Valuation vortex

COVER STORY

tries to find an answer

Giants at home, but minnows in the global arena. That just about sums up the state of Indian banks. So when RBI Deputy Governor V Leeladhar says "We are slowly but surely moving from a regime of a large number of small banks to a small number of large banks," he is only voicing the fond hopes of the domestic banking fraternity.

The problem is real. Consider this: The market capitalisation of Industrial and Commercial Bank of China (ICBC), China's largest lender, at over $157.76 billion is more than double the collective market capitalisation of 37 listed Indian banks, which stood at $69.50 billion as on November 10. It is also eight times the market capitalisation of India's most valuable bank, ICICI Bank.

ICBC may still be far behind Citigroup ($249 billion), but it is a giant vis-a-vis all Indian banks put together. ICICI Bank tops the market capitalisation chart with $16.60 billion (Rs 74,315 crore), followed by State Bank of India's $13.35 billion (Rs 59,729 crore) and HDFC Bank's $7.35 billion (Rs 32,852 crore).

None of the other listed Indian banks has over $5 billion worth of market capitalisation. Punjab National Bank follows with a market cap of just $3.65 billion.

Indian banks indeed fare poorly in terms of market value, but when it comes of the price-to-book value (P/BV) they are quite well placed.

After adjusting for non-performing assets, HDFC Bank's P/BV is 6.22 times and that of ICICI Bank is 3.32 times. UTI Bank's P/BV is 4.60; Yes Bank's 5.44 and Centurion Bank of Punjab's 4.66.

Kotak Mahindra Bank has the highest P/BV at 13.88 and the newly listed Development Credit Bank 9.44. Public sector banks, however, have a lower P/BV "� below two times for most of them, barring exceptions like State Bank of India (2.62), Bank of India (2.12) and a few others.

ICBC's P/BV is about 2.2 times. Most US banks trade in the range of 1.2-3.5 times. In case of European banks, the range is 2-3 times P/BV.

Why are Indian banks so under-valued? ICICI Securities' senior analyst Dipankar Choudhury attributes this to two reasons: First, the interest rate risk is comparatively high and no other country has such a high level of statutory appropriation by the government.

Second, government interference in the functioning of banks leads to a lower value. The 20 per cent cap on foreign institutional investors' (FII) exposure in public sector banks is also a dampener on valuations. Foreign investments in some private banks are as high as around 74 per cent. Incidentally, ICBC is controlled by the Chinese government which holds more than 72 per cent of the bank through investment companies.

ICICI Bank's MD and CEO K V Kamath feels that the market is discounting Indian banks' capability of exploiting growth opportunities. "The real challenge before banks is that they must convince investors that they are capable of making the most of the India growth story," he says.

Ashwin Parekh of Ernst & Young has a different explanation for the undervaluation "� the failure of Indian banks to value their underlying assets.

"The Chinese banks had much higher NPAs than Indian banks but they also focused on the quality of collateral. Naturally, investors have the perception that there is a huge potential in the underlying assets. Unfortunately, this is the not the case in India," he points out.

In May, Ernst & Young estimated that China's bad bank loans were about $911 billion, including $358 billion for the four largest banks alone. The official figures stand at $164 billion and $133 billion, respectively.

The biggest handicap of the Indian banks is the lack of scale. ICBC has total assets of over $ 812 billion, close to the size of India's GDP! Despite such large assets, the big Chinese banks have recorded annual growth rates of over 10 per cent in total assets over the past three to four years.

State Bank of India, which accounts for almost one-fifth of the total banking assets in India, however, has an asset base of only $84 billion. The SBI is roughly one-tenth the size of the world's biggest bank "� Citigroup "� on the basis of Tier I capital. Citigroup's consolidated Tier I capital last year was $79 billion. For SBI, it was just $7.9 billion.

To arrive at the consolidated tier I figure, capital and reserves have been taken into account and revaluation reserves and minority interest (that is the parent bank's investment in group outfits) have been deducted from it.

