RBI Policy Review | Banking

October 25, 2011

RBI Monetary Policy Review

Signaling the peak
Repo rate hike Likely to be the last in the current cycle
The Reserve Bank of India (RBI), in its second quarter review of the monetary policy, persevered with its anti-inflationary stance and raised repo rate by 25bp to 8.5%. The Central Bank maintained status quo on CRR and SLR at 6.0% and 24.0%, respectively. The policy action was in-line with ours and streets expectations. However, importantly, this policy also carried guidance to the effect that in light of the expected inflation and growth trajectory in the coming months, the probability of further rate hikes by the RBI is quite low. We have also held the view that policy rates are close to peak levels; but with this policy, the RBI has increased the certainty that interest rates have now peaked. In our view, the actual decline in policy rates is unlikely until the RBI becomes quite confident that inflationary expectations are well anchored. In any case, term deposit rates are unlikely to go up from current levels, although banks may likely wait till the end of the busy season and a material decline in FD rates may happen from April 2012. In our view, this signaling of the peaking of policy rates removes a key overhang on the outlook for FY2013 Sensex earnings, provided incrementally inflationary pressures do not re-emerge. The likelihood of the latter happening also looks slim, considering that global commodity prices are also cooling off as evidenced in the decline in the CRB Index. The recent trend in the movement of the Reuters CRB Index suggests moderation in headline WPI inflation from December 2011. Over the past five years, there has been ~90% positive correlation between the yoy change in monthly average of the Reuters CRB Index and headline WPI inflation numbers with a three-month lag. The yoy rise in Reuters CRB Index has halved from 32.0% in June 2011 (which has reflected in WPI inflation numbers for September 2011) to just 4.3% during October 2011 MTD (expected to reflect in domestic inflation numbers from January 2012). Also, the impact of the previous monetary tightening is yet to flow through fully, in our view. Hence, we expect headline inflation to start moderating from December 2011 onwards.

Vaibhav Agrawal
022 3935 7800 Ext: 6808 vaibhav.agrawal@angelbroking.com

Shrinivas Bhutda
022 3935 7800 Ext: 6845 shrinivas.bhutda@angelbroking.com

Varun Varma
022 3935 7800 Ext: 6847 varun.varma@angelbroking.com

Exhibit 1: Fall in Reuters CRB to drive inflation lower

YoY rise in Avg Reuters CRB Index (%) 60.0 45.0 30.0 15.0 (15.0) (30.0) (45.0) (60.0) WPI inflation 3 month lag (%, RHS) 12.0 10.0 8.0 6.0 4.0 2.0 (2.0)

Sep-07

Sep-08

Sep-09

Sep-10

May-07

May-08

May-09

May-10

Source: MOSPI, Bloomberg, Angel Research; Note: WPI inflation forecasted figures from October 2011, based on historical correlation with Reuters CRB Index

