SBI preferred banking bet; relatively negative on BoB: UBS

Ekta: Why you are positive over the next 18 months on Indian financials and why are you negative on Bank of Baroda?

A: There are two or three key main drivers for the sector. One is loan growth, second would be asset quality which is obviously most important right now and third would be the interest rate cycle. So, in our view interest rate cycle we have a very bullish stance. Our strategy team has put out a big note on why they think rates will fall around 200 basis points in next two years. They have argued about why inflation structurally will remain low going forward. That I think is a very big driver both in terms of kicking off the loan growth cycle and also at least reducing some stress on the loan book.

Secondly, the recovery of GDP partly is driven by policy, partly driven by the structural base effect. So, you would see asset quality improving anyways over next 18-24 months. That cycle along with interest rate cycle I think we will be in a very good shape especially for banking sector as a whole.

On Bank of Baroda it is more a relative call actually. It is not that we are negative. If you look at it we have like most buy's now relative to our history of ratings.

Anuj: Let's talk about the private banks then. You have got a buy on both HDFC Bank and ICICI Bank. However between the two what would be your top pick and what is your rationale for buy on both these stocks?

A: If you look at both these names they are slightly different in a way you want to play them. For example ICICI Bank offers the whole India cyclical recovery part in terms of the corporate lending business, in terms of corporate asset quality improvement and also on valuation they are more reasonable, trading below 2 times book. So, there is a rerating in ICICI Bank which would be playing out over the next 2-3 years and obviously the work they have done on fixing their liability franchise, also the way they have in fact been very conservative in this particular cycle. So, all that will play out in the rerating part once you see the growth picking up for them.

For HDFC Bank it is slightly different. Lot of underperformance we have seen in HDFC Bank year to date at least. We did report on HDFC Bank alone where we discussed and argued that the current account piece for them is lowest in last ten years. So, if you look at the current account ratio for them it is right now around 16.5 percent. In good times it was around 28-29 percent. Average for last 10-years would be closer to 21-22 percent. Even if you see the current account ratio improving which is obviously related to business activity, capital market activity and also rate cycle. So, all these three things will play into improving current account ratio.

So, even if you build in 5 percent improvement in current accounts it gives them like 40 basis points of margins because it is free of cost. So, that much of margin can be either used in growth or to report better profitability. So, that is the argument there.

Ekta: What about State Bank of India (SBI)? Is that the only stock that you like within the PSU banking space, not NBFC but banking space? Are you may be a little incrementally positive on any other PSU bank besides SBI?

A: As a sector we are very positive on the whole sector. On the PSUs we cover only three names. Within those obviously SBI is a preferred pick. It has corrected from its highs. So, it is now available at reasonable valuations. They have also raised capital. So, they are slightly better capitalised versus others. Plus also their restructured loan book if you look at their base book it is only around 3.5 percent which is quite low compared to other names.

Ekta: You like LIC Housing Finance but you are not that positive on PFC as well as REC, why is that?

A: Since you are referring it from our report, on rate sensitivity LIC Housing benefits a lot because they have a fixed rate kind of loan book and more floating rate liabilities. So, they are the beneficiary of wholesale rates going down.

PFC, REC typically benefit when rates are going up. They would be negatively impacted at least on margins. If you are really playing the rate cycle I think you would rather stick with LIC Housing versus them.

Anuj: A word on midcap PSU banks because they tend to give the highest alpha as far as the bull market is concerned. Any stock that you like from that particular basket or would that we off your coverage?

A: We don’t cover most of the midcap PSU banks. Typically they do really well when rates are going down, when the cycle is recovering and it might happen again as well. I think the biggest problem with them in this particular cycle which is different from the previous two cycles are one, the pension liability part. According AS15 you have mark to market pension liability also for the bond yields which was not the case in the previous rate cycle. Second, is the capital requirements due to Basel III. So, these two things can be a overhang in my view otherwise typically they do well.