>BANKS - RETAIL - INDIA (MERRIL LYNCH)

■ 3QFY10 earnings ahead of est. driven by topline and low credit costs (disappointment)
3QFY10 results, on average, were ahead of expectations led by stronger topline and lower credit costs (disappointing aspect). Topline driven by margin expansion (though down yoy) and loan growth (finally getting there). Govt. banks loan growth at 14- 24%, led by SBI, PNB and BOB. Private banks were a mixed bag; ICICI Bank still showing +15% contraction, while HDFC Bank’s loans grew 21% yoy; Axis Bk only at 12% yoy. Trading profits, while lower qoq, ahead of our est. at 8-20% of PBT. NPL’s continue to rise qoq; but NPL accretion lower qoq (key comfort). NPL recognition from agri debt scheme was key difference. Low credit costs and NPL cover (incl. SBI) key disappointment. Core earnings up 9-10% yoy v/s negative in 2Q.

3QFY10: Core ‘+ve’ surprise, lower credit costs a concern

■ Rising LDRs and expanding margins a big positive; Fees was the silver lining
Banks across the board have seen LDRs rise and margins expand (qoq), helping drive topline growth. Incremental LDR (YTD) is est. at +70-200% for most banks.

■ Future outlook: Margins to expand; LDR set to rise
Margins are likely to expand sequentially owing to a) Rising LDR that would allow banks to re-deploy their lower yielding Gsecs towards loans; and b) Some more re-pricing of their high cost deposits. The LDR will rise owing to a pick up in credit driven by greater infra lending; visible pick up in housing and vehicle loans and due to the cyclicality of the economy (30-40% of all loans are disbursed in 4Q of any fiscal). Hence, core earnings should see further improvement in the 4Q.

■ Buy ICICI Bk, HDFC Bk, SBI and PNB; OBC – preferred small-cap pick
Post results, ICICI Bk appears better positioned delivering across key variables (Credit quality, Costs, Capital, Credit) and still likely to see margin expansion (having raised low cost funds) and likely to grow loans at 20% and FY11 earnings at +30%. SBI, while facing NPL provision headwinds still likely to grow earnings at 20% on rising loan growth. HDFC Bk may end the year with highest growth. Amongst govt. banks (ex-SBI), PNB, OBC, BOB had best results. BOI and UBI lagged.

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