Smooth run for banks

Quality of assets improved despite robust credit growth

Overall, the year 2006 was satisfactory for the banking sector with robust credit growth of about 30 per cent for two consecutive years, stable margin scenario and improved overall profitability due to lesser provisioning for investments and non-performing assets.

However, there were certain hiccups like the spike in crude oil prices, liquidity crunch on account of IMD redemption last December and provisioning hit on the bond portfolio due to rising 10-year government securities yields (it crossed 8 per cent in June 2006 ) till the first half.

Though bank stocks did well in the September quarter due to several positives like a pause in interest rates by the US Fed, falling crude oil prices and RBI allowing banks to raise capital through hybrid and perpetual debt instruments, the rally did not continue.

So far in 2006, the BSE Bankex is up 37 per cent, as compared to the Sensex, which has gained 45 per cent so far. Private sector players like ICICI Bank, HDFC Bank and UTI Bank were undoubtedly better performers (both in terms of operations as well as shareholder returns) as compared with most of their public sector counterparts.

All key sectors like retail, agriculture and industry continued to show great appetite for credit, thanks to the booming economy and higher purchasing power with consumers.

Moreover, despite robust credit growth, quality of assets of the banking system also improved with an average NPA levels of less than 2 per cent.

However, deposit growth lagged behind at 15-20 per cent, thus keeping rise in costs of deposits higher than lending rates. This led to some pressure on net interest on margins (NIMs).

While public sector banks didn't do too well in terms of overall profitability, private banks did well thanks to higher fee incomes.

In order to broad-base customers and achieve benefits of geographical spread, there were some steps towards consolidation in the banking system. Corporation Bank, Oriental Bank of Commerce and Indian Bank forged a partnership to do some businesses jointly.

IDFC, Bank of India and Union Bank of India formed a three-way alliance to finance infrastructure projects together. In the mergers and acquisition space, small or weak banks were acquired by some of the larger banks.

IDBI Bank acquired United Western Bank, Centurion Bank of Punjab bought Lord Krishna Bank and recently, ICICI Bank bought Sangli Bank. In order to rein in credit growth, RBI hiked the repo and reverse repo rates, increased risk weight to commercial real estate and raised the CRR by 50 basisi points recently.

Going ahead, analysts are neutral about the sector. Though credit growth of even 20 per cent will be robust given the higher base, mobilising deposits will be a key challenge especially for the public sector banks as private banks are quite aggressive on this front.

Analysts estimate margins to remain somewhat under pressure as cost of deposits may rise faster than lending rates. No wonder then that SBI has hiked its PLR on Tuesday and also upped some of its deposit rates earlier this month. ICICI Bank too has hiked some of its deposit and lending rates.

Other banks are also likely to follow suit. However, at current valuations, private sector banks appear expensive, and though the public sector banks are cheaper, there are concerns that their margins will be under pressure.

GHCL: Shopping spree

After acquiring three companies abroad over the past year or so, soda ash and textiles player GHCL's shopping spree continues. Recently, it acquired the assets of HW Baker Linen, USA, through its American subsidiary Dan River. At about 10 per cent of HW Baker's annual revenues of $65 million, the deal is quite cheap.

GHCL has been one of the early companies to go abroad shopping for companies. Last December, it bought Romanian soda ash company SC Bega Upsom in Romania and US-based home textile company Dan River. In June 2006, it bought the home furnishings business of UK-based Rosebys.

While HW Baker's offices and plant will not be of much use to GHCL, the acquisition will add $70 million to Dan River's top line, and more than double its institutional sales as HW Baker is a supplier of bed linen and blankets to hotels in the US. The management expects that it will be able to earn an operating margin of over 10 per cent.

According to the GHCL management, it will be able to make the company profitable by the same strategy used at Dan River""by increasing the sourcing from India, China and Pakistan. At present, HW Baker purchases its products from US-based suppliers.

In its domestic operations, the company is expanding its soda ash capacity from 600,000 tonne a year to 850,000 tonne a year, which will be operational by the beginning of the next financial year.

It is also increasing the capacity at its spinning unit from 90,000 spindles to 140,000 spindles, which will be ready in the next quarter. In the September quarter, its standalone sales went up 17.3 per cent, but its operating profit grew slower by 6.8 per cent.

As a result, its operating profit margin declined 240 basis points to 24.8 per cent. GHCL has not consolidated its financials yet, and the stock trades at about 11 times its standalone FY08 estimated earnings.