See Rs 20Kcr inflows due to higher insurance FDI: Macquarie

Latha: What is your take on the legislative victory for the Bharatiya Janata Party (BJP) yesterday? Is this very big for the stocks that are listed?

A: If you look at some of the banks, their contribution of life insurance to the banking overall, some of us is not that great maybe at the most 4-5 percent of the value comes from life insurance business but some of the non banking financial companies (NBFCs) like Max India and Reliance Capital, of course the contribution of life insurance is higher.

This definitely is a positive move because all the analysts are struggling to value these life insurance companies in the absence of disclosure. However, there will be some transparency in the market, the valuation benchmark being established and better disclosures on things like embedded value which establishes a proper valuation benchmark or reference point and overall the foreign capital will come into the country which is considered to be positive. 

Sonia: Talking a bit about foreign capital, we were speaking with Jayant Sinha yesterday and he pointed out that to increase the insurance penetration from 3 to 6 percent, Rs 40,000 to 50,000 crore is needed and if 49 percent of that comes from foreign direct investment (FDI) then we are looking at something to the tune of around Rs 20,000 crore-25,000 crore. Do you think this is realistic estimate and something that can come in?

A: It is pretty much reasonable because for example if you were to look at the top two life insurance companies in the private sector which is ICICI and HDFC, both put together are valued between Rs 60,000 crore and Rs 70,000 crore. However, to assume 20 percent of that money is going to be contributed by the foreign partner, easily will get Rs 12,000 crore-13,000 crore from the foreign partner. So the overall number being quotes at Rs 20,000 crore is not an incorrect estimate and we can get that much amount of capital from the foreign partners over the course of next two-three years.

Latha: You said that the listed NBFC players like Reliance Capital are likely to benefit more. Within the banking space itself are you getting little more positive on say HDFC, it is NBFC but a little more positive on any of the three big stocks in the Nifty?

A: As I said the valuation benchmark, if it is established at a higher level, it will be positive, but as such from a life insurance sector perspective, things like change in bank assurance regulations would actually be a bit more negative in my opinion for players like HDFC and ICICI if it were to come through and that is a tricky part here. You have to understand regulatory changes can bring down valuations by great amount.

At one point in time ICICI Prudential was valued at USD 13 billion in 2007 and today it is valued at USD 6 billion going by the market sources. So, that is the kind of value destruction that you have seen across the life insurance industry. So, the regulatory changes can perhaps hamper valuations for all these companies who have bank selling the life insurance products.

Latha: Yesterday’s conditions – which of them could disrupt value so much among the non-foreign direct investment (FDI) changes made in the bill?

A: The bill is not something which is proposing any change with respect to regulatory regime but Insurance Regulatory and Development Authority (IRDA) itself is in the process of opening up the bank assurance channel in the sense that today ICICI Bank can sell polices of only ICICI Prudential Life Insurance. So, there is a one-to-one tie up. However, there are proposals about IRDA itself suggesting that it should sell policies of more than one life insurance company and impose a cap.

So, for example, the Insurance Act says that or rather it is proposed that if you are getting converted to a broker you cannot sell more than 25 percent of the total amount of policies of your parent bank and today they sell 60-70 percent of the policies. Imagine if the 25 percent cap were to come through it can be quite disruptive.

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Sonia: Coming back to that point about the growth in insurance industry itself even if you look away from this bill, the business for these private insurers has picked up so in nine months of FY15 we have seen about 13-14 percent growth in the premium for many of these players. What is the expectation going ahead now in FY16 and which ones could lead from the front?

A: It is going to be a function of the state of equity markets. These guys do a lot of polices by selling unit linked insurance plan (ULIPs) and more than 50 percent of the mix for at least the larger life insurance players like HDFC and ICICI comes from selling ULIPs. So, unfortunately in India insurance has always been sold as an investment product and not as a protection product and that continues.

