Axis Bank: Buy

M. V. S. Santosh Kumar
Investors with a two-year investment horizon can consider buying the stock of Axis Bank. The bank’s performance has so far allayed fears about an earnings slowdown due to the ongoing global turmoil, high interest rates and liquidity crunch. However, given the highly volatile markets, it is advisable to accumulate the stock in phases.
A large low-cost deposit base, superior net interest margins (NIMs), robust fee income, high quality diversified asset book and aggressive branch expansion are the key positives from a two-three year perspective. The company’s recent wins in litigation relating to derivative exposures, also alleviate concerns on this score.
At the current price of Rs 619, Axis Bank trades at 2.2 times its (September 30) book value and 15 times the estimated FY-09 earnings. (the peak valuation for Axis Bank was 5.5 times book value and 41 times earnings). This places it at a premium to all other private banks, except for HDFC Bank, but is justified by the bank’s low proportion of retail loans and strong earnings growth. Strong loan growth
Axis Bank’s net profits have consistently grown at 60 per cent year-on-year over the past five quarters, amidst challenges such as high interest rates, concerns about derivative exposures, trading losses and so on. In the September 2008 quarter, Axis Bank posted a net profit of Rs 403 crore, a 77 per cent increase Y-oY. The bank has managed a loan growth of 54 per cent and deposit growth of 60 per cent in this period. The growth in advances was driven by SMEs (68 per cent) and retail (55 per cent).
Deposit growth was driven mainly by increase in term deposits (higher by 75 per cent). Yet, the bank has managed to maintain its proportion of low-cost deposits at 40 per cent, in a scenario where there was a scramble for such deposits. Net interest income rose 55 per cent year-on-year. NIMs expand
Despite pressure on cost of funds across the sector, NIMs (3.5 per cent from 3.3 per cent) have improved in the last three months, driven mainly by higher prime lending rates and better cost management.
The fee income also increased 91 per cent, covering almost 90 per cent of operating expenses. The major contributors to the fee-income are debt-syndication, forex treasury, cash management services and third-party distribution, many of which appear sustainable. The slowdown in the trading income pulled down the non-interest income.Capital adequacy declines
Provisions and contingencies increased by 122 per cent, as the bank enhanced NPA provision coverage (52.6 per cent from 42 per cent), and probably due to loss in the investment book. However, Net NPA/advances came down from 0.55 per cent to 0.43 percent.
The only point of concern in the numbers is the sharp deterioration in the capital adequacy ratio, down to 12.1 per cent from 17.59 per cent. This can be explained by strong growth in advances and a possible increase in exposure to assets with higher risk weights. Loan book
Axis Bank’s loan book is focussed mainly on mid/large corporate (49 per cent), retail advances (24 per cent), SME advances (19 per cent) and agriculture advances (8 per cent). Eighty four per cent of the corporate advances and 78 per cent of SME advances are ‘investment grade’, which demonstrates a prudent focus on asset quality.
Asset quality relating to retail advances is not as big a source of concern for Axis Bank as for other private sector peers, given that only a fourth of the retail book is accounted for by personal and credit-card loans.
The bank has a credit-deposit ratio of 67 per cent, below the industry average of 73 per cent, indicating that the bank has been investing excess cash, rather than deploying it to grow advances aggressively in the uncertain environment. Outlook
Axis Bank has maintained its return on equity at 17 per cent and return on assets of 1.25 per cent (both higher than the industry average). While the bank is expected to continue its growth momentum, the quality of assets may deteriorate if interest rates do not decline. The recent 250 basis point cash reserve ratio cut may release Rs 2,500 crore of funds to aid growth. That the bank has managed to add to its deposit base despite its rates being not too competitive, gives it an edge in the current environment.
In the last 12 months, the bank has added 135 branches and 582 ATMs across 90 new towns and cities (opened 16 branches in September quarter); this may help to further attract low-cost deposits and boost fee income.
Favourable Court rulings for Axis Bank in litigation relating to derivative transactions structured for corporates, reduce risk on this count and may allow the bank to write back the contingent provisioning of Rs 70 crore towards these cases.
Apart from an uncertain macro environment and risks relating to asset quality, high FII holdings in the stock will remain a key risk to the stock price. Between March and September this year, FIIs have pared their holdings in the stock from 35 per cent to 27 per cent.