On this basis, State Bank of India's global position is 72. It is not even within the first 10 big banks in Asia where the first three slots have been occupied by Chinese banks with each of them having a capital base of over $30 billion. In fact, six Chinese banks feature among the top 25 Asian banks, while India has only two representatives "� SBI and ICICI Bank.

The top 10 global banks list features three banks each from the US and Japan, two from the UK, and one each from France and Spain.

Things don't get much better even when we shift the focus to Asia (excluding Japan.) China Construction Bank Corporation is the Asian giant with a capital base of $35.6 billion. It is followed by its local peer Industrial & Commercial Bank of China (Tier I capital: $31.7 billion) and Bank of China ($31.4 billion). China dominates the Asian banking space occupying five of the top ten slots, Australia accounts for four slots and South Korea one.

The Asian giant is four-and-a-half times bigger than SBI. The other Indian bank that features in the list of the Top 25 in Asia is ICICI Bank, at the 22nd slot. ICICI Bank's capital base is much lower than that of SBI ($4.3 billion versus $5.9 billion). Punjab National Bank has less than half of ICICI Bank's capital ($1.99 billion).

Bank of Baroda is next with a Tier I capital of about $1.65 billion, followed by Canara Bank ($1.49 billion). Three other Indian banks have more than $1 billion worth of Tier I capital are Industrial Development Bank of India ($1.41 billion), HDFC Bank ($1.15 billion) and Bank of India ($1.01 billion).

When it comes to two other parameters relating to scale "� total assets and profit (pre tax) "� Indian giants are pygmies on a global scale. SBI's total assets are $155.72 billion against Citigroup's $1.5 trillion. Similarly, ICICI Bank's asset base is $61.90 billion and that of Punjab National Bank is $33.16 billion.

The one area where Indian banks are able to compete with their global peers is their return on assets (RoA). Among big Indian banks, ICICI Bank, PNB, Canara Bank and HDFC Bank have a return on assets of over 1 per cent, while SBI's return on assets is 0.89 per cent.

Among Indian banks, HDFC Bank has the highest return on assets "� 1.71 per cent. This is lower than that of Citigroup (1.97 per cent) but much better than the RoA of HSBC (1.40 per cent).

"Our banks are small and yet efficient but they must build the scale," says a finance ministry official in the context of a fast growing economy.

Indeed, a beginning has been made in that direction. IDBI's acquisition of United Western Bank in October was the fourth M&A deal in the banking pace this year.

The other three deals relate to the merger of Ganesh Bank of Kurundwad, another Maharashtra-based bank, with Federal Bank of Aluva, Kerala; takeover of Bharat Overseas Bank by public sector Indian Overseas Bank and that of Lord Krishna Bank by Centurion Bank of Punjab.

For Centurion-BoP, it's the second M&A deal in two years. In June 2005, Centurion Bank and Bank of Punjab, two new private banks that had not been in the best of health, were merged to create this entity.

The main driver for such M&A deals are two critical rules of the Reserve Bank: All banks must have net worth of at least Rs 300 crore and they should have a wider investor base with no single entity holding more than 10 per cent stake. At least nine old private sector banks now have less than Rs 300 crore net worth.

While two of them "� Lakshmi Vilas and Citi Union Bank "� are within sniffing distance of the threshold limit, quite a few of them are wide off the mark. For instance, Sangli Bank and Ratnakar Bank do not have even one-sixth of the required net worth.

Similarly, the promoters' stake in at least seven banks are higher than 10 per cent. They are IndusInd Bank, Development Credit Bank, Dhanalakshmi Bank, Tamilnadu Mercantile Bank, Catholic Syrian Bank, Nainital Bank and Bank of Rajasthan.

Although there is no timeframe to achieve these twin targets, the merger momentum is likely to gain pace to weed out the fringe players and achieve some degree of scale by April 2009 when the sector is set to open up for foreign players.