>GLOBAL LIQUIDITY: Opportunity in adversity? (ESPIRITO SANTO)

Given liquidity pressures and heightened capital requirements, EU banks are reducing exposure to Asia, including India, creating an opportunity for Indian banks to capitalise on. Our top plays on this being Bank of Baroda and SBI. Moreover, in a year with a $5.2bn wall of FCCB redemptions, we think there are likely to be opportunities appearing from FCCB mispricing. The FCCB’s of companies such as Educomp, Rolta and Suzlon look like interesting opportunities.


The objective
The stage is set for another round of liquidity infusion by the major global central banks, at a time when domestically bank credit growth is showing signs of significant moderation (16% YoY vs. 24% last year). This note analyses the extent to which changes in global liquidity have impacted the availability of resources to the domestic commercial sector, especially at a time when a) European banks are expected to deleverage ahead of the EBA core Tier 1 capital requirement and b) huge FCCB refinancing/restructuring needs have arisen for Indian corporates.


The impact of EU banks deleveraging on Asia
Continental European (ex UK) banks account for approximately USD 70bn of0 bank claims in India, and if including the UK, then European banks in total account for 45% of the total claims on India. While no significant deleveraging was noted by the UK in Q3’11, other European banks have reduced exposure by USD 5bn from Q1’11 to Q3’11. Given their robust liquidity and capital and strong presence in Asia, both HSBC (Buy) and Standard Chartered (Buy) are well positioned to capitalize on the deleveraging of European banks, as our banking analyst Shailesh Raikundlia explains in his report of 6 February 2012: “HSBC, Standard Chartered: Opportunities in Adversity”.


Indian banks exposed to this opportunity
We think PSU Banks are best placed to gain access to critical dollar funding to exploit this opportunity given quasi sovereign guarantees. Among the PSU banks under our coverage we recommend Bank of Baroda (BOB IN, BUY) as our top pick to play this theme, given its international loan book constitutes 26% of advances, and its 15% QoQ international growth in Q3FY12. Our second choice to play this theme would be State Bank of India (SBIN IN, BUY), with its international loan book of Rs. 1.3tn.


Is India facing a foreign funding crunch?
The data suggests that despite fears of a contraction in foreign funding, actually foreign funding (notably ECBs and FDI) has played an important role at a time when domestic sources have contracted. The biggest test this year in terms of foreign funding of corporate India will be the USD 5.2bn of Indian FCCB redemption coming up, pretty much all of them underwater, so requiring restructuring, refinancing or replacement with other forms of borrowing, such as
ECBs.


How much risk do the FCCB redemptions pose?
Whilst the FCCB redemptions pose a challenge, the fears around the issue means that opportunities are likely to arise in FCCB mispricing. We review examples from historical price/yield movements of these instruments and present FCCBs of companies that provide high YTMs (yield to maturity), as well as relative safety of principal.


The FCCBs of companies such as Educomp, Rolta look like interesting opportunities to us, and even the Suzlon situation with multiple tranches on very high YTMs is worth us monitoring. First Source, Tulip IT, REI Agro, Jaiprakash Power, Videocon Ind., Sintex, JP Associates, Welspun Gujarat, Bharat Forge are all trading at high YTMs with relatively low probability of default given leverage, higher interest coverage and respectable credit ratings implying easier
access to international and domestic funds. We think GTL Infra and Suzlon look like candidates for restructuring with haircuts, and 3i Infotech looks to us to be the most likely candidate for default given its weak core business.


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