Banking on huge value

POUND WISE

Improving business scenario and unlocking of value in its subsidiaries make the country's largest bank attractive.

The year 2005 was a historic year for Indian equity market, which saw the biggest ever rally and highest ever FII inflows of $10 billion.

While most sectors such as capital goods and metals significantly outperformed the broader indices - the Sensex and the Nifty, banking stocks largely proved to be laggards.

Banks incurred huge treasury losses on account of rising yields on their SLR investments, which ate into their profits leading to slow earnings growth.

Even the big daddy - State Bank of India (SBI) - had to bear the brunt of the southward movement, significantly underperforming the broader market, especially since January 2006.

SBI is the largest holder of government securities (G-sec) and yield on the 10-year paper has shot up by 100 bps in the last one year. "This resulted in an additional burden of Rs 1,800 crore as provision for depreciation on investments during the year," says a State Bank official.

In Q4FY06, SBI's net interest income declined 10 per cent at Rs 3,554 crore despite a staggering 37 per cent jump in interest income from advances and a fall of 6 per cent in interest expenses. 
 

FINANCIALS
Rs crore	FY06	% chg	Q4FY06	% chg
Net Interest Income	15635.60	12.13	3554.60	-10.03
NIM (%)	3.40	No chg	3.40	-
Other Income	7388.70	3.78	2677.00	59.35
Cost-Income Ratio (%)	50.90	310 bps	47.40	-80 bps
Operating profit	11299.00	2.81	3277.20	12.08
OPM (%)	49.10	-310 bps	52.60	80bps
Net Profit	4407.00	2.39	853.30	-19.88
NPM (%)	19.14	-129 bps	13.70	-420 bps
P/BV (FY07E)	1.4x	-	-	-

Interest income from investments slumped 22 per cent to Rs 3,291 crore. Net interest margin (NIM) was maintained at 3.4 per cent, though this was due to slight improvement in yield on advances and marginal decline in cost of deposits.

The bank's non-interest income grew 59 per cent to Rs 2,677 crore solely on the back of improved fee-based income and other income - other than the money market and foreign exchange activities.

This, combined with the rising operating expenses due to increasing overhead expenses, has led to only 12 per cent rise in its operating profit. The bank's net profit fell about 20 per cent to Rs 853 crore, also owing to higher provision of investment depreciation.

The bank also witnessed subdued growth in the financial year ended March 2006. The performance of the bank was partly affected by $7.3 billion India Millenium Deposits, which carried a higher interest of 6.5-6.6 per cent. However, in future, it won't be an issue as these deposits were redeemed in December 2005.

However, SBI's associate banks did well as the consolidated net profit grew 13 per cent last fiscal, while deposits and advances increased 17 per cent and 33 per cent, respectively.

The bank managed to improve its gross and net non-performing assets (NPAs) through cash recovery, corporate debt restructuring, securitisation and recovery of written-off accounts. However, net NPAs at 1.9 per cent are still higher than most banks, where the metric is below 1.

Ajit Dange, the banking analyst, UTI Securities, says, "In order to bring down its NPA levels below one per cent, the bank will have to provide substantially for loan loss in addition to the provisions for investment portfolio. This would not augur well for the bank's profitability if the yields on advances and fee based income don't improve substantially."

Hopefully, things will be better for the bank in future. The hike in PLR rate of 50 bps and revised service charges effected by the bank will start showing results in the coming quarters.

Although the cost of deposits is a concern, the growth in low-cost deposits of the bank due to its improved ATM network and technology should help the bank rationalise it.

The bank expects the cost of deposits to go up only marginally. NIM is expected to inch up to 3.5 per cent in the current fiscal driven by stable cost of deposits and an improved yield on advances from the current 7.7 per cent to around 8 per cent.

However, the bank's core NIM (excluding the income from investments) is only 2.9 per cent, which is very low vis-à-vis 4 per cent in the case of rival Punjab National Bank.

In the current year, the bank targets 16 per cent growth in deposits and 23 per cent growth in advances.

Jayprakash Sinha, VP and head of research, Kotak Securities PCG, says, "The positive thing about SBI is that it has a diversified portfolio of advances with a tilt towards high-yielding SMEs and the retail sector, which also have low delinquency rates."

SBI has SLR-deposit ratio of 39 per cent and investment-to-deposit ratio (except equity and subsidiary investments) of 43 per cent, much above other banks.

According to a bank official, "The bank's investment portfolio is also completely de-risked as 70 per cent of the SLR securities are in the held-to-maturity (HTM) category. Thus, another 100 bps rise in yields should not threaten the bank's profitability." However, he adds that some hitch like a hike in provision for NPAs may not be ruled out.

Plus, the bank is expected to amortise the SLR investments in the HTM category for at least next four years - the average duration of its investments currently, say analysts.

According to RBI guidelines, if an SLR security is bought at a cost higher than the face value, then the premium over the face value must be amortised over the remaining period of the maturity of the security.

Nevertheless, higher proportion of investments can also be considered blessing in disguise, as the bank has the opportunity to liquidate and raise resources, say analysts.

Above everything else, the major trigger for the stock performance going ahead would be the significant unlocking of value in its seven associate banks - State Bank of Patiala (SBP), State Bank of Bikaner and Jaipur (SBBJ), State Bank of Indore (SBInd), State Bank of Mysore (SBM), State Bank of Travancore (SBT), State Bank of Hyderabad (SBH) and State Bank of Saurashtra (SBS).

All of these seven banks taken together rank next to SBI in terms of size of the business, and they are starving for capital to feed growth. The amendments to the SBI Act, if passed in parliament, will allow these banks to raise money through the capital markets.

SBI, too, will be able to sell the stake in these banks to raise significant resources. SBI holds 75 per cent stake in SBBJ and SBT which are listed on the bourses and 92 per cent in SBM, which again is listed. SBH, SBP, SBS and SBInd are unlisted entities and the parent holds 90-100 per cent stake them.

SBI trades at 1.4 times and 1.3 times price-to-book value for FY07E and FY08E, respectively. The bank's share price has fallen significantly, so the downside risk seems to be low. It is also time to see how the new chairman shapes the future of India's largest bank.