The RBI quarterly monetary policy review, which emphasized an ‘exit’ from the expansionary stance, provided a backdrop for a flurry of profit-taking in bank stocks. The BSE Bankex is down 2.7% since the policy announcement on October 27, 2009.
Given the prevailing inflationary trend and growth pick-up, the stance wasn’t unexpected. However, the sterner tone appears to have taken the markets by surprise. Or perhaps, it was just an excuse for the profit-taking which was imminent given how fast and high stocks had risen.
The central bank took the route of administering monetary policy primarily via banks. The key initial steps to contain money supply were by reverting SLR (statutory liquidity ratio) to 25% of demand and time liabilities, from 24%. It also advocated that loan loss provisioning coverage be increased to 70% by September 2010 which is a clear positive as a risk mitigant for weaker bank balance-sheets.
The RBI has increased the general provisioning for real estate loans to 1% from 0.4% earlier. Liabilities from CBLO transactions will also now come under CRR prescription versus prior exemption. Credit growth outlook for the year was also trimmed to 18% from 20% earlier.
While a marginal trimming of earnings growth expectations is expected, banks with good asset quality and adequate provisioning will have a minimal impact to their balance sheet. Also, barring a few, most already maintain loan-loss coverage around 70%.
Most banks have been maintaining SLR well ahead of 25% (currently at 27.6% for the sector at large, according to the RBI). “However, if credit growth picks up in the next quarter, then the impact of SLR hike will start to show up in terms of cost of funds,” cautions Yashika Singh, Head, Economic Analysis, Dun & Bradstreet.
Impact assessment
Canara Bank, which has loan loss coverage currently of about 28%, could see a FY10 pre-provisioning earnings impact of about 21% and book value hit of 7% according to Citibank estimates.
SBI (standalone entity pre-provision profits impacted about 19.5% and book value down 6%), OBC (Oriental Bank of Commerce) and Bank of India are other public sector banks which have lower coverage ratios and will therefore feel the pinch on profitability and book values (See Impact of monetary policy).
| Impact of monetary Policy on banks | ||||||
| Company | Current Coverage Ratio % | Earnings impact % | Book value impact % | CMP (Rs) | P/E(x) | P/B (x) |
| Can Bank | 27.8 | -17.3 | -6 | 337.25 | 5.0 | 1.0 |
| SBI | 45.1 | -12.4 | -4.9 | 2190.05 | 10.4 | 1.8 |
| ICICI | 51.1 | -14.3 | -3.2 | 777.7 | 16.8 | 1.6 |
| OBC | 57.7 | -5.9 | -1.7 | 242.1 | 4.6 | 0.7 |
| Corp Bank | 75.4 | 1.4 | 0.5 | 415 | 4.9 | 0.9 |
| BoB | 81.7 | 4.4 | 1.4 | 512 | 6.8 | 1.2 |
| UBI | 88.4 | 8 | 2.9 | 260 | 6.6 | 1.3 |
| PNB | 89.6 | 7.4 | 2.7 | 838.5 | 6.7 | 1.4 |
| * Based on Citigroup FY11 estimates and 29-Oct NSE closing price | ||||||
Among private sector banks, ICICI Bank (possible EPS downgrade of 10-11% according to Motilal Oswal estimates) will bear the most brunt of the provisioning increase.
Given that soaring expectations of growth and margin expansions had fuelled fairly high valuations in the sector, the policy has allowed for some rational thought to peter in. Bank stocks with poor asset quality and lower provisioning are down between 4% (SBI) to 9% (Canara Bank and ICICI Bank) post the policy announcement. However, the sector remains the fundamental anchor to the India growth story with the tight regulation increasing its attractiveness.
This correction largely factors in the possible book value downgrades for stocks with low provision coverage, according to a Motilal Oswal report. Underlying business environment remains intact and conducive and thus we would buy the stocks on correction, it adds.
Declines could also provide buying opportunities for bank stocks with good asset quality and strong balance sheet especially for quality franchises even at a premium to others. These stocks, however, give limited visibility in terms of absolute returns at current valuations.