HDFC Bank: Buy

Investors can consider accumulating the HDFC Bank stock with a two-year perspective, given the bank’s resilience in a challenging environment and scope for strong growth in earnings.
At the current price of Rs 1,026, HDFC Bank is trading at 19 times its estimated earnings per share for 2008-09 and 3.2 times historic book value. Best-in-industry Net Interest Margins (NIMs) which provide a cushion against rising costs, a high proportion of low-cost deposits and an extensive branch network that can drive advances growth, make the stock a preferred exposure in the banking space.
After including the effect of the Centurion Bank of Punjab (CBoP) merger, HDFC Bank posted a profit growth of 44 per cent, backed by net interest income growth of 66 per cent in the September quarter. NIMs at 4.2 per cent increased due to a hike in lending rates effected this quarter; the impact of this will be sustained over the next few quarters. Deposit growth was strong at 46.7 per cent, with the proportion of Current Account Savings Account at 44 per cent. The recent CRR cut will also release around Rs 3,300 crore to fund growth plans.
Over the past two quarters, strong topline growth for the bank has not translated into equivalent profit growth. The CBoP merger has increased operating costs and reduced asset quality, and added a higher proportion of retail loans. However, as the integration of CBoP takes shape over the next one year, the expansion in the branch network and asset portfolio may help ramp up the bank’s growth.
HDFC Bank’s successful integration of Times Bank in the past induces confidence on this score. The bank’s branch network has expanded 85 per cent post-merger, with a presence in 200 cities added over a year. With this, HDFC Bank’s branch network rivals its peer ICICI Bank, but its advances are less than half its rival’s levels, suggesting untapped potential.
A high proportion of retail advances (54.7 per cent) is a matter of concern, making the bank more vulnerable to asset quality slippages in a high interest rate scenario. However, macro indications suggesting a peaking of rates and the bank’s ability to limit slippages over the past two quarters are the positives. The net NPA to advances ratio remains at a comfortable 0.57 per cent, with the provision coverage on NPAs at 65 per cent. HDFC Bank’s capital adequacy ratio at 11.4 per cent is relatively low. But conversion of warrants issued to the promoter, which expire in December 2009, may infuse Rs 3,600 crore and may improve this ratio.
M.V.S. Santosh Kumar

Union Bank of India: Buy

M.V. S. Santosh Kumar

Investors can consider buying the Union Bank of India stock with an investment horizon of more than a year. A low price-to-book value, with a high return on equity, indicates the stock to be relatively undervalued. Investors should, however, be willing to wait out the current period of tight liquidity and uncertain macro environment.

Given the volatility in the markets, investors are advised to accumulate the stock gradually during dips. Union Bank of India at current market price of Rs 145, trades at 5.4times its estimated FY-09 earnings and 1.26 times its June 30 book value, at a discount to most PSU banks, except Syndicate Bank and Allahabad Bank.

Strong return ratios (return on equity of 26.8 per cent and return on assets of 1.26 per cent) place the bank among the best in the PSU space in terms of profitability.

This apart, a strong branch network, which is 100 per cent CBS-enabled, a diversified loan book with a tilt towards corporate advances, a high NPA provision cover and higher efficiencies (cost-income of 40 per cent) are also investment positives.

Business

Union Bank’s advances mix features a 16.6 per cent exposure to SMEs, 21 per cent to retail clients, 14 per cent to agriculture, while the rest of the portfolio is contributed by corporate advances. The bank is the first nationalised bank to be 100 per cent Core Banking Solutions (CBS) enabled. This enables the bank to receive fee income by way of electronic fund transfers (from NEFT, RTGS) and reduce processing time and expenses. The bank expects 25 per cent of its transactions to be done electronically by March 2009.

Over the past five years, the bank’s balance-sheet and advances have grown at a 20.8 per cent and 26.5 per cent Compounded Annual Growth Rate (CAGR) respectively.

During the June quarter, the advances and deposits grew at 19 per cent and 23 per cent year-on-year, driven by SME advances growth. Net profits grew marginally at 1.51 per cent owing to higher provisioning and employee costs, both of which will continue to be a challenge in the quarters ahead.

Union Bank has seen high cost deposits reduced to 15 per cent in the quarter, from 21 per cent; but this ratio could show some increase this quarter because of the ongoing liquidity crunch. The bank has been successful in improving its CASA by 1.5 percentage points to 34.76 per cent.

