Bankex falls prey to mkt mechanics: What's in store?

One sector where the sentiment has been fairly emphatic is the banking sector. Starting from the highs of January, as of now, there are several stocks that have lost upto 80% and some of them are very vulnerable names like ICICI Bank, Axis Bank and Bank of India. A whole host of extremely well run banks have seen some fairly steep losses, clearly the markets comment is on the sector and the macro economic environment and not individual stocks.

Kajal Jain, Chief Manager of Research at ICICI Direct, said even though stocks have been beaten down, one needs to wait for some more time because when earnings come in, there will be pressure on margins.

Tarun Bhatia, Head of Corporate and Government Ratings at CRISIL, believes the area which would be sensitive to ratings would be on the earnings side because the next 12 months could be difficult with rising cost on deposits and increasing credit costs.

SA Bhat, CMD of Indian Overseas Bank, sees interest rates going up further, but doesn't see banking sector margins being affected on any more rate hikes.

Excerpts from CNBC-TV18's exclusive interview with Kajal Jain, Tarun Bhatia, SA Bhat:

Q: There have been severe reverses for the banking sector in terms of the interest rate scenario, the possibility that it can damage, impair the quality of assets, reduce margins and also the farm loan waiver, a host of negatives have been impacting it; would you say now that the interest rate scenario is more or less in the price now and you are not expecting too many severe pressures on margins or on the interest rate itself?

Bhat: I have a feeling that interest rates will further go up. Reserve Bank of India (RBI) hasn't stopped the increase cycle so far, but according to me whatever be the RBI’s move, banking sector has already taken care to see that the margins are not affected.

Majority of our loans are below the prime lending rate (PLR) loans where the interest rate hike has already happened and to that extent, I don’t know why the markets should pull the banking stocks down the way they have done so far.

Q: Would would be the worries on account of treasury losses for one and more importantly impairment of assets as the yield curve or interest rates starts rising, surely there could be more victims in terms of inability to repay?

Bhat: As regards the treasury losses are concerned, these are only Mark-To-Market (MTM) losses - as and when the inflation comes down the situation corrects, my MTM losses gets converted back into profitability. Of course that will be below the line but my net profit will be affected in anyway. It may affect today but say after about 6-7 months, when the situation corrects it is going to come back to profitability.

As regards impairment, if you see majority of the banks have not raised their PLR (Public Lending Rate)-related interest rates, which affects the people in the bottom; people who are paying over the PLR and that’s where the delinquencies come more from. We have increased it only recently and we have been fairly conservative in increasing the interest rates there to see that unnecessarily we are not penalizing the people, who are paying us good interest and we are not trying to jeopardize their industry in anyway. So according to me, some pick-up in the delinquency may happen but I don’t think it will be on the marginal, I don’t really see it affecting the biking industry very badly.

Q: Come in on this, the rating that you are giving out on banks currently, given the current environment on interest rate and also on credit quality?

Bhatia: We need to keep two aspects in mind; clearly this is a relatively difficult phase as compared to what we have seen 2-3 years back because we expect credit growth to slow down and it has already slowed down in 2007-08 to around 22% and it could be below 20% and the cost of borrowing is going up with deposit rates being increased. In the market, the tenure of deposits has already shortened in the last two years and so there is continuous need to refinance. So we expect earnings pressure to be on the banks.

On the ratings front, with respect to public sector banks or private banks, the biggest comfort we enjoy is on terms of capitalisation. Most banks on the private side were able to raise significant amount of capital last year, which enables them to manage both asset side risk and grow as and when opportunity is available. 

In case of public sector banks, the asset side risk appears relatively lower because the pressure is on the retail assets much more with rising interest rates and private sectors banks have 50% of their assets on the retail side whereas public sector banks have around 25%.

For us the bigger area where we would be more careful and which would be sensitive to the ratings would be on the earnings side because we believe the next 12 months could be difficult with rising cost on deposits and increasing credit costs.

Q4: Do you think the bankex are adequately reflecting the troubles that the sector is going through. Do you think they have been beaten down beyond and are now good cherry picking opportunities?

Jain: I am not denying the fact that stocks have been beaten down very badly, but I would say we still need to wait for sometime because when earnings will come in we'll see the pressure in the margins. How much of the pressure in this MTM provisioning will be there? So all these things are definitely impacting earnings and may go on for couple of more quarters. Also what RBI will continue on the tightening front, all these measures will impact the margins. So basically not all the banks, which have been beaten down, will be good.

I think there will be banks with higher Current Account and Savings Account (CASA) like HDFC Bank, PNB and those banks that will have higher CASA, at the same time also enjoy higher margins will be able to survive this current crash. Those one’s could come out as best picks. There will be value picks in public sector banks also, but since they don't have great CASA or margins and will have a good Held to Maturity (HTM) mark-to-mark hit also, in that scenario I would take some more time and will then pick up stocks across the board in the banking sector.

Q5: The worries that Bhatia raised about the possibility of retail assets being more impacted because of rate hikes, If you look at impairment of assets and the likely impairment of assetsm what would be your choice? Are you all putting out any buys in any of the banking stocks at all?

Jain: We did put a buy on State Bank of India (SBI), and recently Bank of India (BoI); in banking we have to see the scale, even if there are assets impairment, that is expected to happen soon, so if the scale is enough to manage those, they will be able to survive those asset impairment losses also.

But if the bank is too small in size, then those losses can turn out to be negative for them. So we have come out with recent buys on SBI. We think Indian Overseas Bank at these levels is also a value pick because it gives a high Return on Equity (RoE) and has good CASA. But certainly PNB comes out to be a much larger beneficiary.

Q: You are a veteran of the Asset Liability Management (ALM) balances of several banks - not just the one you are now heading. What would your views be on the PSU banking space as a whole - there are well-run banks and well-managed asset liability balances and not so well managed one’s, will the banking sector definitely end up with a higher Non Performing Asset (NPA) ratio in he current year or by FY10?

Bhat: To the best of my knowledge, I feel that banking sector will not end up with too much of a high NPA ratio. In fact majority of the banks according to me should have a lower NPA ratio because the NPA in the agricultural sector, which was there, and standing outstanding in the books of the banks is going to be wiped off, with the recovery that is going to be affected out of the debt recovery scheme of the government. So to that extent, my percentage will come down and whatever slippages occur in case of retail sector - basically coming from housing loans because the housing loans are going up. Majority of the banks have not increased the housing loan rates for old accounts or if they have risen, they have raised it marginally and they are willing to extend the repayment schedule. So to that extent, there could not be much of a fear of delinquency there.

In the case of SMEs also, I don’t think SMEs also are going to sink to the extent that the market is feeling that they will sink. Economy is growing at a reasonably good pace at around 7.5-8%; it is not a small growth rate. So the delinquencies even if they happen, I think majority of the banks will be able to take care of that and the overall percentage wise we should be at the same level or slightly better than what we had as upto ’08.