So, the state of the equity markets is good. You can see a good 15-16 percent kind of a premium growth. Otherwise I think with the changes it is going to be proposed in the traditional policies again, it is going to be a tricky thing. So, the base case assumption is roughly about 14-15 percent kind of a premium growth is sustainable for FY16.

Lath: You have a buy on the three private sector banks Yes Bank, Axis Bank and ICICI Bank. Does life gets better in FY16 for these guys? Are you seeing an improvement in margins earnings?

A: If you look at it growth wise all these guys have done very well compared to the state own banking system and that is something which will continue in FY16 because the public sector undertaking (PSU) banks are heavily under capitalised, in fact the government has also taken has an attitude that they are not bothered about at least the weak PSU banks. So clearly there can be a market share shift due to which these guys can continue to report good amount of loan growth.

In my opinion margins should also be stable so more or less the bottomline growth should be a function of where the topline is, which is closer to be about 18-20 percent is what I am expecting. So net-net FY16 is also going to be relatively decent year for the private sector banking universe.

Latha: In the latest quarter itself State Bank of India’s stressed loans announcements were lower than what the street expected. I am only looking at delta over here and ICICI Bank’s was higher than what the street expected. Nevertheless you are not convinced that even SBI stock merits a second look? What kind of targets do have on SBI?

A: We have an underperform on SBI. Our target price is Rs 250. Having said that SBI reported lower stressed asset formation but they missed the earnings by 5 percent. ICICI Bank reported higher stressed asset formation but they managed to maintain their earnings or rather meet the analyst expectations.

The problem here is that most of these PSUs including SBI are heavily underprovided on bad loans. So, the provisioning requirements are not coming down as the non-performing loans’ age whereas that is not the case with the banks like ICICI. Moreover those guys have been in a very good position to improve margins. ICICI’s margins have gone up by 70-100 basis points in the last three-four years but SBIs margins have collapsed.

So, at least in an environment when credit cost is increasing, the private sector banks are keeping higher margins and also controlling their operating expenses (opex) to improve Return on Assets (RoA). SBI’s RoA was 110 bps; with lower stressed asset formation in the last quarter the RoA was closer to 60 basis points. There is an improvement in fundamentals that you are seeing in these PSU banks.

Sonia: Talking about the two recommendations that you have in the private sector banks, you have one on Yes Bank and one on Axis Bank. Axis Bank has been rising ever since that sub limit for foreign investors was diluted. Do you think a lot of that has been priced in or do you expect to see a lot more upside now?

A: There could be, the entire balancing would have not happened, the passive funds will buy a bit more when the actual Morgan Stanley Capital International (MSCI) inclusion is going to be announced. So, that can still happen and our estimates are closer to about USD 750 million of buying or USD 500-750 million of buying can happen in Axis Bank if the MSCI inclusion happens. So, there is more technical upside in my view and longer term performance will be governed by how the guidance for FY16 stressed asset formation is going to be.

Latha: When are you expecting base rate cuts in the sector? How many do you think in 2015 and your take on credit growth?

A: Let me begin by the interest rate cuts that we are expecting. We are expecting another 50 basis point cut to happen. So, on a cumulative basis we are expecting totally a 100 basis point cut in benchmark rates, 50 having already been done. For that 100 basis point cut in benchmark rates, best banks can cut lending rates by 50 basis points. I would assume 25 would be more likely but not more than 50 and that too perhaps in the second half of calendar year 2015 i.e. post June.

There is such a poor volume growth and April to June is also going to be a very bad quarter when restructuring thing goes off and loan growth is seasonally very weak in April to June. How can banks justify cutting lending rates in such an environment? They just don’t have any cushion to cut lending rates and pass it on to the borrowers. If they do that it is going to be at the expense of severe erosion of their profitability. So, the monetary policy transition is going to be a major issue, at best I think not more than 50 basis point cut in lending rates and that too if borrowers are lucky.