The advances growth did not translate into growth in net interest income due to increased cost of funds and falling yields on funds due to 25 bps cut in PLR in February. The net interest margin stood at 2.63 per cent for the quarter. Operating profits were hit by shrinking non-interest income and higher operating expenses. Cost-income ratio has increased from 38 per cent to 40 per cent, still among the lowest in the industry. The bank had taken a one-time hit on the additional AS-15 employee provisions last year. Going forward, provisions on this count will not be necessary, placing it in a better position than peers, in terms of earnings. Lower provisioning on the investment portfolios on softening bond yields, may also see a partial writeback of the Rs 330 crore it provided last quarter.

Though gross NPA to advances stands at 2.06 per cent, the provision coverage of 93 per cent has helped the bank maintain its net NPA to advances at 0.15 per cent.

The Government stake in the bank is 55.4 per cent, which will make it challenging for the bank to raise additional capital in the form of equity; but head-room exists for raising capital up to Rs 3,500 crore in the form of tier-1 bonds, perpetual cumulative bonds and so on.

The bank’s capital adequacy ratio is 11.28 per cent according to Basel-II. Focussed lending to different sectors by setting up specialised branches helped the bank in healthy disbursement of the loans.

Outlook

Among PSU banks, Union Bank of India has a first-mover advantage in technology adoption. The bank’s re-branding exercise at Rs 75 crore to target the younger generation may also help; the roll-out of more than 100 branches this fiscal may also aid in attracting low-cost deposits. A recent entry into wealth management services has the potential to boost ‘other income’. Though an entry into mutual funds and insurance businesses is also on the cards, these may be challenging in the current environment.

The bank’s ‘other income’ covers only 53 per cent of total expenses. Leveraging on branch expansion and international presence can boost its ‘other income’; with 55 per cent of the branches in rural and semi-urban areas where there is lower competition, there is greater scope for sourcing low-cost deposits.

The bank expects to grow deposits and advances at 23 per cent and 22 per cent respectively over the next year, but earnings growth may be muted because of tighter liquidity, leading to high cost of funds. NIMs may also be flat, though the bank expects them to improve to 2.85 per cent by end-FY-09 as it has increased PLR by 125 bps.

The bank intends to improve asset quality by bringing GNPA/advances down to less than 2 per cent, but the prevailing interest scenario may lead to higher delinquencies.

With the CRR cut of 150 bps, the bank may have around Rs 1,500 crore additional funds, which were yielding no returns; this may helpin reducing the burgeoning cost of funds.

Bank of India: Buy

M.V. S. Santosh Kumar

Investors can consider buying the Bank of India stock with at least a two-year horizon. Valuations are quite attractive, but the stock can be re-rated only when sentiment towards the banking sector improves on a rend reversal in interest rates.

At the current market price of Rs 275, the stock trades at 1.6 times its June 30, 2008 book value and 6.8 times its FY-08 earnings; 5.5 times FY-09 earnings.

Despite outperforming its peerls in the last three years, the stock trades at a discount to larger public sector banks, except Canara Bank .

Given that the broader markets might be volatile in the medium term investors can accumulate the stock during declines.

Bank of India is the sixth largest in terms of balance-sheet size and has superior profitability ratios, a diversified loan book, a de-risked bond portfolio, robust non-interest income and healthy levels of low-cost deposits. It created 50 SME centres and 20 retail hubs for focussed lending to these sectors.

The loan book, which has the ability to weather the current interest rate regime with relatively lower slippages, constitutes 13 per cent agriculture credit, 20 per cent retail credit, 21 per cent SME credit and 47 per cent corporate credit.

Financials

Bank of India’s balance-sheet and earnings have each grown at 18 per cent compounded annual growth rate (CAGR) in the last five years. The net NPA/advances have come down dramatically from 5.5 per cent to 0.5 per cent during the same period.

In the June quarter, a troubled period for most banks, Bank of India posted a 78 per cent growth in earnings thanks to strong growth in net interest income (25 per cent) and non-interest income (45 per cent), even as operating expenses remained flat.

The major boost to ‘other income’ came from forex transactions, commission, exchange and brokerage income and write-back of loans.

