Sunday, June 21, 2009


Higher loan growth, lower NPL’s to sustain re-rating

Sector re-rating to sustain on growth, reforms
We expect the banking sector re-rating, already underway, to sustain owing to a) higher than estimated loan growth at 16.5% in FY10 and +20% in FY11 driven by our GDP upgrade (by Indranil Sen Gupta, our India economist) to 6.3%, greater focus on infra spend; b) easing rates and less likelihood of spike in bond yields as govt. pursues divestment (making it easier to fund the fiscal deficit); c) easing concerns on asset quality with NPL formation levels peaking at a lower level (though NPL’s will rise and remain the key challenge); and d) progress on reforms incl. insurance, with higher visibility on banks’ monetizing their stakes.

Raising PO’s on higher ROEs; Upgrading Axis, Fed to Neutral
We are raising our PO’s across banks to capture i) the sector re-rating due to the expected improvement in macro; ii) roll forward of our estimates to FY11; iii) capturing higher RoE’s due to higher growth and lower credit costs; and iv) rerating of equity related biz. like insurance and asset management for banks that have stakes in these biz. Re-rating accounts for 40-60% of the PO upgrade. We are also upgrading Axis and Federal Bank to Neutral owing to easing of NPL
concerns. But given the sharp run up, we refrain from taking them to a Buy.

ICICI Bank, HDFC – Preferred picks in large caps
ICICI Bank remains our top pick in the sector as it remains a key beneficiary of easing rates, less vulnerable to rising NPL’s (even though concerns are easing), benefits from re-rating of its equity related biz. (insurance and asset management) and positive risk return trade off. HDFC is the other stock we like (despite being expensive) as it is a key beneficiary of the likely uptick in mortgage lending, good asset quality and also offers a play on HDFC Bank and insurance and asset mgmt. SBI, while offering a positive risk return (1.2x FY11 book for subs; 17% ROE) is behind ICICI and HDFC owing to near term margin and NPL issues.

Govt. banks (like PNB, BOI) can provide +30% upside
The bigger upside, may, however, come from some of the govt. banks (ex-SBI) that could offer much better value, trading at 1.1-1.3x FY11 adj. book with RoE’s of +20%. The key triggers would be higher growth and rising comfort on asset quality. Key risks remain the rise in bond yields (that we hope will not spike). In particular, we like PNB and BOI (+30-35% upside) followed by UBI. Indian BK is our preferred small cap pick (+40% upside). These banks are also better placed
on asset quality, amongst govt. banks.

To see full report: BANKS-RETAIL