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I

nstitutio

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earch

HDFC Securities Limited, Trade World, C. Wing, 8th Floor, Kamala Mills Compound, Senapati Bapat Marg,

Lower Parel, Mumbai 400 013 Phone: (022) 6171 7330 Fax: (022) 6615 2374

India Bank

Slow ing but not Stumblin

The Bankex has corrected by 13% since Sep10 due to concerns over profitability, slowing growt

momentum and possible spurt in asset quality issues. Most banking stocks are trading near/ belo

their 5-yr P/ Adj. book value and we believe the correction is now overdone. In our estimates, th

banking system will still generate a healthy earnings growth of 22% CAGR over FY11-13E driven b

lower opex, moderating credit costs and healthy topline grow th of 16-20% CAGR. However, given th

current environment of macro headwinds, we remain selective and prefer banks with a) robu

deposit franchise, b) diversified loan book & growth visibility, c) healthy capital adequacy and d

comfortable valuations. Our top picks include a) ICICI Bank, b) Axis Bank, c) Yes Bank, d) Unite

Bank of I ndia and e) Bank of Baroda. We also initiate coverage on ING Vysya (HOLD), Allahabad Ban

(BUY) and IndusI nd Bank (HOLD).

Inflation v/ s growth

Inflation precedes over growth in the RBIs agenda. In order to tame inflation, the RBI, in its 4QFY11 cred

policy, raised repo rate by 50bps to 7.25% while it has set the credit growth target at 19%.

With more rate hikes on the card to (mainly to tame inflation), the growth momentum in the economy (GD

and industrial production) will moderate.

The systemic credit growth will slow down to 19-20% in FY12E-FY13E due to a) rising interest rates (es

another 25-50bps hikes in lending rates), b) moderation in high growth sectors such as infra., constructio

and real estate and c) fragile business confidence.

We estimate the growth to be largely driven by a) working capital, b) regular capex related credit deman

c) agriculture (esp. for PSU banks) and d) retail loans (expect modest demand).

Liquidity situation to r emain mixed; Interest rates to remain tight

The liquidity situation in the system will remain mixed for a large part of the year as it has become more of

structural issue than a seasonal one.

During fiscal 2011, the liquidity overhang in the system was mainly due to a) higher currency with public (

Rs9.2tn higher than 3yrs average by Rs500bn), b) higher govt. balances, c) negative real return and

rise of other asset classes such as gold/silver.

We believe there are factors which will be critical for liquidity position such as a) higher inflation, b) sluggis

foreign flows, c) higher current account deficit (est. at 3%) and d) higher cash balances with public.

We expect deposit rates to remain at elevated levels however we do not expect deposit rates to go u

sharply (not more than 25-50bps), as the system braces lower growth regime. Our estimate for depos

growth in FY12-13E is at 17-18%.

Earnings grow th to remain healthy; Cherry pick the stocks

We estimate that the earnings for our coverage universe will grow at 22% CAGR over FY11-13E. While PS

banks will register earnings CAGR of 21%, private banks to realize 25% growth in earnings.

We expect margins (NIMs) to shrink by 15-20bps over FY11-13E, cost/income ratio to moderate ~200bp

and credit cost to come-in lower as asset quality is likely to improve YoY.

Bankex corrected ~13% (since Sep10), and most of the stocks are trading at below 5yr average. Whi

macro headwinds to keep re-rating under check in the near to mid term, we prefer stocks with a) robu

deposit franchise, b) healthy capital adequacy, c) diversified loan mix & growth visibility and d) comfortab

valuations.

We like ICICI, Axis, Yes (new initiation), BoB and United Bank of India (new initiation) with an averag

upside of 25-30%.

Also initiate coverage on other banks Allahabad Bank (BUY, Rs232/share), IndusInd (HOLD, Rs223/share

ING Vysya (HOLD, Rs358/share).

Rahul Jain Vishal [email protected] [email protected] 7344 91-22-6171 7324


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Ind ia Banks - Slow ing but not Stumbli

May 18, 2011 Page

Table of Contents

Section 1: Inf lation v/ s grow th .....................................................................................................................