Trading profits remained flat due to underperformance of the capital markets. The bank’s cost:income ratio of 38.6 per cent is the lowest among the larger banks and shows good operating efficiency.

Advances grew by 37 per cent in the tough market conditions but at the cost of shrinking net interest margins (NIM).

The bank’s Indian operation’s NIM (3.3 per cent) is strong but the international operations pulled down the overall margins to 2.9 per cent. The NIM contracted as the bank’s cost of funds increased, even as yields remained flat on the back of a lending rate (PLR) cut of 25 basis points. Low-cost deposits form 34 per cent of the total, which is above the industry average, but does not give the bank an advantage vis-À-vis other banks (PNB, SBI, BOB).

Bank of India’s capital adequacy ratio (CAR) stands at 12.39 per cent, well above the RBI’s stipulated limit. The Government holds 64 per cent stake in the bank which is higher than most of the PSB peers. This gives the bank adequate room to raise capital to fund aggressive advances growth.

The bank made Rs 129 crore mark-to-market provision for available for sale (AFS) investments, but it may see some write-backs this quarter, on the softening of bond yields.

For AS-15 retirement benefit, the bank had provided Rs 70 crore for the current quarter (this provisioning will be recurring in all quarters for the next four years).

The bank has to provide for the employee wage revision. It has exposure to risky investments overseas which might lead to losses or higher provisioning.

The bank had also taken a hit of Rs 54.6 crore as the premium on held-to-maturity (HTM) bonds was amortised from interest income. Prudent risk management helped the bank to limit slippages in asset quality. The Gross NPA/advance has come down from 2.29 per cent to 1.64 per cent over the year. Net NPA/advance stands at 0.5 per cent. The provision coverage at 80 per cent will cushion the bank in adverse conditions.

Outlook

The bank has one of the highest return on equity (28 per cent) and return on assets at 1.25 per cent, which places it among the better banks; the credit deposit ratio is also the highest among nationalised banks.

The bank has displayed robust growth in advances and earnings in a challenging environment. Though it may be hard to replicate the same growth rates going forward, healthy growth rates are still expected.

The management expects 20 per cent growth in advances this fiscal. Given the high corporate exposure, any sharp slowdown in the corporate capex cycle will be a key risk. An increase in PLR by 125 bps is likely to help the bank maintain its NIM at healthy levels in the coming quarters. A core earnings growth at about 19 per cent in FY-09 appears possible; trading profits and forex gains have the potential to boost growth rates further.

Going forward, the bank may have to choose between growth in advances and quality of assets. Low-cost deposits are hard to come by in the current scenario where the banks are wooing customers with higher rates.

As with other PSU banks, the bank is leveraging on its branch network by offering various third-party products such as mutual funds and insurance.

To boost its ‘other income’, the bank has entered loan syndication, increased fee structures across various products and entered into an insurance joint venture with Dai–Ichi. The bank intends to cover operating expenses with its non-interest income this fiscal.

Yes Bank: Buy

M.V. S. Santosh Kumar

Investors with a two-year perspective can consider buying the stock of Yes Bank at the current price (135.65). The bank trades at 3 times its June 30 book value and 20 times its FY-08 earnings; at 15.8 times its FY-09 earnings and 2.4 times the FY-09 book value.

Yes Bank is among the youngest and the fastest growing private banks in India. The stock trades at a premium to ICICI Bank and at a discount to private sector rivals such as HDFC Bank and Axis Bank.

The bank has high quality assets, small exposure to the retail segment (2 per cent), comfortable capital adequacy, high proportion of core non-interest income to total income and strong growth in advances and deposits in the current challenging scenario.

However, a relatively small proportion of low-cost deposits and limited branch network are curtailing the company’s retail banking growth opportunities.

Yes Bank is aggressively foraying into retail banking for deposits, while retail advances are not the focus. Its loan book is divided between corporate (57 per cent) and small and medium enterprises (41 per cent).

This loan mix holds the ability to weather the current high interest rate scenario with limited threat of slippage. Until 2007, the bank had no slippages, but in FY-08 and the Q1 of FY09 there has been an increase in delinquencies.

Financials

The 51 per cent earnings growth in Q1FY09 was much slower than the four preceding quarters when the earnings grew over 100 per cent. Yes Bank’s balance-sheet and advances have grown by 130 per cent (compounded annually) in the last four years ended March 2008, whereas the deposits grew at 170 per cent (annualised rate) in the same period.

