>An Indian Bank Analyst In China (CITI)

■ Industry Structure — We recently attended Citi’s China Financial Tour, to compare the banking industry structures. We expect these to be increasingly benchmarked together given strong growth potential, dominating role of financial systems, and converging valuations. While there is a lot in common, key structural differences are: a) Size: China is 8.5x of India in loans; b) Penetration: 121% loan/GDP in China (India 54%); c) Loan growth: China 30% in 2009 vs. 17%; d) Competition: Fewer scale banks in China; e) Regulations: More protection in China vs. India.

■ Operating Fundamentals — Fundamentally, return profiles in both countries are relatively similar (ROAs of 1-1.2%, ROEs – 18-20%); details though are different: a) NIMs: implicitly protected in China (controlled lending and deposit rates); b) Loan composition: China banks are mainly corporate focused and concentrated in fewer sectors/SOEs; c) Funding: deposits dominate for both, higher demand deposits in China; and d) Leverage: slightly higher asset/equity for China.

■ Valuations — There has been a convergence in valuations of Indian PSU banks and Chinese banks recently (China 1.8x, India 1.5x P/BV): a) Historically, Chinese banks trade at premiums to Indian PSUs (Mean: 2.1x vs 1.2x for India); b) Key reasons for premiums: protected NIMs/profitability, greater industry concentration (top 4 banks: 78% of listed market cap vs. 56% for India), implicit government backstop on asset quality; c) Valuations (P/BV) for Indian PSUs have been more stable than Chinese banks (China – Max: 4.0x, Min: 1.2; India PSUs – 1.8x, 0.6x).

■ Industry Cycles — India and China banks are at opposite ends of the cycle: a) Loan growth, ROEs: India at lower end of historical range (trending up) vs. China at the higher end (trending down); b) Valuations: Indian PSU banks trading at 1SD above mean, China banks at 0.6 SD below; and c) Chinese banks at a similar stage to India banks in Mar09. Citi’s regional banks analyst Simon Ho is overweight China banks and neutral on India; our India strategist Aditya Narain is overweight banks in his India portfolio.

To read the full report: INDIA BANKS