>Draft guidelines on base rate: Impact on banks (CRISIL)

The RBI has come out with a draft circular on the base rate, which is expected to substitute the current Benchmark Prime Lending Rate (BPLR) system with effect from April 1, 2010. The base rate would act as a minimum rate for all commercial loans, including loans up to Rs 2 lakhs where the BPLR currently acts as the ceiling rate.

CRISIL Research estimates the base rate for majority of the banks to be in the range of 8.0 to 9.5 per cent. Moving to a base rate system would increase transparency in lending rates. However, if the base rate were to become the minimum rate for all commercial loans, it would adversely affect the bank’s ability to extend short-term funding to large corporates.

The Reserve Bank of India has released a draft circular on the base rate, which is expected to substitute the current Benchmark Prime Lending Rate (BPLR) system with effect from April 1, 2010. Although final guidelines in this regard are awaited, the draft circular provides broad contours of the new base rate system.

Salient features of the base rate system:
1. The base rate system will replace the BPLR system from April 1, 2010 onwards.
2. Criteria for determining the base rate -

• Cost of deposits
• Adjustment for negative carry in cash reserve ratio (CRR) and statutory liquidity ratio (SLR)
• Unallocatable overhead cost for banks such as aggregate employee compensation relating to administrative functions in corporate offices, directors’ and auditors’ fees, legal and premises expenses, depreciation, cost of printing and stationery, expenses incurred on communication and advertising, IT spending, cost incurred towards deposit insurance
• Profit margin

3. The base rate will act as minimum rate for all commercial loans, including loans up to Rs 2 lakhs where the
BPLR currently acts as the ceiling rate.
4. Actual rate charged to borrowers would be the base rate plus borrower-specific charges, which will include
product specific operating costs, credit risk premium and tenor premium.
5. Base rate to be the reference rate, henceforth, for all new loans and for loans coming up for renewal. The
existing borrower could also shift to the new system on a mutually agreed rate structure between the borrower and the bank. Moreover, the base rate could act as a benchmark for floating rate loans.
6. Interest rates for Differential Rate of Interest (DRI) scheme loans will continue to be fixed without reference
to the base rate. RBI will separately announce the stipulation for export credit.
7. Banks would be required to exhibit information on base rate at all branches and post it on their respective
websites as well.

Impact on banks
CRISIL Research estimates the base rate for majority of banks to be in the range of 8.0 to 9.5 per cent. As of March 2009, around 67 per cent of outstanding advances by scheduled commercial banks (SCBs) were at sub-BPLR. Moving to a base rate system would increase transparency in lending rates. However, if the base rate were to become the minimum rate for all commercial loans, it would adversely affect the bank’s ability of extending short-term funding to large corporates. Currently, banks, saddled with surplus liquidity and lack of avenues to deploy funds, have been providing short-term loans to large corporates (with healthy credit profile) at rates as low as 5.5 to 6.0 per cent. Moving to the proposed base rate system would make it impossible for banks to provide loans at these rates, which, consequently, would lead to corporates considering alternative sources.

Background
A working group, under the chairmanship of Deepak Mohanty, was constituted to examine the lending rate practices of banks and subsequently, submit its recommendations on the same. The RBI’s guidelines (announced approximately 4 months later) are broadly in line with the recommendations of the working group.

The RBI, concerned about the sub-BPLR pricing of commercial loans by banks in India and the wide divergence in BPLRs of major banks, had constituted the working group to review the BPLR system and suggest changes to introduce greater transparency in credit pricing.

The working group was assigned to review and provide suggestions on the following:
1. Extent of sub-BPLR lending and reasons for the same
2. Wide divergence in BPLRs of major banks
3. An appropriate loan pricing system for banks
4. Administered lending rates for small loans up to Rs 2 lakh and for loans extended to exporters
5. Suitable benchmarks for floating rate loans in the retail segment
6. Consideration of any other issues relating to lending rates of banks

To read the full report: BPLR

>Global Steel 2010 (RBS)

We attended the Global Steel conference hosted by Gujarat NRE and The Economic Times last week at Goa. Various industry reps and analysts spoke about steel demand in India, the raw material pricing environment and the way forward for steelmakers. We sum up conference highlights here.

■ Near consensus on domestic expansion story
Speakers at Global Steel 2010 cited the 2020 steel-capacity projections of various agencies that ranged from 110mt to 293mt. However, there was near consensus on the strong growth expected over the next two to three years, as a result of expected strong demand backed by the current low per capita steel consumption and access to cheap raw materials. Potential negatives were land-acquisition delays, infrastructure bottlenecks and a lack of adequate coking coal resources domestically. Despite the strong resilience of domestic steel markets, versus world markets that are in the doldrums, speakers believed domestic steel players had recently missed a big opportunity to improve backward integration levels, due to their overleveraged balance sheets. For example, Sesa Goa was sold to a non-steelmaker and

■ Dempo was sold to Sesa Goa.
More analysts bullish on coking coal; times to get tough for non-integrated producers Most speakers and analysts appeared more bullish about coking coal than iron ore in the long term. They expected iron ore prices to peak next year and coking coal prices to remain high for a sustained period due to the poor prospects of existing finds delivering the desired coal on time. On the other hand, they expected scrap prices to continue to be volatile. We also see a need to increase exploration and discovery of new coking coal assets.

