Banking Stocks

Advance on declines

Sandeep Singh

Posted online: Monday , April 09, 2007 at 1035 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST -->

The market’s jumpy response to rising interest rates is throwing up juicy opportunities to buy good businesses that are facing temporary strife.

History is witness that one of the best times to buy a stock is when people are rushing out of it because of events that will cause momentary pain to the company. Last Monday threw up one such opportunity and, chances are, it might linger in the weeks to come. When the market opened after the Reserve Bank of India (RBI) caught everyone offguard over the previous weekend with sharp increases in two benchmark rates, bank stocks tumbled 5-10 per cent.
The RBI move signalled higher interest rates, which is bad for banks. By RBI rules, at least 25 per cent of a bank’s deposits have to be in government bonds. When interest rates rise, the value of these bonds falls; conversely, when rates fall, their value rises. When the RBI raised rates on Monday, investors reacted to the damage that would be revealed when banks declared results over the next month. In doing so, they discounted the long-term economic story of banks, which is still something to covet.
The worst-case growth scenario for the economy, and this is unlikely, is GDP growth of 6.5 per centThe banking business has two parts. The first part is the ‘deposit’ side. A bank borrows money from various sources — like the balance in your savings and current accounts, and the term deposits you hold with it. The second part is the ‘lending’ side. It uses its money to either give loans or to invest in bonds. The difference between its lending rate (its return) and its borrowing rate (its cost) is its operating margin, or ‘spread’. A bank’s aim is to earn as high a spread as possible and keep its other costs as low as possible.
At present, of Rs 100 a bank raises as deposits, it invests about Rs 30 in government bonds, where it will receive some temporary setbacks. The other Rs 70 goes into corporate and individual loans, which have been growing at 30 per cent a year. Not much has changed here. Sure, the cost of funds for a bank will increase, but it can recover this by raising lending rates. Fears that, because of higher lending rates, demand for loans will fall is also unfounded.
The opportunity
Sanjay SinhaSBI Mutual Fund
Some PSU banks are good value buys. They have access to low-cost funds, which helps in tough timesThere is ample loan demand, much of which is unlikely to be deterred by the prospect of paying more. Even if the economy slows down, it’s not like growth will stall. Says Abheek Barua, chief economist, ABN AMRO Bank: “The worst-case scenario, and it’s unlikely this will come about, is GDP growth of 6.5 per cent.” Most experts still project 7.5-8 per cent growth. If a bank can grow its assets by 20-25 per cent a year, it means it doubles in size every three years.
On interest rates, the consensus is that rates are close to peaking. Says Sanjay Sinha, head of equities, SBI Mutual Fund: “Inflation should plateau by May, which will bring down rates.” If rates fall, banks will record treasury gains, as they did heavily in 2001-03. But that may not happen soon. Says Barua: “Rates might stay range-bound for some time before starting to fall.” Overall, the worst seems to be factored in.
The picks
There are five attributes to look for in a bank stock.
Low-cost deposits. A high contribution of current account and savings accounts (CASA) in its total deposits reduces a bank’s cost of funds. Banks don’t pay any interest on current account balances, just 3.5 per cent on savings account balances.
Good asset quality. Net non-performing assets — assets gone bad as a percentage of total assets — are a historic number, but it does shed light on the quality of a bank’s loan portfolio. The lower this ratio, the better. The frenetic leading over the past three years might come to haunt banks. Says Barua: “Loan quality has deteriorated a bit in the past eight months, but it’s more in personal loans and credit cards. On the corporate side, asset quality is fairly good.”
Efficient use of capital. A bank leverages its capital to raise funds. How well it is able to use this money is indicated by the return on equity (RoE) and return on assets (RoA). An RoE of over 20 per cent and RoA above 1 per cent is good.
Business intent. Good numbers aside, one would like to see a bank growing at a healthy pace, even gaining market share.
Worthy valuations. Current valuations should justify paying for the growth expected in the business.
Looking at the 39 listed banks through these five lenses, some obvious pointers emerge. Like HDFC Bank is the country’s most-efficient bank. Like some PSU banks are great value buys. Says Sinha: “They have a higher CASA, which will bail them out if growth falls or margins shrink.” Adds Ashutosh Narkar, banking analyst, India Infoline: “Valuations-wise, they are cheaper.”
Our three bank picks HDFC Bank, ICICI Bank and Punjab National Bank are tailored to capture these stories. HDFC Bank, scores high on efficiency. It’s not as aggressive as an ICICI Bank in lending, but it promises growth and stability. Then, there’s ICICI Bank. Its low CASA might squeeze it in tighter times, but right now, it’s riding a wave and has shown an ability to manage growth. Finally, there’s PNB, which offers the best of what PSU bank stocks stand for today a good, established and growing bank available at low valuations. And if the market catches a cold again, it will be an even better time to buy them.

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