>INDIA BANKS: Socialistic attitude of Govt and regulators add to woes (MACQUARIE RESEARCH)

■ Structural de-rating – return ratios to come down sharply
The eternal long-term optimism on Indian banks in our view is unfounded. What gets neglected is the structurally lower growth, rising opacity of the quality of book thanks to restructuring, grossly under-provisioned state relative to regional peers and increasing burden in the form of priority sector/financial inclusion norms all of which is going to exert pressure on earnings and return ratios over the longer term. Leverage ratio is likely to be structurally lower due to Basel III implementation and we expect a deluge of equity capital raising over the next five years. Our earnings are ~15% below consensus for FY13E/FY14E and we expect ROEs to come down from 18.1% in FY11 to 15.7% by FY14E. Our ROEs are around 300bps lower than consensus for PSU banks. HDFC Bank is the only Outperform in banks. Top Underperforms are PNB and SBI.


■ Gearing up for Basel III: Flood of capital raising in next 5yrs
As banks gear up for Basel III beginning 1stJan’2013 to achieve a common equity ratio of 8% and a CAR of 11.5% over the next five years, assuming an 18% CAGR of loan growth, we expect the banking system in India to raise a minimum of US$30bn of equity capital, posing significant dilution risk. Capital required is more for growth than meeting solvency requirements.


■ Socialistic attitude of Govt and regulators add to woes
We believe the socialistic mindset of regulators as well as the government is going to exert more pressure on bank profitability. What is good for customers is not necessarily good for shareholders. The tougher priority sector guidelines, financial inclusion targets and a possible farm loan waiver over the next few years are only going to worsen profitability dynamics. Our analysis suggests that the revised priority sector guidelines could impact margins by c.30bps for private sector banks on a ceterus paribus basis.


■ Asset quality – the pain hasn’t disappeared
While the government announcements with respect to greater coal supplies to power projects do improve sentiment, their track record of implementation leaves much to be desired. Nevertheless pains with respect to gas based power projects and power projects where PPAs are fixed at low prices will continue to face stress as renegotiation of PPAs is unlikely. Our analysis of independent power projects (IPPs) suggests that close to 23,000MW of power projects or 16% of power exposure of banks could be at risk of restructuring or default. Another 10–15% could be contributed by SEBs. NPLs/restructuring related to SMEs, export
oriented sectors etc are unlikely to significantly abate. We are very worried over the moral hazard issue in the agriculture sector. Our worry is also on the underprovisioned state of Indian banks. We expect stressed assets, defined as net NPLs plus restructured assets, to net-worth ratio for the system to increase to a ten-year high of 57% (90% for PSU banks) by FY13. NPL coverage on stressed assets stands at a dismal sub 40% vs. regional peers averaging at 150% plus.


■ Valuations – where is the comfort?
Stocks currently are trading above ten-year historical averages on the back of an opaque book which is grossly inflated thanks to restructuring. The 20% re-rating from the recent lows more than adequately factors a ~100bps cut in benchmark rates and aggressive rate cuts are unlikely considering the fiscal and inflation
dynamics.


To read full report: INDIA BANKS
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