Section 2: Liquid ity s ituation to remain mixed; Interest rates near peak leve ls .......................................... 1

Section 3: Earn ings growth to remain healthy; Cherry p ick the stocks ........................................................ 2

Appendix ..................................................................................................................................................... 4

Banks New Initiations

Al lahabad Bank ........................................................................................................................................... 5

ING Vysya Bank .......................................................................................................................................... 6

IndusInd Bank ............................................................................................................................................ 7

United Bank of India ................................................................................................................................... 8

Yes Bank ..................................................................................................................................................... 8

Banks Updates

Ax is Bank .................................................................................................................................................... 9

Bank of Baroda .......................................................................................................................................... 10

Bank of India ............................................................................................................................................ 10

Canara Bank .............................................................................................................................................. 11

ICICI Bank ................................................................................................................................................ 11

Oriental Bank of Commerce ....................................................................................................................... 12

Punjab National Bank ................................................................................................................................ 13

State Bank of India ................................................................................................................................... 13

Union Bank of India .................................................................................................................................. 13


3/144

Section 1: Inflation v/ s grow

May 18, 2011 Page

Intensifying war on inflation

Section 1: Inflation v/ s grow th

The Reserve Bank of India intensified its war on inflation in its 4QFY11 moneta

policy. In a ninth consecutive policy rate hike, RBI increased the repo rate by 50b

to 7.25%.

According to the RBI, a 50bps increase in repo rate was necessitated because

change in drivers of inflation. Between November 2010 and March 2011, the maj

driver of inflation was manufacturing non-food inflation. Prior to this, inflation wadriven by food, fuel and power and primary non-food articles. In fact, in Mar

2011, core inflation had increased to 7.1% from a low of 3.2% in March 2010.

Chart 1: Trend show ing the movement of policy rates

Ninth consecutive rate hike by the

RBI to 7.25%

New corridor (MSF) introduced and

pegged at 100bps above repo rate;

making liquidity available but at a

higher price (8.25%)

Source: RBI , Bloomberg

Chart 2: WP I and core infl ation

Focus shifts from food inflation to

core inflation

Source: Office of Economic Advisor

Inflation to average 9% in 1HFY12

and 8.4% in FY12

With steady pass through of high commodity prices to finished goods, RBI saw th

as a necessary measure to anchor inflationary expectations. RBI expects inflation

average at 9.0% in 1HFY12. With partial pass through of high crude oil prices

retail prices of diesel and petrol, we expect inflation to average 8.4% during FY12

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

May-05

Oct-05

Mar-06

Aug-06

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Jul-09

Dec-09

May-10

Oct-10

Mar-11

WPI Core

3.0%4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

Feb-09

Apr-09

Jun-09

Aug-09

Oct-09

Dec-09

Feb-10

Apr-10

Jun-10

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

Call money Repo Reverse repo MSF (notional)


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May 18, 2011 Page

Higher rates to moderate growth

momentum

RBI pegs GDP growth target at 8%for FY12

Growth momentum to moderate

With the central government turning more hawkish in recent times and with t

control of inflation being a clear agenda, the growth momentum of the economy w

certainly slow down, hurting the investment climate and in-turn hurting the dema

for bank credit.

RBI expects FY12 GDP growth at 8.0%, lower than the government projection

9% GDP growth in FY12. Investment demand will slowdown owing to rising intererates. Government consumption is also expected to remain muted with fiscal defi

projected at 4.6% of GDP.

Chart 3: Nominal GDP grow th Chart 4: Fiscal deficit estimated at 4.6% in FY12

Source: CSO, HDFC Securities Institutional Research Source: CSO, HDFC Securities Institutional Research

FY11 witnessed record

disbursements of Rs6.9tn

Growth, in our view, was largely led

by working capital related demand

Credit in the system to grow ~19-

20% YoY in FY12-FY13E

Growth drivers to shift away from

infrastructure

Credit growth to subside

The credit growth in FY11 came in marginally higher than expectations at 21.5%

1.5% higher than the RBI target levels. The growth during the last year picked

to a high of 24.6% - highest since Jan09, even as net disbursements (during FY111) were at Rs6.9tn which was the highest so far.

