SBI trips again, may give banking sector a bloodied nose

Share analysts are predicting a slowdown in earnings and profit growth for the banking sector in the first quarter (Q1, April-June 2011), with public banks underperforming private ones.

[caption id="" align="alignleft" width="380" caption="If rates go up further, analysts expect banks to take a hit on their own profits since they cannot afford to drive off more customers. Jayanta Dey/Reuters"]

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The main reasons are monetary tightening and a slump in growth. The Reserve Bank of India (RBI) has been consistently raising interest rates since last year to tame prices, and not every bank has been able to pass on the full rise of costs to borrowers. This, coupled with increased provisioning requirements for non-performing and restructured assets (bad loans), will mean banks must take a hit on their net interest margins. Net interest margin is interest income minus interest expenditure divided by average loans deployed.

Centrum Broking expects the net profits of private banks to grow 29% on a y-o-y basis, but for public sector banks, the growth will be flat. The State Bank of India, though, may see a huge dip. According to Centrum, its profits may drop 45%, with new chairman Pratip Chaudhuri preferring to clean up the bad loan book as quickly as possible.

The clean-up job at the SBI is blighting the aggregates of the entire sector. According to Kotak Securities, net profits for all banks and non-banking financial companies (NBFCs) will grow only at 2.9% this quarter. But if the SBI were left out, the figure would shoot up to 18.4%. When it comes to net interest margins (NIMs), Kotak expects a 0.15-0.2% drop in NIMs on a quarter-on-quarter basis, though the figures might not look as bad on a year-on-year basis due to the low base of profits in the April-June quarter last year.

For Motilal Oswal, the dip in NIMs for the quarter compared to last quarter could be anywhere between 10-30 bps. (100 basis points, or bps, make 1%).

For private sector banks, net interest incomes (NIIs) are expected to grow at a healthy 23% and pre-provisioning profits at 8% on a yearly basis. For the public sector, NIIs can grow at 20% and pre-provisioning profit at 7%.

Bhavesh Kanani, analyst for Centrum Broking, said: "The main issue with the banking sector now will be asset quality." With incessant rate hikes in the last four quarters, the RBI might now indicate an end to its monetary tightening policies with another 25 bps hike in August or September. With the 25 bps hike last month, most banks found it difficult to pass it on to consumers by hiking lending rates.

If policy rates go up further, analysts expect banks to take a hit on their own profits since they cannot afford to drive off more customers. A further hike in lending rates could increase the percentage of bad loans even further, and loan quality will deteriorate.

Provisioning for bad loans and restructured loans is less of a concern for private banks as they had adequately provided for it even before the RBI had set the new guidelines. However, earnings can be impacted for restructured assets with many banks -- restructured asset is essentially a loan which has been reset with a longer repayment period and interest rates. The highest impact is expected to be on Bank of India, Oriental Bank of Commerce, Punjab National Bank and Indian Bank.

In the case of provisioning for bad loans, the RBI has directed all public sector banks to quantify their bad loans on the basis of data in their centralised database known as core banking solution. "Gathering data through regional heads makes the number susceptible to subjectivity and banks might report lower non-performing loans than they should," points out Kanani.

ICICI Bank, City Union and HDFC Bank are seen to be performing better, while Bank of Baroda could be an outperformer in the public sector, says Centrum.

Things to watch out for an investor:

• Net interest income - The difference between total revenue generated by a bank through its assets and total expenses incurred by it. This divided by average earnings assets will give net interest margin. NIM must be positive for banks and averages between 2.5 and 3. The higher the NIM, the better.

• Non-performing assets : The assets who are not fetching any interest and principal payments for the bank. This must be seen as percentage of total loan book for the bank. Net NPA below 1% is considered to be safe for a bank.

• Sequential jump in gross non-performing assets: How much the NPA has increased from one quarter to another.

• All the numbers must be seen in broader context to gauge the asset quality of a bank.