Tuesday, January 19, 2010


For better or for worse
As the deepest economic and financial crisis developed economies have experienced since 1929 is drawing to a close, the review of the year cannot be limited to the unhoped-for performances posted in all markets. Of course, a systemic crisis has been avoided, thanks to the coordinated actions of governments and central banks.

Governments, first, provided the required guarantees to the banking sector to lift the mistrust prevailing in the interbank market until March, and, second, supported the real sphere that started to be hit head-on by the effects of the recession. Central banks succeeded in unblocking the funding of financial institutions, while trying to outdo each other in innovative measures.

2009 was the perfect illustration of the fickle nature of the markets. While the worst level was reached end-March in terms of valuation of risky assets, the first signs of cyclical improvement were interpreted as the signal of an incipient rally. Initially, there was talk about a bear rally, but then a downright bullish trend took root in all equity markets, while volumes were, however, limited at the outset. Once it was clear that the bottom had been reached, most investors returned to the equity markets, not wanting to "miss the rally", even though uncertainties hovered over the future of this asset class only one year ago. The market went from a regime of total risk aversion to one of almost unlimited appetite! That obviously does not justify talking about “irrational exuberance" again...

In the wake of the surprising year that was 2009, we will single out two themes that we will have to face in 2010: - Concerning the characterisation of the end of the crisis (V,
W, L, etc.), the market has settled for the V. However, what can the level of activity be in developed countries once the government stimulus packages have been spent? Whereas economic agents show a real determination to deleverage, is it possible to rely on China and emerging countries to drive global growth?

- The recession has technically been over for several months, but it has left two significant macroeconomic imbalances in its aftermath. First, central banks' balance sheets have reached stratospheric levels, as they are pumping overabundant liquidity into all markets. Mopping up this liquidity and the first normalisations of key rates will be tricky exercises. Second, governments ended the year with huge fiscal deficits likely to penalise bond markets somewhat more, or even resulting in risks of sovereign defaults.

Macroeconomic context: Paradigm shift in the United States, resilience in Asia
The recession was far stronger than expected. While we expected, according to the region, a stagnation at best, if not a fall in activity, the reality proved to be far worse: according to our estimates, global economic growth (Chart 1 - economic situation section) declined in 2009 by 2.5% (-1.3% in PPP). This deterioration is explained by: (i) the fall - or even a halt - in international trade (Chart 2); (ii) the halt in credit at the
beginning of the year, whether due to the determination of private agents having to deleverage (Chart 3) or banks facing funding problems; (iii) the continued drop in investment, especially in real estate in most OECD countries (Chart 4). The Asia zone (China and emerging Asia, Chart 5) stood out in particular, posting positive growth in 2009.

Thus, US GDP dropped by 6.4% in the first quarter (in annualised Q/Q terms). At the peak of the crisis, the US economy destroyed in excess of 740,000 jobs in one month.
The reason why the move was particularly marked in the United States was because the crisis put an end to the debt economy. Households should prove to be far more cautious in the future, bringing their consumption to levels more in line with the fundamentals. The reason is that the outlook for households has been ruined by the wealth shock caused by the crisis (financial and real estate, Chart 6) and the recession, which is accompanied by a sharp and long-lasting deterioration in the labour market (Chart 7). As a corollary, the savings rate reached 4.7% at year-end. We have to go back to before 1998 to find such a high level (Chart 8)!

In the United States, the favourable counter-cyclical factors such as fiscal stimulus (USD 270 bn spent in fiscal year 2009), the expansionary monetary policy (see below) and disinflation nevertheless enabled the US economy to enjoy renewed growth from the second half. Technically, the end of the recession was confirmed in Q3-2009, thanks to a rebound in residential investment (+23.4% at an annualised pace) and consumption (+3.4% at an annualised pace). Companies also contributed to this recovery (lower destocking, slight rise in productive investment). This development remains to a large extent accounted for by the fiscal stimulus: the slowdown in wages is for the time being more than offset by the various transfers to individuals (car-scrapping incentives, tax credits, etc.).

To read the full report: FINANCIAL MARKETS


Axis Bank’s Q3FY10 results surprised positively – net profits rose an impressive 31% YoY propped by 45% YoY NII rise and 35% YoY surge in other income, despite tepid advances growth at 12.5% YoY. Expansion-related costs pushed up overall operating expenses 28% YoY. Cost-to-income at 41.2% was stable QoQ and declined 408bps YoY. Asset quality was healthy with GNPAs and NNPAs at 1.23% and 0.46% respectively. Restructured accounts were at Rs23.1bn or 2.42% of gross advances (2.53% in Q2FY10). We raise FY11E earnings 7.4% to factor in higher-than-expected margin and lower FY11 loan-loss provision. We raise our target price to Rs1,228/share based on 2.7x FY11E BV (implying 16.6x FY11E EPS). Maintain BUY. Sluggish credit growth and NPL rise are the key risks.