We believe the demand at the later half (of fiscal) was largely driven by workin

capital related funding and the regular capex exercise of the corporate whereas t

large ticket capex activity slowed down due to multiple bureaucratic and politic

issues concerning esp. land acquisitions and environmental clearances.

The systemic credit growth will slow down to ~19-20% in FY12E-FY13E due to

rising interest rates (another 25-50bps hikes in lending rates), b) moderation

high growth sectors such as infra, construction and real estate and c) frag

business confidence.

We expect the growth drivers to shift away from infrastructure to other sectosuch as manufacturing, retail, agriculture and other industries. The industri

directly related to infrastructure will also see some moderation. Over FY12-FY13

we expect the credit growth to be driven by working capital related demand a

other regular industrial capex related credit demand; retail to grow 15-16% CAG

over FY11-13E.

6%

10%

14%

18%

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11BE

FY12E

-8.0%

-7.0%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E


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May 18, 2011 Page

18% of incremental credit growth

during came from infrastructure

during FY06-11

Limit to infrastructure nearing its

peak

Estimate infra sector to grow at

~25% CAGR over FY11-13E to a

proportion of ~16%

Limiting growth

The Indian banking system realized a loan growth of 21% CAGR over a period

FY06-11. The key drivers of the growth have so far been infrastructure (36

CAGR), construction (30% CAGR) and commercial real estate (24% CAGR). Duri

FY06-11, the above mentioned industries contributed 24% of incremental grow

during FY06-11 while during FY11; they contributed 27% to incremental book.

Given that the outstanding proportion of infrastructure in the systems loan bo

has reached ~14%, nearing most of the banks sectoral limit, the increment

disbursements to the sector would slow down. In which case, the increment

growth from the infrastructure sector would moderate and hence will affect t

headline credit growth as well. Furthermore, the other faster growing sectors su

commercial real estate, construction also likely to slowdown due to underlyin

weaknesses in the respective sectors.

We estimate the infrastructure sector to grow at a slower pace of ~25%

FY12-13E not only as banks (select large ones) have reached their limits b

also due to higher interest rate environment and fragile business confidenc

We estimate that the proportion of infrastructure on a systemic level wou

remain in the range of current 14-15%.

Chart 5: Loan grow th over FY06-11 (5yr CAGR) Chart 6: Industry segment wise grow th over FY06-1

(5yr CAGR)

Source: RBI, HDFC Securities Institutional Research Source: RBI, HDFC Securities Institutional Research

Chart 7: Incremental loan book mix (FY 06-11) Chart 8: Incremental loan book mix (FY 10-11)


0% 10% 20% 30% 40%

Infrastructure

Construction

Cement

Basic Metal

Food Processing

Engineering

Textiles

Vehicles

Petroleum & Coal

Chemicals

Gems & Jewellery

5% 10% 15% 20% 25%

Industries

Total services

Agri

Non-food credit

Personal loans

OtherIndustries,

23%

Infra, 18%

Otherservices,

16%Agri, 13%

Other pers.loans, 7%

Housing,7%

BasicMetals, 6%

NBFCs, 6%

Comm.Real

Estate, 4%

Infra, 23%

OtherIndustries,

18%

Otherservices,

15%

NBFCs,10%

Other pers.loans, 9%

BasicMetals, 7%

Housing,7%

Agri, 7%Comm.Real

Estate, 3%


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May 18, 2011 Page

Chart 9: Proportion of I nfra in banking systems credit

has increased from 4% in FY02 to ~14% in FY11

Chart 10: Trend showing infrastructure credit (Yo

growth)

0%

2%

4%

6%

8%10%

12%

14%

16%

18%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E


Chart 11: Commercial real estate loans grew higher

than the credit growth of banking system

Chart 12: Commercial real estate loans as % of ban

credit increased from 0.4% in FY02 to 2.8% in FY11


Chart 13: Proportion of construction as % of bank

credit increased to 1.3% in FY11 from 0.7% in FY02

Chart 14: NBFCs loans as % of bank credit rose

4.5% in FY11 from 1.6% in FY02


0%

20%

40%

60%

80%

100%

120%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

-20%

0%

20%

40%

60%

80%

100%

120%

140%

0%

5%

10%

15%

20%

25%

30%

35%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

Non-food credit growth YoY (LHS)

Comm. Real Estate growth YoY (RHS)

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

1%

2%

3%

4%

5%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11


7/144


May 18, 2011 Page

Credit growth drivers in FY11

During FY11, the credit growth drivers became broad based. While the growth

infrastructure sector slowed down, that for services and retail picked up. As w

highlighted above that banks are nearing the limit to infrastructure sector an

therefore the growth momentum from this sector will slow down.

