We believe Indian banks have exited the 'sweet spot' of rising rates, leading to margin expansion, coupled with the still-strong GDP growth. We recommend UNDERPERFORM on SBI (largest adverse shift asset and deposit mix shift) and wholesale funded banks (Yes).
Rates rising sharper than forecast
Over the past six months, domestic deposit rates have risen by 250-350 bp, as liquidity shortfall has intensified. One-year wholesale deposit rates are now up 350 bp, and retail term deposit rates are up 100-250 bp from the beginning of the year. We estimate that incremental deposit costs have moved up by 150 bp for banks from their lows, even taking into account the benefit of the mix. However, as repricing of the existing deposit base is slow, cost of deposits on the balance sheet rose by 10 bp in the last quarter. As the higher incremental cost of deposits now starts to feed through to the deposit base, we expect a sharp increase in funding cost for banks in the coming quarters. Our economist team also expects the rate rise to lead to a moderation in FY12 GDP growth.
Incremental spreads have contracted
The domestic yield curve has also witnessed a quick flattening, and over the last eight months, the spread of yield of a 10-year treasury bond to a 1-month T-Bill has contracted from 400 bp to 100 bp. On account of this, incremental spreads for the banks on their investment book (a large 25-30% of assets owing to SLR needs) have dramatically collapsed in 2010 from a high of 3%-plus to virtually negative carry now. The increase in loan yields has also not kept pace with the rise in deposit costs. The incremental spreads on loans have dropped to under 200 bp from over 400 bp in March 2010 if we impute the incremental wholesale borrowing rate as the funding cost. While, the increase in loan yields has not kept pace with the rise in deposit costs, NIMs expanded 50-100 bp, as deposit repricing comes through with a lag.
Shift in mix will also weigh on NIMs
A favourable shift in incremental asset and deposit mix had driven the NIM expansion over the past few quarters; this is now set to reverse. Incremental loan-deposit ratio (LDR) for the banks was 100% over the past year. This will now drop to a more sustainable 75%, in line with the reserve requirements. With investment spreads nearly 200 bp lower than loan spreads, a 25 pp moderation in incremental LDR will lead to a 50 bp contraction in spread on incremental assets. Even on the funding side, banks were enjoying the benefit of the low-cost CASA deposits comprising 65% of the incremental deposits over the past year.
With rising rates, as the share of low cost deposits normalises to around 35%, a 30 pp shift in mix toward term deposits will lead to 1.5% rise in incremental cost of deposits.
Little room for rerating
NIM have expanded 50-100 bp for banks over the past four quarters on deposit repricing benefits and favourable deposit and asset mix. We cut our earnings estimate for Indian banks by 7-10% for FY12, as we lower our NIM forecast by 10-15 bp for FY12. Indian banks, particularly government banks, have YTD witnessed big rerating and are at 1.8x book, trading 2.0 standard deviation above their historical range. Valuations for the government banks also do no appear cheap, factoring in estimated pension fund underfunding (10-15% of book value). Private banks at 3.0x book are trading 1.0 standard deviation above their historical average.
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