Bank stocks down 28% amid rate impact fears

Bank stocks have declined 28 per cent from their peak level about a month ago, in line with the market meltdown. Over the past year, the banking sector index (Bankex) has underperformed markets with the Bankex rising only 9 per cent against the BSE Sensex's rise of 42 per cent.

All valuation ratios for listed banks are down and few are ruling at around three-year lows. The price to earnings multiples declined to 10.61 times now from 11 a year ago. The price to book valuations for many of the bank stocks are now close to levels seen three years ago.

Analysts at Merrill Lynch say the key fundamental change has been the higher-than-expected interest rate risk arising from tightening liquidity globally and higher oil prices impacting inflation in India.

Most bankers accept that rates are heading north but believe the hikes may be short term. They expect the overall rate hike to be moderate and the benchmark 10-year government paper yield at around 8 per cent by year end.

However, the 10-year yield has already pierced the 8 per cent level and now at ruling at its three-year high of around 8.10 per cent. Bankers are forecasting loan growth of 24 per cent for the full year (FY07) against 30 per cent credit growth in FY06. On a year on year basis, it is currently running at 27-28 per cent.

A faster-than-expected rise in interest rates could impact bank earnings by 5-10 per cent based on the extent of the bank's deposit franchise, loan mix and composition of their gilts portfolio. It is expected that loan growth for banks to be slower by 2-3 percentage points.

Merrill Lynch report says in 2006-07, Oriental Bank of Commerce will be hit hard with earnings growth cut down by 23 per cent.

Other banks which are mostly affected by rise in interest rates are Vijay Bank (8.7 per cent), Federal Bank (8.5 per cent), Canara Bank (7.1 per cent), IDBI and Punjab National Bank (6 per cent each) and Corporation Bank (5 per cent).

The least affected banks are UTI Bank (0.3 per cent), HDFC Bank (2 per cent), ICICI Bank (2.7 per cent), Bank of India (3 per cent) and State Bank of India (3.5 per cent).

Analysts expect private bank earnings to grow at a buoyant pace with both UTI Bank and HDFC Bank estimated to grow at 30 per cent each in FY07. ICICI Bank's earnings could grow by 18 per cent in FY07.

The public sector banks, in contrast, are likely to show a wide range of earnings owing to the base effect and transfers of portion of their SLR securities to the held to maturity portfolio of bond holdings to ward off the adverse impact of rate hikes.. Earnings growths are likely to be 10 per cent for OBC, 25 per cent for PNB and 11 per cent for SBI in 2006-07.