Please refer to important disclosures at the end of this report

May-11

Sep-11

Jan-08

Jan-09

Jan-10

Jan-11

RBI Policy Review

Savings rate deregulation

Impact on retail deposit market share: In our view, high savings account balances (and their proportion in the total deposit base) are indicative of a larger retail customer base for any bank. In our view, the advantage of having a higher proportion of retail funding will remain, irrespective of savings rate deregulation. The deregulation will provide an additional tool for newer private banks (small as well as large) to acquire customers by more targeted customer segmentation and product attributes. Also, like in the case of FDs, smaller banks are likely to offer 50-100bp higher rates to try to attract customers. That said, in our view, public trust and a wider network reach will remain the key factors in maintaining/gaining retail customer market share and, hence, we would not expect any material change in market share dynamics due to savings rate deregulation. Longer-term impact on profitability: In our view, the advantage of savings accounts being low-cost deposits will remain, irrespective of savings rate deregulation. However, the advantage of savings accounts being fixed rate deposits will clearly vanish and this, we believe, is the key negative impact of savings rate deregulation. In the context of the Indian banking system, the negative impact of compulsory SLR investments, which are at a fixed coupon rate, was managed by banks by virtue of corresponding fixed rate CASA deposits on the liability side. Hence, in a rising interest rate environment, there was some extent of matching in terms of interest re-pricing buckets by having fixed rate SLR investments countered by fixed rate CASA. This advantage was clearly more so in case of high savings banks which will now erode. We have accordingly recalibrated our target multiples to an extent, as we believe that the premium commanded by the larger, high savings banks (HDFC Bank amongst private banks and SBI and PNB amongst PSU banks) will marginally erode. While, at the other end of the spectrum, the disadvantage of having relatively lesser share of low-cost funding will reduce to an extent for low savings banks (such as Yes Bank). Immediate impact on profitability: Since, the savings rate has been deregulated at what we view as the peak of the interest rate cycle, wherein the gap between FD rates and savings rate is at its widest, the above-mentioned impact of deregulation on profitability is likely to be immediately felt in the next two quarters itself on near-term earnings as well. In our view, to the extent that there is some scope for the average cost of savings accounts to increase, we believe the average impact on the overall banking sector would get passed on to customers. As per our calculations, a 1% increase in savings rate would have a 20bp impact on the total cost of funds for the sector as a whole and is likely to get passed on to a large extent in the form of lending rate hikes and/or a cut in FD rates. We have assumed 75% of the incremental costs to be passed on to customers in our scenario analysis. Evidently, for banks with a higher proportion of savings account balances, the impact on total cost of funds will be higher and, in our view, this incremental impact could be reflected in NIM compression in the near-term itself. As per our scenario analysis, the highest percentage impact on PBT in case of larger banks would be for banks such as SBI, PNB and Union Bank of India from the PSU space and HDFC Bank from the private banking universe; and in case of smaller banks, it would be for United Bank of India, Bank of Maharashtra, Central Bank of India and Dena Bank. While the PBT impact for some of the PSU banks appears the highest, at the same time most of their savings accounts balances are from the rural hinterland where the concerned banks have minimal competition and which in the near-term could shield the impact on their cost of funds from this development.
October 25, 2011

RBI Policy Review

As a corollary impact of the savings deregulation, we believe it will become all the more unattractive for banks to hold any excess SLR and, hence, we maintain an upward bias on government bond yields, which is likely to be exacerbated by this development. This will increase the negative earnings impact on banks with a higher proportion of high-duration SLR holdings in the AFS segment. We have recalibrated our target P/ABV multiples for this change in regulation and will look to revise earnings estimates depending on the actual changes in rates in the coming weeks. In our view, among banks that are expected to gain the most from this move will be new-age banks such as Yes Bank. These banks will also gain from further liberalization of branch-licensing norms, in terms of not requiring RBI approval for opening branches in Tier 2 to Tier 6 centers. We maintain our Buy recommendation on Yes Bank with a target price of `347, implying an upside of 23.4% from current levels. Amongst the PSU banks, the banks that stand to benefit the most include Corporation Bank on which we maintain our Buy rating with a target price of `489, implying an upside of 20.8%.

Exhibit 2: Scenario analysis for savings rate deregulation

Bank SBI BOM UTDBK J&KBK DENABK PNB HDFCBK ALLBK CENTBK INDBK UNBK SYNBK ICICIBK BOB AXSB ANDHBK CANBK FEDBK BOI VIJAYA IOB SIB UCOBK OBC CRPBK IDBI YESBK Coverage SA as a % of Deposits (FY2011) 35.4 30.6 29.8 28.5 27.0 29.9 30.4 26.5 26.6 24.8 22.1 23.0 29.6 21.1 21.6 21.3 19.9 21.3 19.8 18.2 22.1 17.5 16.8 17.8 13.9 7.7 1.8 25.0 PBT impact as a bp of average assets Inc. Impact as a % of FY2013E PBT

4.5
(6) (6) (5) (5) (4) (4) (4) (4) (3) (3) (2) (2) (1) (1) (1) (1) (1) (1) (1) (1) (0) (0) (0) (0) 2 4 7 (3)

5.0
(13) (11) (11) (10) (8) (8) (8) (7) (7) (6) (4) (4) (3) (2) (2) (2) (2) (2) (1) (1) (1) (1) (0) (0) 4 8 13 (5)

5.5
(19) (17) (16) (16) (13) (12) (12) (11) (10) (9) (6) (6) (4) (4) (3) (3) (3) (3) (2) (2) (1) (1) (1) (0) 6 12 20 (8)

6.0
(26) (22) (21) (21) (17) (17) (16) (15) (14) (12) (8) (8) (6) (5) (4) (4) (3) (3) (3) (2) (2) (2) (1) (0) 8 16 27 (10)

4.5
(4.2) (5.6) (6.1) (3.0) (3.7) (2.8) (1.5) (2.9) (4.2) (1.8) (1.7) (2.0) (0.7) (0.7) (0.5) (0.9) (0.7) (0.5) (0.6) (0.8) (0.5) (0.3) (0.2) (0.1) 1.6 4.0 3.6 (1.7)

