Strong Capital Base A strong capital base is the number one issue to consider before investing in a lender.

Almost all the private banks managed to raise adequate funds in 2007 and thus maintain Capital Adequacy ratios in FY08 well above the mandatory nine percent stipulated by RBI. None of the banks seem to be very highly leveraged either, with SBI being on the higher side. (An average bank has a Financial Leverage of 12x as compared to 2x or 3x for a non-financial company.) However the NPA (Non-Performing Assets) levels tell a story as well. ICICI Bank ( IBN) stands out with the poorest record on NPAs, and given the overall deteriorating credit quality scenario (due to the slowing economy), should give investors cause for concern. On the flip side, Yes Bank in particular, Axis Bank, and HDFC Bank (HDB) are managing NPA levels nicely. The provisioning coverage ratio (Provision Expense/Gross NPAs) reveals much more. While HDFC Bank (HDB) lives up to its conservative image with a high provision cover of 241 percent, ICICI Bank ( IBN) has the lowest provision coverage at ~54 percent, lower than even PSU State Bank of India. However the best record here belongs to the smallest, Yes Bank. Return on Equity (RoE) and Return on Assets (RoA) These metrics are the de-facto standards for gauging bank profitability. Generally investors should look for midto high-teen returns on equity. It is easy to boost a bank's earnings in the short term by under-provisioning or leveraging up the balance sheet, which can be unduly risky over the long term. For this reason, it is good to see a high level of return on assets as well. For banks, a top RoA is in the 1.2 to 1.4 percent range There are only three levers for boosting ROE: Net Margin, Asset Turnover and Financial Leverage. Again, among all the private banks, ICICI Bank ( IBN) has the poorest record. As we can see, it is the dismal net margin (~5% ) that has resulted in such poor Return on Equity (~8%) and Return on Asset (~0.7%) ratios. Again, Yes Bank shines bright with the best RoEs and the best ROAs followed by HDFC Bank ( HDB), closely followed by surprisingly, State Bank of India. Efficiency Ratio The efficiency ratio, or cost to income ratio, measures non -interest expenses, or operating costs, as a percentage of income. Basically it tells you how efficientl y the bank is managed. Many good banks have efficiency ratios under 55% (the lower the better). Again, Yes Bank presents the best record on cost efficiency among the private banks. What is remarkable is the way Yes Bank has shown significant improvement in cost-efficiency levels over the years. From a high of 83% in FY06, Operating costs as a percentage of Total Income has progressively come down, year on year, to 29.5% in FY08. State Bank is the biggest surprise here, coming in second at ~36%, with Axis Bank following closely behind. Both HDFC Bank (HDB) at 48% and ICICI Bank (IBN) at 51% are way behind the others in this sector. Net Interest Margins (NIM) Another simple measure to watch is net interest margin, which looks at net interest income as a perc entage of average earning assets. Track margins over time to get a feel for the trend. This is where HDFC Bank's (HDB) NIM record is unmatched. It's the reason why it is valued so highly. A consistently high NIM of over 4% for several years takes some doing, especially in the rising interest scenario that we witnessed in the last few years in India. What is also n otable is how Net Interest Income as a percentage of Total Assets has improved over the years. Axis Bank comes in a creditable second, followed by what is no longer a surprise, State Bank of India. Strong Revenues

Historically many of the best-performing bank investments have been those that have proven capable of aboveaverage revenue growth. Yes Bank has been growing at a scorching pace for the last four years, albeit on a much small er base. This shows in the overall growth track record of over 225 percent CAGR over four years. What is also commendable is that Interest Income as a percentage of Total Assets has been steadily rising. FY08 levels are at 7.72%, beating HDFC Bank's (HDB) 7.6%. Other private banks like HDFC Bank ( HDB) and Axis Bank have maintained a very decent growth rate in excess of 40%. ICICI Bank has also clocked a growth rate of over 44%. However that growth has come at the cost of rising NPAs and declining margins and profitability. Price to Book Because a banks balance sheet consists mostly of financial assets with varying degrees of liquidity, book value is a good proxy for the value of a banking stock. Also, many of the assets included in their book value are marked-to-marketin other words, they are revalued every quarter to reflect shifts in the marketplace, which means that book value is reasonably current. So the base value for a bank should be the book value. Any premium over that, investors are paying for future growth and excess earnings. Typically big reputed banks trade at 2x to 4x book value. Yes Bank is currently (Mar 30, 2009) trading at 1.12 Book Value, historically at its lowest levels in the last 4 years. Similarly on a price-to-earnings measure, it is quoting at 5x TTM earnings, again historically the lowest levels in 4 years. State Bank of India too is quoting at 1.05x Book Value. It is significant to note that the two banks - Yes Bank and SBI - have the best RoE records, with 18.34% and 16.78% respectively. With low P/B relative to their peers but with t he highest RoEs, Yes Bank and SBI are potential bargains, but we will want to do some gold digging. P/BV and RoE have a very strong correlation for Bank stocks as mentioned in 1. Valuing Financial Services Firms Fig 216, pp 37-38 and 2. The Five Rules for Successful Stock Investing, Valuation -The Basics chapter, pp 130-131 While we need to dig deeper to make sure, it is promising to see that Yes Bank in particular, and State Bank too, have impressive records on some of the most important metrics for bank stocks, as we have seen from the above Indian private banks comparison. Overall Verdict There might be some big concerns on derivatives exposures and other contingent liabilities that are not reflected in this snapshot. However, if you are to choose between the two U.S.-listed Indian banks, ICICI Bank ( IBN) and HDFC Bank (HDB), HDFC Bank is the clear winner. It has grown at a similar 40% plus five -year CAGR to ICICI bank, maintaining high RoEs. In fact, it has the best RoA record, at 1.42%, among all Indian banks. Its NIM record is unmatched, and to its credit, it has proven conservative in managing and provisioning for NPAs.

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