Firm on its axis

Margins rise even as credit growth remains tepid. Subdued 12.5% YoY credit growth in Q3FY10 was a result of just 4% YoY corporate credit growth. Deposits grew 7.7% YoY with large-scale deposit repricing and strong accretion to CASA, which in turn led to 46% CASA ratio in Q3FY10. These coupled with the effect of capital raising led to margin expanding a sharp 48bps to 4% QoQ. We expect margin to come off from ~4%, but it will likely expand 18-20bps YoY in FY10E to 3.18%, leading to 21% NII CAGR through FY11E.

Strong core fee performance; costs up. Other income grew a strong 35% YoY, led by 29% YoY rise in fee & commission income. Trading income rose 49% YoY to Rs1.7bn. Despite a sharp 28% YoY rise in operating expenses, cost-to-income was stable QoQ at 41.2% in Q3FY10. We expect FY11E cost-to-income ratio at 42-44%.

Asset quality surprises positively. GNPAs & NNPAs rose 2bps & 1bp to 1.23% & 0.46% respectively. Accretion of Rs870mn from restructured accounts in Q3FY10 led to total restructured accounts at 2.42% of gross advances (2.53% in Q2FY10). We reduce FY11E loan-loss provisions to 105bps to factor in likely lower slippages.

Earnings upgrade, maintain BUY. Axis Bank is a strong play on pick-up in corporate credit growth, which will materialise as system credit growth picks up hereon. We anticipate this to lead to stronger YoY margin expansion and healthy other income growth through FY11. We FY11E earnings 7.4% to reflect better-than anticipated margin accretion, higher other income growth and lower loan-loss provisions. We raise our target price to Rs1,228/share based on 2.7x FY11E BV (implying 16.6x FY11E EPS). Reiterate BUY. Continued sluggishness in credit growth and re-emergence of slippages are the key risks.

To read the full report: AXIS BANK


Profits in line (up 32%) but fundamentals keep getting better — 3Q10 was another strong quarter: profits grew 32% YoY (largely in line with estimates), and operationally strong too (pre-provisioning profits ex-trading gains up 35% YoY). Margins have expanded yet again (over 4.3%), loan growth appears immune from the industry slowdown (+20% YoY) and is broad-based, and asset quality trends appear to be improving decisively. In sum, HDBK is threatening to set a healthiergrowth, highly-profitable path and pull further away from the rest of the pack.

P&L: margins expand more, fee growth remains moderate, costs under control — HDBK's NIMs have expanded further to above 4.3% as its deposit franchise kicked in strongly (52% CASA, declining cost of funds) and the mid-quarter capital infusion provided support. Fee growth remains at a moderate 12% YoY (for the third successive quarter), hit by slower retail distribution fees – and could remain slow for another 1-2 quarters as the base adjusts down. Costs remain in check (flat YoY), but there are signs of acceleration as inflation likely catches up.

Balance sheet: strong, broad-based growth, lower asset risks, well capitalized — HDBK's loan growth was healthy (+5% QoQ) and broad-based (across retail, corporate). Management appears more comfortable with a high growth trajectory as asset risks appear to have peaked - delinquencies are declining across all product lines, NPLs/restructured assets are starting to reduce (NPLs down 3% QoQ) and coverage levels remain quite comfortable. Recent capital infusion (conversion of promoter's warrants) have improved HDBK's capital adequacy even further and should sustain a stronger growth path for longer.

Best placed for rising interest rates, but valuations likely cap, maintain Hold (2L) — HDBK remains looking best placed to negotiate challenges from higher policy/interest rates due to its strong deposit base, low duration bond book and l east asset risk.

To read the full report: HDFC BANK


Corporation Bank is one of the major banks of south India with a diversified business mix of 133,456 crore and 100% network connectivity of its core banking. Recently it was ranked as the Best Bank by Asset Quality by the Business Today – KPMG study and has also won awards for the “Use of technology for financial inclusion”

Key Highlights
Robust credit growth and operational efficiencies to boost profitability:
Corporation Bank’s projected credit growth at 20-22% over the period FY2010- 2011 is superior to the projected industry growth of 16-18%.This coupled with its superior operational efficiencies in terms of costs should help the bank boost its profitability.

Bank’s asset quality and capital adequacy is the highest amongst peers: Prudent lending and conservative provisioning policies have helped the Bank maintain high asset quality despite its large exposure to the retail and SME sectors. Its gross and net NPLs at 1.18% and 0.29% are one of the lowest whereas its capital adequacy of 18.2% is the highest in the industry. Though restructured loans are up substantially from 0.3% to 2.1%, they are still one of the lowest amongst peers. We further forecast that the worst case stress impact (assuming 100% write off) of these restructured loans at only 18% of FY2011 book value.

Fee income continues to remain buoyant: Corporation Bank’s fee based income continues to demonstrate robust growth at a time when most public and private banks have seen a slowdown. This growth in fee income is from its core lending business and hence we do not expect any slowdown in the fee receipts over the period FY2010-2011.

Valuation and Recommendation: We are initiating coverage with a BUY recommendation on Corporation Bank and assign a price objective of Rs 632 for FY2011, based on our blended valuation methodology, representing an upside of 39% from current levels over a 18-month horizon. At the CMP of Rs 455, the stock is trading at 1.0x Adj BV and a forward PE multiple of 5.1x for FY2011 respectively.

To read the full report: CORPORATION BANK