Economic growth, less stringent Basel III norms are positives for bank stocks.
Even after outperforming the broader markets over the last one year, the uptick in banking stocks continues unabated. The Bankex notched gains of 3.7 per cent in Monday’s trade. In fact, banking stocks world over have registered gains after new rules that will apply to banks globally did not turn out to be as stringent as some had expected.
Also, experts suggest markets reacted positively as lenders were given a longer time frame than expected to comply with the rules.
The new requirements have tripled the amount of capital banks must hold in reserve (intended to augment financial strength and provide a cushion against potential losses). Besides, banks will be required to have a Tier-I capital ratio of six per cent, up from the current four per cent level. Tier-I capital refers to common shareholder funds and disclosed reserves or retained earnings.
Relief comes in the sense that Indian banks will not be significantly affected by the higher capital requirements proposed under Basel III norms. Private sector banks’ Tier-I capital seem better-placed than that of public sector banks (PSBs). The Tier-I level of the largest private banks in the country – ICICI Bank and HDFC Bank – is decent at 12.9 per cent and 13.3 per cent, respectively.
Public sector banks (PSBs) also look comfortable: The largest bank in the country – SBI (along with associates) – has a Tier-I level of 9.3 per cent. Among the larger PSUs, Bank of India and Union Bank have the lowest Tier-I ratios. But the fact that their existing ratios is higher than Basel III requirement is a positive.
Some asset quality worries
On the asset quality front, slippages in the June quarter slightly marred the operating performance of banks. This was largely driven by slippages in their restructured portfolio, the highest being observed in the case of PSBs like Bank of India and Union Bank.
In the next two quarters, slippages from the restructured assets would be a key ‘monitorable’ as loans restructured a year ago would come out of RBI’s moratorium. Their impact on banks’ earnings, however, may not be significant, say experts. Considering Indian banks are fairly capitalised, it’s a cushion against potential shocks.
Credit growth to improve?
Another glitch of late has been the slow pick-up in credit growth. However, an improving economic and investment outlook should lead to better credit demand. The recent industrial numbers have been a positive — India’s industrial production expanded 13.8 per cent during July, beating estimates by a strong margin after a relatively tepid June show.
Demand is expected to be robust from infrastructure, retail and industrial segments. From lows of about 10 per cent in end-2009, these have been inching up and are around 20 per cent. Bankers suggest that loan growth could average at 20-22 per cent for the current financial year.
Getting over the new Basel III rules would be stiffer for PSU banks than their private peers. Suresh Ganapathy, head of financial research, Macquarie research, says: “PSU banks have a larger component of perpetual debt (and, hence, higher leverage) and also lower Tier-I ratios in general, compared to private sector banks. Hence, a quicker transition to Basel III would relatively impose greater capital requirements on them if they have to maintain current levels of growth.”
Outlook
The pick-up in economic activity and stronger industrial numbers could be a precursor to the RBI increasing policy rates when the central bank meets later this week. This would come in the wake of deposit rates having risen more than the prime lending rate in the past two quarters.
Coupled with the increase in savings deposit costs, there could be a short-term pressure on net interest margins in the September quarter.
| STILL A VALUE BUY? | ||||||
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EPS
| P/E (x) | P/BV (x) | ||||
| FY11E | % chg | FY10 | FY11E | FY10 | FY11E | |
| Public Banks | ||||||
| SBI | 186.0 | 11.4 | 18.9 | 17.0 | 2.9 | 2.5 |
| PNB | 141.0 | 17.5 | 10.4 | 8.8 | 2.4 | 2.1 |
| BOB | 92.0 | 29.6 | 12.3 | 9.5 | 2.4 | 1.9 |
| Bank of India | 46.0 | 21.1 | 13.1 | 10.8 | 2.0 | 1.8 |
| Canara Bank | 73.0 | 2.8 | 8.1 | 7.9 | 1.8 | 1.5 |
| Private Banks | ||||||
| ICICI Bank | 46.0 | 24.3 | 29.6 | 23.8 | 2.5 | 2.3 |
| HDFC Bank | 89.0 | 34.8 | 34.6 | 25.7 | 5.0 | 4.1 |
| Axis Bank | 76.0 | 24.6 | 23.3 | 18.7 | 3.6 | 3.2 |
| E: Analyst estimates, % change is year-on-year, EPS: Earnings per share in Rs | ||||||
Valuations
On the valuations front, good June quarter results, improving core business and relatively lower valuations could help public sector banks outperform. Positively, despite the recent sharp run-up in share prices of PSBs, they continue to trade at a significant discount to private peers.
Hence, expect this valuation gap to narrow in the second half of 2010-11. However, lower treasury profits could impact public sector banks more than private peers, at least in the short term. Among PSBs, Bank of India, PNB, SBI and Union Bank could be considered on dips.
