Banks to buckle under margin pressure; buy ICICI: Kotak

Banks are going to see pressure on margins in the next couple of quarters says MB Mahesh of Kotak Institutional Equities. He feels State bank of India (SBI) will lead the pressure because of its huge size it has been growing its balance sheet aggressively.

Getting investors feedback from the Kotak BFSI conference that kicks off today, Mahesh says, "The confidence to get back into public sector banks has still not come in. Barring the interest rate outlook which seems to have softened a bit over the last quarter, there doesn't seem very strong argument to get back at least in the public sector banks."
In case of private sector banks, most of them are continuing to hold their positions rather than taking a very strong call on increasing exposure, he says.
Among private sector banks, he is bullish on ICICI Bank after its recent correction. He advises caution on SBI as the bank is likely to face asset quality issues. Below is the verbatim transcript of MB Mahesh's interview on CNBC-TV18 Q: State Bank of India (SBI) has been a big talking point last week. There is a bit of a concerning trend in the entire banking sector after SBI reported de-growth of 5 percent in the net interest income. Do you think many of these banks are trying to grow their loan book aggressively at the cost of margins and will be a trend for a couple of quarters?
A: Our call on this space has always been that they have slowed down over the last two years. The corporate loan book of most of the banks is running a bit dry, so the investment pipeline has come to a complete halt. There will be pressure for at least the pubic sector banks who have a skewed loan book towards corporate side to chase some of these assets.
Some of these banks could chase because they have pressure on asset quality so look forward for some of these high quality, low yielding assets. Also, you could have some of these banks who are having their entire investment pipeline coming to a complete halt. Therefore, with respect to some of the actions that we are seeing today, whether it is in the form of SBI or any other bank in the next couple of quarters, you are going to see pressure on margins coming in for the entire sector.
SBI is leading because for a bank of this size, it has been growing its balance sheet aggressively. Therefore, the pressure is lot more than what we are seeing in some of the other banks. Q: You have an add rating on SBI but do you think there will be some amount of change in your rating if in case there would be a significant change in the asset quality? For example, do you expect the gross non-performing assets (NPAs) to be below 5 percent going forward?
A: If one looks at loan impairment as a parameter of how the asset quality looks like, one notices that to some extent the NPAs that we are seeing in some of these banks have kind of slowed down, at least the fresh accretions. But the slowdown is not being seen in the restructured book. In the next couple of quarters or over the course of one year, one will start seeing some of these very large ticket infrastructure assets showing some level of strength in the bank’s balance sheet.
SBI will not be an exception to it given the nature of this balance sheet that has got a large share of infrastructure assets. So, whether the entire public sector banks or to some extent some of the large private sector banks, one should see the loan impairment level at least to remain at these levels or slightly inch up from hereon. On asset quality, we will continue to remain cautious for FY14.
_PAGEBREAK_ Q: Apart from SBI, which are the other public sector undertaking (PSU) banks that you would be most concerned about where asset quality pressures could continue?
A: The structure of this balance sheet is inherently skewed towards corporate so the entire public sector banks would be facing this trouble in 2014. Therefore, one does not have a very positive outlook in the entire space at this point of time. However, if you look at private sector banks then you have banks like ICICI Bank and Axis Bank who have bought a fairly high share of their assets in infrastructure assets. So, you would be broadly cautious on the entire space and within public sector banks our preference has been towards SBI because it has a model, which is slightly more flexible moving towards retail as compared to some of the other public sector banks. Q: Regarding private sector banks, you came out with a report on Yes Bank as well where you mentioned that it is an opportune time to exit the stock. What will make you cautious on private banks such as Yes Bank and what would your top picks be with the private banking space?
A: The problem with private sector banks is that on valuation side, they are on the higher side as compared to what public sector banks have. Therefore, if one looks at the differential valuation then one is seeing at peak level today. However, if one looks at some of the assets, some of these banks are yet to see any loan impairments hitting their balance sheet. Since our call has been to be cautious, especially in this particular space, the valuation may not hold up if one starts to see some level of slippages in their underlying asset quality.
With respect to some of these banks, like Yes Bank has been that we need to see their balance sheet lot more stronger than what it is today, their tier one ratio is just above 9 percent but the core is a tad below 9 percent. If they have a stronger balance sheet, which can withstand if there is any level of loan impairments hitting them in the course of one year, then one would relook at some of these banks. But for some of the other private sector banks, the call has been the cautious outlook on asset quality which is driving our rating at this point of time. Q: Which are you top picks in the banking space. What are your target prices and what kind of a time horizon are you looking at?
A: In the private sector banks at this point in time, we like ICICI Bank at these levels. The recent correction gave a little bit of comfort to look at this tock again.
In the public sector banks we like SBI, but if one goes beyond that, then there is no specific order of preference anywhere in the entire public sector banks.
In the private sector banks barring ICICI Bank, we do not have a very strong preference anywhere in the entire space. Q: What about the conference in general. In terms of your interaction with investors who are participating in the conference, what do you think their preference is within the banking space? Are they more cautious towards public banks? Do you think there is some preference towards public banks due to valuation difference between private and public banking space?
A: The feedback that we are receiving from investors is that at least the confidence to get back into public sector banks has still not come in. Barring the interest rate outlook which seems to have softened a bit over the last quarter, there doesn’t seem very strong argument to get back at least in the public sector banks. Private sector banks, most of them are continuing to hold their positions rather than taking a very strong call of increasing our exposure here.