■ Our view: positive near term; repetition of 2008 likely if steel demand recovery slips
We expect steel prices to spike over the next two to three months, aided by strong seasonal factors that should almost entirely flow through to the bottom line. However, we expect the real challenges to begin after July-August, as steelmakers exhaust their low-priced iron ore and coking coal supplies. Current spot prices of iron ore and coking coal are more than 80% higher than contract prices, indicating significant price increases for FY11 raw material contracts. Based on historical movements, the market expects steel stocks to follow the direction of profitability and outperform up to June-July. However, after that period, it expects stocks to underperform depending on the strength of the economic recovery.

To read the full report: GLOBAL STEEL

>AIRLINES - INDIA (MERRILL LYNCH)

■ Strong traffic growth despite fog
Indian airline passenger traffic came in at 4.1 mn passengers for the month of Jan’2010 showing a strong 22.6% YoY growth broadly in line with our view. We expect Industry to show ~15% growth for FY10. Industry traffic witnessed a sequential decline of 9% in Jan’10 on account of (a) seasonality with December being the peak holiday season, and (b) cancellations due to poor weather conditions prevalent in the northern India. Seat factors for most airlines also showed a sequential decline for the same reason.

Strong traffic growth yet again

■ Jet’s loss of market share due to poor weather conditions
Jet along with JetLite was the most affected airline due to the poor weather conditions. JetLite had the highest cancellation rate of 12.6% followed by Jet at 9.2%. This has resulted in loss of market-share for Jet (including JetLite) by 1%. However, despite this one-time loss of traffic Jet Airways will be able to achieve our estimated 8.3mn passengers for FY10 showing a modest growth of ~5%.

■ Demand supply growth rates remain favorable
In January’10, supply (ASKMs) increased by ~7% YoY while demand (RPKMs) increased by ~25% YoY. With most carriers maintaining fleet over next 12 mths, improving demand trends will continue to keep the demand-supply gap favorable. This strong demand has enabled the carriers to maintain good yields even after the peak holiday season as pricing power has returned to the carriers.

■ February expected to be strong as well
Seasonally February is a weak month for the airline traffic. However, based on our interactions with the management of the carriers on the demand situation, we expect February to be strong as well. This coupled with the current softening of crude prices would enable the industry including Jet Airways to post strong numbers for the month of February as well.

To read the full report: AIRLINES - INDIA

>HERITAGE FOODS (INDIA) LIMITED (FIRST CALL)

• Heritage Group is one of the fastest growing Private Sector Enterprises in India, with three-business division’s viz., Dairy, Retail and Agri under its flagship Company Heritage Foods (India) Limited (HFIL).

• Heritage is now become the ISO 22000 certified company by maintaining international quality Standards.

• Heritage’s milk products have market presence in Andhra Pradesh, Karnataka, Kerala, Tamil Nadu and
Maharashtra and its retail stores across Bangalore, Chennai and Hyderabad.

• The Board of Directors of the Company has allotted 8,00,000 warrants of the Company on preferential allotment basis to the promoter.

• Net sales of the company are expected to grow at a CAGR of 19% over 2008 to 2011E.

To read the full report: HERITAGE FOODS

>LARSEN & TOUBRO (MERRILL LYNCH)

■ Stands by its guidance
L&T reiterated 25%yoy sales growth target for 4QFY10E as all the key reasons of miss in 3Q execution reverse such as a) financial closure of its own five toll roads with backlog of ~50bn, b) opening of work fronts and c) receipt of delayed orders.

■ Finance could be first of the block for monitization
L&T’s finance subsidiaries are maturing well and registering good growth and margins. L&T Finance is in the equipment finance business and is likely to be the first subsidiary to be monetized through a listing. L&T Infrastructure Finance is involved in project financing and is growing at a rate of 30-40% annually. Company has asset size of Rs38bn and leverage of 4.5-5x which management believes to be conservative.

■ Shift in portfolio to support long term margins
L&T derives 75% of its revenues from E&C business and 25% from the manufacturing and services business. Company’s long term strategy is to increase the share of manufacturing and services revenues to 40%. Margins in company’s E&C projects business are 2-3% lower than those in the manufacturing and services businesses. Shifting of the mix in favor of manufacturing and services would help the company improve it margin profile.

■ Power business could impact margins near term
L&T said margins are expected to be lower for super critical plants. Power business is expected to hurt overall margins till the ramp up has been achieved.

To read the full report: LARSEN & TOUBRO