt) at Rs693/shr. Upside to SOTP, as assoc. banks have done better than est. and life ins. also showing better profitability.

To read the full report: SBI