See 50-bps rate cut by Feb; value in PSU banks: Experts

Although the Sensex is down 5% this month, the Bank Nifty is down only 0.8% - in fact it is up nearly 20% in last two months and a large part of this is could be on account of a sharp fall in bond yields and hopes of a rate cut by the Reserve Bank of India early next year. Ashutoh Khajuria, president-treasury, Federal Bank and Vaibhav Agarwal, vice president- banking research, Angel Broking in an interview to CNBC-TV18 shared their opinion and outlook on the 10-year yield, the Bank Nifty and banking stocks.According to Ashutosh Khajuria the market seems to have already discounted a 50 basis points rate cut by RBI and so the 10-year yield is likely to remain range bound around current levels of 7.75 percent because the risk reward trade off at that levels is very high towards risk.Vaibhav Agrawal expects interest rates to have a downward bias. He sees value in PSU banks like Canara Bank, PNB and from the smaller PSU banks Allahabad Bank, OBC and Vijaya Bank. He thinks they are likely to gain if yields fall. "All these banks are looking interesting at this point and we do have a buy on them," he addsBelow is the transcript of Vaibhav Agrawal and Ashutosh Khajuria with CNBC-TV18's Menaka Doshi and Anuj Singhal.Anuj: We have seen quite a bit of inflows into debt market this year, in fact exceeding the equity markets. Do you think Indian debt is still attractive and would you expect some more inflows?Khajuria: We never saw this type of inflow happening in debt market. All through the calendar year debt inflows had been having an edge over equity in flows. In fact equity inflows were at all-time high in 2010. This year despite such healthy inflows coming into equity market, it has not surpassed that level and neither have they surpassed the 2012 levels, whereas inflows into debt have been almost 1.6-1.8 times of equity inflows and that was because the mood was getting built up on interest rate softening. All those who have entered the market even as late as last week of September would really be smiling all the way because on September 30, the 10-year benchmark yield was around 8.51 percent and we are presently at about 7.78-7.84 percent range, that was days range 7.78 on one end and 7.84 current rate (around 3:10 pm). So, it is almost 70 basis points movement in less than three months. So, there is good money to make and those who have invested earlier definitely would be trying to encash part of it as profits before the calendar year sets off.Anuj: What would have led to today's jump in yields intraday?Khajuria: The fall in yield was because of WPI being lower than what the market was expecting by more than 100 basis points. Market was expecting it to be around 1 percent or so because of base effect and oil softening. In the later part of the day one news item came wherein PDs, their limit of keeping bonds in held-to-maturity (HTM) have been slashed by half. So, instead of Rs 200 crore they can keep now only Rs 100 crore or so. So, that could be one of the reasons wherein they just can't park it in a portfolio where they are not required to mark-to-market. In fact if they buy at these levels they will have to mark-to-market it and that could be one of the sort of refrain for the traders to really fully absorb the news and see what could be the impact of it. I see that as one of the reasons for this, and also the overall rupee weakness to impact the bond market. The weakening the way it has happened in last 3-4 sessions is really not so good for bond markets and that could be partly because some people may be booking profits and taking away the green bags.Menaka: So using all these news triggers - the circular that came in a short while ago with regards to what you can hold in terms of your portfolio held to maturity, the rupee weakness and the fact that at various levels Indian debt continues to look very attractive - what is your short, medium and long term assessment of where the 10-year yield will be not withstanding any cut or no cut from the RBI over the next 1-3 months? Khajuria: The first reversal of trend that happened in 2003-04 wherein all the way from 14 percent in 1995-1996, 10-year benchmark had gone to as low as 4.96 percent in October 2003 and from thereon you saw the reversal because we had been seeing secular fall of yield for almost 8-9 years and thereafter we saw the rise in it. If you just see the pattern 10-year benchmark vis-à-vis the policy rate, earlier it used to be reverse repo rate because market was in liquidity mode but now since we have a single policy rate and that is repo rate the spread between the policy signalling rate and 10-year benchmark ranges between 30-70 basis points. However right now it is negative. It has gone below it. That means market has already discounted at least 50-basis points of rate cut. In medium term if you ask me it is quite likely that the monetary authority starts with a cut of 50 basis points itself as early as February.So, if that be the case there is not much of a scope for yield to further fall from here. So, anytime it inches towards 7.75 percent there could be a fear creeping in whether to buy at those levels or not.Menaka: So, you are saying moving further lower from here onwards is unlikely in your assessment unless ofcourse there is a degree of certainty that the RBI is going to cut rates or at the point when RBI cut rates. So, the 10 year yield will stay range bound at this level is your expectation?Khajuria: That is what I am saying because the risk reward trade off at around 7.75 percent is very high towards risk. Even if the cut happens from 8 percent and goes to 7.50 percent, for a 10-year benchmark you should have normally a 30-35 basis points higher than that. So, if 7.50 percent is your new policy rate assuming that the cut is of the order of 50 basis points, your 7.80 percent doesn’t give you much scope to really fall. I would say because of euphoria, because of the expectation being much more than 15 days to come I don’t think in next 6 months it should be more than 50 basis points, I mean upto June if I may say so. Thereafter, we can have another 50 basis points in the second half of the calendar year 2015. So, if that be the case I think at 7.78 percent the risk of buying at those levels would be really high and that could have seen the reversal from that particular point.

Anuj: It has been quite a bit of rally that we have seen already in Public Sector Undertakings (PSU) banks but do you see more gains over the next few days and if yes, what would be your top picks?Agrawal: Yes, clearly we still feel that there is value especially in the PSU banks space. They typically do benefit in a declining interest rate environment as they have lesser Current Account and Saving Account (CASA) so more FDs as well as more of bond book. So, on both sides of the balance sheet they start benefitting more than the private banks.In our view although there has been a rally but even now we believe there is value. We expect interest rates to continue to have a downwards bias and at the same time lower interest rates, lower inflation will eventually also lead in the Gross Domestic Product (GDP) growth cycle where again benefits of asset quality improving etc will start kicking in. So from that point of view we remain quite positive on the banking sector including a large part of the PSU space as well.

_PAGEBREAK_Menaka: Can you quantify for us how you see treasury profits moving up and therefore the impact on the financials of these banks, at least in the next two quarters. We heard from the State Bank of India (SBI) chief today and she did also allude to the fact that treasury profits are looking better now?Agrawal: Very clearly looking at even their September ending AFS investment book positions for the various PSU banks ranging from the smaller banks like Vijaya Bank etc could gain anywhere between Rs 250-300 crore in terms of gains. In terms of as a percent of their assets as well it would be a gain of almost 20-25 basis points of assets ranging up to the larger banks even closer to Rs 800-900 crore gains.

Maybe not all of it would get accounted in third quarter - there are accounting policies related to that but eventually that gain is coming and it will come in either in the form of gains or Net Interest Margin (NIM) improvement. So clearly there is a pretty large amount of benefit that is going to come in from these falling bond yields.Menaka: So if you were to name the banks that stand to gain the most let’s say the top three ones and whether you are revising price targets on these banks based on this improvement on this improvement on these treasury profits what would that list have?Agrawal: In the larger PSU banks the biggest gainers would be banks like Canara Bank, they do have large investment book and at the same time they do rely more on FDs more than other banks. So Canara Bank would be one, even Punjab National Bank (PNB) would benefit at least on its very large bond book.