The high growth in the past is partly attributable to the effect of a low base.

The going can get tough from hereon. In the recent quarter, the bank posted a deposit and advances growth of 45 per cent.

The deposit base declined sequentially as the bank has shed high-cost deposits but improved low-cost Current Account Savings Account (CASA) deposits. After phenomenal growth in FY08, with total income growing at 112.9 per cent, the June 2008 quarter saw a decline in growth. The bank’s net interest income grew at a healthy 122 per cent. However, the slow down in non-interest income as a result of decline in “income from financial markets” tempered the growth of the total income to 37 per cent in the June quarter.

Segments such as transaction banking, financial advisory and third-party product distribution have grown at a good pace to boost ‘other income’.

Improving net interest margin

Comparison on a sequential basis suggests that the bank has managed costs well, with cost of funds remaining flat at 8.4 per cent, despite hikes in CRR and repo rates during the quarter.

This may have been achieved through an improvement in CASA (at (8.9 per cent) by 96 per cent over the year. Improvement in gross yield on advances from 11.2 to 11.5 per cent (PLR was hiked during this period) helped in propping up the net interest margin of the bank to 2.88 per cent.

A Rs 22-crore provisioning was created for the bank’s mark-to-market loss in the available-for-sale bond portfolio. There was increase in gross NPA to Rs 21.3 crore and net NPA to Rs 17.4 crore, amounting to gross NPA/gross advance of 0.21 per cent and the net NPA proportion of 0.17 per cent.

The provision cover is low at 18 per cent but the bank is confident of recovering these advances. The bank has said that there has been no further loss in forex derivatives in the quarter in addition to the provision it made in the previous quarters.

The capital adequacy of Yes bank stands at 15 per cent after recent capital raising of Rs 564 crore. This will help the bank increase its asset base with ease this year. The credit-deposit ratio of the bank at 80 per cent is high but may come down as the balance-sheet expands.

Outlook

While the bank’s balance-sheet may see lower growth, it may nevertheless grow at a rate superior to its peers, given its aggressive moves in opening retail branches, targeting SMEs and also building corporate relationships. Yes Bank has 100 branches mostly in large cities and it is likely to add 17 more (it has already received licences to open these branches) this fiscal year, but in future the bank may have to look towards semi-urban and rural areas to continue growing at these rates.

Yes Bank also plans a foray into asset reconstruction business by the end of this year; this can boost its ‘other income’. The bank intends to increase its SME clientele to 1,000 by FY-09 and plans to add 5,000 customers under its Urban-Micro Finance programme.

The recent PLR hike to 17 per cent will cushion the bank from increasing cost of funds and maintain its net interest margins in the current quarter but there could be more slippages as the advances grow. The FII exposure of 28 per cent as of June 2008 exposes the stock to the risk of institutional liquidation.

Banks: Higher lending rates hold the key

Banks may not use any commodity inputs, but they have been in the pincer grip of rising costs as well. Rising interest rates, higher reserve requirements and the aggressive battle for market share have escalated costs for the banking sector in recent times. However, the performance of leading banks hasn't deteriorated sharply. Yes, banks' Net Interest Margins (NIM) have contracted due to the increased cost of funds, higher reserve requirements (due to CRR hikes) and yields on advances not rising in sync with costs. In the June quarter, HDFC Bank, Punjab National Bank and Kotak Mahindra Bank were better placed in terms of NIMs, while PSU banks have come off slightly worse, thanks to the cut in lending rates in February. Aggressive increases in lending rate in recent months, efforts to step up fee income and a more cautious stance on loans to riskier segments are the key ways in which banks are attempting to hold on to margins. For one, banks have hiked their PLR twice in as many months recently, to transfer the burden of higher costs to customers. The recent hikes in lending rates (as high as 150 basis points for some banks) more than made up for higher deposit rates and build in the possibility of future rate increases to some extent. Banks are also looking at other income (now 30 per cent of total income), from non-lending activities to bolster margins. This includes commission, exchange and brokerage and fees from distribution of 3rd party products, cross selling, advisory services and trading. Recently a few banks have increased fees on various services they are offering, also an effort to boost other income. Finally, banks are on an expansion spree, targeting areas where bank penetration is very low, for tapping into low-cost deposits. On the lending side, banks are aggressively targeting SMEs for their advances growth. Banks are also going slow on the advances that are more prone to default (personal loans, consumer durables) to prevent bad loans from escalating. M.V.S. SANTOSH KUMAR

Bank of Baroda: Hold

M. V. S. Santosh Kumar

Bank of Baroda (BoB) shareholders can consider staying invested in the stock at the current price of Rs 294.65. The stock trades at 1.13 times the company’s 2007-08 book value and 7.5 times the earnings, translating into 0.93 times the estimated book value for 2008-09.