Key growth drivers during the year were services (24% YoY) led by NBFCs mainl

infrastructure (39%), metals (~30% YoY), textiles etc. The sector that witness

increase in proportion were industries, services while retail and agri declined.

Industry segment growth was driven

by infra (39% YoY) , metals (29%

YoY) and textiles (19% YoY)

NBFCs led the services segment

growth (55% YoY)

Retail loans grew slower than

systems growth

Table 1: Key components o f bank credit

Rsbn Mar-09 Mar-10 Mar-11 YoY growt

Agriculture & Allied Activities 3,387 4,161 4,603 11%

Industry 10,544 13,115 16,208 24%

Food Processing 538 657 849 29

Textiles 1,027 1,214 1,447 19

Chemicals 756 857 945 10

Basic Metal 1,288 1,629 2,099 29

Engineering 658 738 932 26

Construction 385 442 501 13Infrastructure 2,700 3,799 5,267 39

Other Industries 3,193 3,778 4,167 10

Services 6,463 7,268 9,008 24%

Transport Operators 393 525 655 25

Professional Services 454 434 603 39

Trade 1,444 1,645 1,863 13

Commercial Real Estate 924 921 1,118 21

NBFCs 989 1,134 1,756 55

Other Services 2,260 2,608 3,014 16

Personal Loans 5,625 5,856 6,854 17%

Housing 2,794 3,009 3,461 15

Advances against FD 487 487 605 24

Credit Cards 280 201 181 -10

Education 286 369 437 19

Vehicle Loans 621 638 793 24

Other Personal Loans 1,158 1,153 1,376 19

Total 26,018 30,400 36,674 21%

Source : RBI , HDFC Securities Institutional Research

Chart 15: YoY credit growth (Mar11)

Source : RBI, HDFC Securities Institutional Research

0%

5%

10%

15%

20%

25%

Services Industry Personal Loans Agri


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May 18, 2011 Page

Chart 16: Outstanding credit break up (FY11) Chart 17: Incremental credit break up (FY10-11)

Source : RBI, HDFC Securities Institutional Research Source : RBI, HDFC Securities Institutional Research

Chart 18: Infrastructures contribution to incr. creditdropped last year

Chart 19: Trend showing housing loans growth (YoY

5%

10%

15%

20%

25%

30%

FY07

FY08

FY09

FY10

FY11

Infra's contribution to incr. credit (YoY)

Infra's (ex-telecom) contribution to incr. credit (YoY)


Chart 20: Trend showing real estate loans growth(YoY)

Chart 21: Trend showing NBFCs loans growth (YoY)


0%

5%

10%

15%

20%

25%

30%

FY07 FY08 FY09 FY10 FY11

-5%

0%

5%

10%

15%

20%

25%

Mar-10

May-10

Sep-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

0%

10%

20%

30%

40%

50%

60%

Mar-10

May-10

Sep-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Industry,44%

Services,25%

PersonalLoans,19%

Agri, 13%

Industry,49%

Services,28%

PersonalLoans,16%

Agri, 7%


9/144


May 18, 2011 Page

Chart 22: Incremental retail loan mix (FY10-11) Chart 23: Housing contributed 50% of thoutstanding retail credit (FY11)

Source : RBI, HDFC Securities Institutional Research Source :RBI, HDFC Securities Institutional Research

Higher interest rates & uncertain

economic environment to weaken

growth momentum

Industry interaction confirms

slowdown

Higher interest rates to moderate growth momentum

Given our view that the interest rates will remain high, we believe growmomentum of the economy will slow down for a large part of the year. Definitel

higher interest rates are not conducive to the capex environment and therefore w

believe due to this, the big ticket capex activities will slow down in FY1

Historically, it has been seen that in higher interest rate environment, the cred

growth moderates and so does the credit multiplier. We expect the credit growth

be affected too this time around.

