ShareKhan: Banking earnings preview

The earnings of banking companies are much awaited in the forthcoming earnings season owing to the various concerns that have emerged since the end of Q3FY2008. We present below our analysis on the macro variables and earnings estimates for the banks under our coverage.

Moderate credit growth trend continues… The non-food credit growth remained moderate during Q4FY2008, as is evident in the following chart. According to the latest data, the non-food credit registered a year- on-year (y-o-y) growth of 18.8% during Q4FY2008 compared with a 21.9% y-o-y growth in the previous quarter and a 28.0% y-o-y growth in Q4FY2007. The moderate credit growth was primarily driven by a lower retail credit demand as housing mortgage demand declined substantially during the quarter. Near-peak interest rates on mortgage products coupled with a correction in property prices seem to have

forced buyers to sit on the fences, thereby reducing the retail credit demand. Adding to that, the corporate credit demand too has moderated, leading to a lower growth in the credit offtake compared with the last fiscal

In line with the moderation in the credit growth, the deposit growth too moderated during Q4FY2008. During the quarter, the deposits grew by 18.5% year on year (yoy) compared with a 23.6% y-o-y growth in the previous quarter and a

Deployment largely flat With the credit growth (18.8% yoy) marginally outpacing the deposit growth (18.5% yoy), the deployment was largely flat. The average deployment level, represented by the credit-deposit (CD) ratio, for Q4FY2008 stood at 71% compared with 70% for the previous quarter, and remains below the year-ago quarter’s average of 72%. In line, the average incremental CD ratio for Q4FY2008 stood at 66.2% compared with 65.4% in the previous quarter and was significantly lower compared with the Q4FY2007 average of 87.6%.

Notably, during the latter part of the quarter, the incremental CD ratio as well as the incremental investment-deposit (ID) ratio showed an upward trend. This implies that the credit offtake was lower than expected and hence banks were forced to park their surplus resources in investments. This leads to the anticipation of pressure on the overall yields Inflation fears lead to delay in policy rate cut

On the flip side, the inflation rate (the Wholesale Price Index) registered a significant rise and reached 7%, primarily driven by higher prices for food articles and steel products. In response, the Government of India lowered import duties on many articles and declared a ban on the export of certain commodities. Importantly, the headline inflation is a major worry for the banking companies as this puts a pause on the anticipated softening of interest rates. In fact, many economists are also expecting the hardening of interest rates. The resulting pause in the interest rate softening implies pressure on the credit growth.

Margins likely to remain flat sequentially… Owing to the slower than expected credit growth and the increasing trend in the ID ratio, we believe that the overall yields should witness some pressure. In addition, the public sector banks (PSBs) will face pressure on their net interest margin (NIM) due to the prime lending rate (PLR) cuts announced. However, the retirement/repricing of bulk deposits should help the banks keep the NIM flat sequentially

Reduction in PLRs: During February 2008, many leading PSBs (including State Bank of India, Punjab National Bank and Canara Bank) lowered their PLR by 50 basis points with a view to stimulating the credit demand. The reduction in the PLRs came as a surprise to us and we believe that this would add to the pressure on the NIMs of the PSBs, as deposit rates have been left unchanged.

– Retirement of bulk deposits: The high-cost bulk deposits contracted last year have plagued the NIM of most of the banks. However, many banks have reduced the excessive bulk deposits keeping in mind the moderation in the credit growth. Also, the bulk deposit rates have tapered down and are ~100 basis points lower compared with the ~11% level a year ago. The retirement of bulk deposits or their repricing at lower rates should help banks ward off the pressure on their NIMs due to the reduction in the PLR and a slower credit growth. pressurising NII growth

The expectation of a flattish NIM sequentially coupled with continued moderation in the credit offtake implies likely pressure on the net interest income (NII) growth. Also, the year-ago quarter included the one-time income of the interest on the cash reserve ratio (CRR) balance with the Reserve Bank of India (RBI) for nine months. The absence of this income in Q4FY2008 further contributes to our outlook of a muted NII growth on y-o-y basis.