5.0
(8.5) (11.3) (12.1) (6.0) (7.3) (5.5) (3.1) (5.8) (8.3) (3.6) (3.5) (4.0) (1.4) (1.5) (1.0) (1.7) (1.3) (1.0) (1.3) (1.6) (0.9) (0.6) (0.4) (0.1) 3.2 8.1 7.2 (3.5)

5.5
(12.7) (16.9) (18.2) (8.9) (11.0) (8.3) (4.6) (8.6) (12.5) (5.5) (5.2) (6.1) (2.1) (2.2) (1.6) (2.6) (2.0) (1.4) (1.9) (2.5) (1.4) (0.9) (0.6) (0.2) 4.8 12.1 10.8 (5.2)

6.0
(17.0) (22.6) (24.3) (11.9) (14.7) (11.1) (6.1) (11.5) (16.6) (7.3) (6.9) (8.1) (2.8) (3.0) (2.1) (3.4) (2.6) (1.9) (2.5) (3.3) (1.8) (1.2) (0.8) (0.3) 6.4 16.2 14.3 (6.9)

Source: Company, Angel Research; Note: SA: Saving Account, scenario analysis is a based on various saving interest rates

October 25, 2011

RBI Policy Review

Exhibit 3: Recommendation summary

Company AxisBk FedBk HDFCBk ICICIBk* SIB YesBk AllBk AndhBk BOB BOI BOM CanBk CentBk CorpBk DenaBk IDBI# IndBk IOB J&KBk OBC PNB SBI* SynBk UcoBk UnionBk UtdBk VijBk Reco. Buy Buy Neutral Buy Accumulate Buy Accumulate Neutral Buy Accumulate Accumulate Accumulate Neutral Buy Neutral Neutral Accumulate Neutral Neutral Accumulate Accumulate Buy Buy Neutral Accumulate Accumulate Neutral CMP (`) 1,169 384 484 869 23 282 147 114 736 323 49 440 100 405 72 103 207 97 817 282 971 1,908 101 67 212 71 52 Tgt. price (`) 1,414 444 1,102 24 347 169 871 362 55 463 489 220 314 1,085 2,267 123 238 82 Upside (%) 21.0 15.7 26.8 6.2 23.4 14.7 18.3 12.1 13.7 5.2 20.8 6.1 11.5 11.8 18.8 22.3 12.3 14.6 FY2013E P/ABV (x) 1.9 1.0 3.3 1.6 1.1 1.8 0.7 0.8 1.0 0.9 0.6 0.9 0.7 0.6 0.5 0.7 0.8 0.6 0.9 0.7 1.1 1.4 0.7 0.8 0.8 0.6 0.7 FY2013E Tgt. P/ABV (x) 2.3 1.2 2.0 1.2 2.2 0.8 1.2 1.0 0.7 0.9 0.8 0.9 0.7 1.3 1.7 0.8 0.9 0.7 FY2013E P/E (x) 10.2 7.8 16.9 12.6 6.7 9.3 4.1 5.2 5.6 5.3 4.2 5.1 4.9 4.1 3.5 4.9 5.3 3.9 5.7 4.9 6.0 7.3 4.4 4.1 4.8 4.3 6.4 FY2011-13E EPS CAGR (%) 17.7 19.5 30.5 24.1 15.6 19.9 8.9 (0.9) 10.6 15.2 38.1 (2.8) (14.6) 2.3 5.8 12.3 0.2 20.3 6.7 5.4 7.2 41.4 11.8 14.0 5.2 11.7 (3.2) FY2013E RoA (%) 1.5 1.2 1.7 1.4 1.0 1.3 0.9 0.9 1.1 0.7 0.6 0.9 0.5 0.8 0.8 0.7 1.1 0.6 1.2 0.8 1.0 1.0 0.7 0.6 0.8 0.6 0.4 FY2013E RoE (%) 20.0 14.0 20.9 15.6 18.2 20.8 17.7 15.8 19.6 17.1 16.5 17.1 14.2 16.8 16.2 14.0 17.4 15.9 16.4 13.9 20.0 21.9 16.3 16.5 17.0 13.8 10.5

Source: Company, Angel Research; Note:*Target multiples=SOTP Target Price/ABV (including subsidiaries), #Without adjusting for SASF

October 25, 2011

RBI Policy Review

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October 25, 2011

RBI Policy Review

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October 25, 2011