As one of the larger public sector banks, BoB’s stock has performed better than most of its peers in 2008. What makes the bank attractive from an investment perspective is its diversified high quality loan book, high proportion of investments in the held-to-maturity (HTM) category, healthy proportion of low-cost deposits, specialised centres for retail and SME credit and extensive branch network which still remains under-leveraged.

The loan book comprises of 20 per cent loans to retail, 16 per cent to agriculture, 23 per cent to the corporate segment and 14 per cent to SMEs. International presence is important to BoB, as it contributes to 20 per cent of the total business.

Though the margins are lower in international branches, the diversified presence reduces risks related to a domestic credit slowdown. The bank intends opening 100 domestic and 10 overseas branches this fiscal, which may bolster low-cost deposits, advances and fee income.

Financials

The bank’s advances have increased at a 31 per cent compounded annual growth rate (CAGR) from FY04-FY08 and the credit-deposit ratio has improved from 51.2 to 77.3, indicating robust credit growth, with excess cash being deployed for lending instead of ending up as low-yield investments.

In the June 2008 quarter, the bank clocked a loan growth of 42 per cent year-on-year but could not translate this into equivalent growth in earnings. The cost-income reduced to 45 per cent from 51.5 per cent, indicating that the bank has efficiently managed costs in a challenging climate. Net interest income grew by 10 per cent and profit after tax by 12 per cent.

The low growth in profits can be attributed mainly to provisioning — mark-to-market loss on the bond portfolio, employee retirement benefits (AS-15), provision for credit-linked notes and arrears on employees salary towards impending pay revisions. In its investment portfolio, the bank has transferred a portion of its available-for-sale securities to the HTM category last quarter, which led to a relatively lower mark-to-market loss of Rs 180 crore.

The bank holds 68 per cent of its SLR investments in HTM portfolio. The bank’s net interest margin has come down to 2.76 per cent from 3.06 per cent due to increased cost of funds, reduction of lending rates in February and also rising interest rates which led to a fall in yields.

Low-cost current account savings account deposits (CASA) account for 36.86 per cent of the total deposits, which is quite high, which will act as cushion for the bank in a high interest rate scenario.

The government’s stake in BoB is 53.81 per cent; this may limit the bank’s capital raising options should a need arise to bolster capital adequacy. However, BoB is well-placed both on capital adequacy and NPA coverage. The capital adequacy is at a comfortable 13.19 per cent, which will help the bank grow its loan book aggressively. The bank’s NPA provisioning coverage is at 72 per cent, well above the RBI stipulated norms.

Outlook and risks

The bank’s financial performance has been good in these challenging times. Yet, there are risks to earnings from macro factors such as rising interest rates and reserve requirements. A rising CRR stipulation may affect the bank’s profitability as this yields no income to the bank. Technology upgradation is a challenge as it requires higher costs to upgrade the rural branches to CBS.

Overseas branch exposure to credit-linked notes, provisioning for bad loans and mark-to-market losses on AFS portfolio may dampen the bank’s profitability.

In this context, the NPA, as a proportion of advances, has decreased year-on-year, but increased slightly on a sequential basis, on the back of an aggressively growing loan book. There is a possibility of asset quality deteriorating if the current economic and financial conditions continue.

The bank has indicated its intention of re-pricing assets in interest-sensitive sectors, which might lead to higher yield on advances.

Business apart, the other trigger to the stock valuation may arise from a possible stake sale or IPO by UTI AMC (in which BoB holds a 25 per cent stake). Any successful turnaround of subsidiaries — BoB Capital markets, BoB Asset Management Company and BoB Credit Cards — may also lead to better valuations. Pioneer AMC has bought 51 per cent stake in BoB AMC.