Based on our interaction with industry sources, we realize that due to high

interest rates and fragile business conditions, corporate are going slower o

embarking on any big ticket capex activity. Therefore, on the back of this, t

credit growth would also be under pressure.

Chart 24: Higher interest rates may impact GDPgrowth adversely

Chart 25: High interest rates to hurt industriproduction

Source : RBI , Bloomberg Source : Bloomberg

Housing,50%

OtherPersonalLoans,

20%

VehicleLoans,12%

Advancesagainst FD,

9%

Education,6%

CreditCards, 3%

10%

11%

11%

12%

12%

13%

13%

14%

14%

-15%

-5%

5%

15%

25%

35%

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

IIP growth (LHS) SBI PLR (RHS)

Housing,45%

OtherPersonalLoans,

22%

VehicleLoans,16%

Advancesagainst FD,

12%

Education,7%

CreditCards, -2%

10%

11%

12%

13%

14%

15%

8%

10%

12%

14%

16%

18%

20%

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

GDP Nominal (LHS) SBI PLR (RHS)


10/144


11/144


May 18, 2011 Page

Structural liquidity issues to have its

overhang on credit growth

Structural liquidity issues

Based on our assumption of 17% YoY growth in deposits in FY12, the availability

loanable funds to the banking system would be Rs7.3bn just enough to achiev

the credit growth of 18%.

Furthermore, with investment to deposit ratio coming down to a low of ~29%, t

excess cushion in the form of investments would also not be available for banks

fuel credit growth by selling investments.

Loanable funds would be just enough

for 18% credit growth

Table 2: Loanable fund availab le with the banking systemParticulars FY11 FY12

Deposits (Rsbn) 52,047 60,89

Deposit Growth (% YoY) 16% 17

Incr. Deposits (Rsbn) 7,181 8,84

Govt. net borrowings (Rsbn) 3,43

Banks' subscription to G-secs 50

Banks' subscription to G-secs (Rsbn) 1,71

- as % of incr. deposits 19

O/S G-secs 14,955 16,67

G-Secs as % of deposits 29% 27

Incr. CRR requirement (@6%) 53

Incr. funds available to lend 7,26

Incr. LDR 82

O/S Loans 39,387 46,65

YoY growth 22% 18

Source : HDFC Securities Institutional Research

Note: Incr. funds available to lend includes estimated profits of the banking system for FY12

Loan growth to be driven by working

capital, regular capex, retail and agrirelated demand

Loan book to grow 19-20% CAGR over FY11-13E

We estimate that the loan book will grow at a CAGR of 19-20% over the next tw

years. The growth in credit will be largely driven by demand for working capit

loans and regular capex activity (especially brownfield expansion projects). T

project/infrastructure loans which were sanctioned or where the disbursals ha

begun should continue though with some moderation.

However, we expect the big ticket and greenfield projects to halt/slow down give

the uncertain global and domestic business environment and further expectations

higher interest rates.

Chart 29: Loan book to g row at 19-20% CAGR over FY11-13E

Loan growth to be driven by working

capital related credit demand,

regular capex and agriculture

Source :RBI ,HDFC Securities Institutional Research

15%

20%

25%

30%

35%

-

10,000

20,000

30,000

40,000

50,000

60,000

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

Bank credit (LHS) YoY growth (RHS)

Rsbn


12/144


May 18, 2011 Page

Chart 30: Trend show ing loan book composi tion

Retail proportion to remain in the

range of 17-18% v/s ~19% over the

last three years (average)


Chart 31: Working capital loans contributed 48% of

incremental loan (FY06-10)

Chart 32: Working capital loans to contribute 54%

incremental loan book over FY11-13E

z`

Source :RBI ,HDFC Securities Institutional Research Source :RBI ,HDFC Securities Institutional Research

Table 3: Key loan book components

Particulars (Rsbn) FY09 FY10 FY11 FY12E FY13ECAG

(FY11-13E

Food Credit 462 485 643 675 709 5

Agri 3,545 4,364 4,863 5,836 7,003 20

Corporate Loans 18,069 21,695 26,640 31,812 38,306 20

- Infra 2,835 3,989 5,530 6,931 8,687 25

Retail 5,625 5,860 7,241 8,374 9,732 16

- Housing 2,770 3,010 3,461 3,980 4,597 15

Total Credit 27,700 32,404 39,387 46,697 55,750 19%

Source: HDFC Securities Institutional Research

High commodity prices to push

demand for working capital related

loans

Working capital demand to continue to lead

With commodity prices expected to remain firmer, we expect the demand f

working capital related credit to remain high during the course of the year main

due to the higher raw material prices.

Historically, it has been seen that the working capital loan growth picked up in th

years when commodity prices were higher. (See chart 33). During the period

buoyant global economic growth, the demand for working capital related loans gre

24% CAGR during FY04-08.

WorkingCapital ,

48%

RetailLoans,13%

Infra , 16%

Agriculture, 15%

Capex ,-1%

WorkingCapital ,

54%RetailLoans,15%

Infra , 19%

Agriculture, 13%

Capex ,-2%

0%

20%

40%

60%

80%

100%

FY09 FY10 FY11 FY12E FY13E

Agri Industries Retail Services


13/144


May 18, 2011 Page

Working capital related loans to grow

22% CAGR over FY11-13E

In the current year, the demand for working capital will be largely led by industri

such as oil marketing companies (which are currently heard to be borrowing

foreign currency), metals, chemicals and other capital intensive companies.

We estimate that demand for working capital related credit demand to sustain an

grow at 21-22% CAGR over FY11-13E. The proportion in systemic loan book

expand by 200-220bps over FY11-13E to ~49%.

Chart 33: Trend showing working capital loans growth and commodi

indexHigh correlation between commodity

index and banks working capital loan

growth

Source:Bloomberg ,HDFC Securities Institutional Research

Chart 34: Proportion of working capital related loan to total loan book

Proportion of working capital loan to

expand

Source: RBI ,HDFC Securities Institutional Research

Retail growth to moderate

We estimate retail to grow 15-16%

in FY12-13

Retail credit demand to remain under pressure

The growth in retail loan portfolio picked up over the last six-eight months main

driven by housing (growth picked up from 10% in Sep10 to 15% in Mar11

vehicle loans and other personal loans (~18% of portfolio).

In higher interest rate environment we expect the growth in retail to moderate fro

~17% in FY11. We expect retail sector to register a growth of ~15-16% over FY1

13E CAGR.

While we reckon that the higher property prices and interest rates will have a dra

on the housing segment (which contributes ~50% to the total retail segment

higher wages would keep the demand from genuine buyers intact though with som

moderation especially in metros.

However the demand for vehicle loans (~12% of loan book) might moderate due

a) lower volumes growth indicated by auto players due to base effect and increa

in prices of vehicles, and b) higher interest rates.

5%

10%

15%

20%

25%

30%

100

150

200

250

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

CRY index Working capital loan growth YoY

40%

45%

50%

55%

60%

65%

70%

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10


14/144


May 18, 2011 Page

Chart 35: Retail loan grow th (FY06-11 CAGR) Chart 36: Retail loan grow th YoY (FY11)

Source :RBI ,HDFC Securities Institutional Research Source :RBI ,HDFC Securities Institutional Research

Chart 37: Trend showing HDFCs loan disbursal and

retail lending rates

Chart 38: Trend show ing vehicle loan growth

Source : HDFC Securities Institutional Research Source :RBI ,HDFC Securities Institutional Research

Chart 39: Property prices movement in major towns

High property prices made up for

lower volumes growth but going

forward high interest rates and high

property prices could moderate

housing loans growth


10%

11%

11%

12%

12%

13%

13%

14%14%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%30%

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

Dec-10

Feb-11

Vehicle loans YoY (LHS) SBI PLR (RHS)

0% 20% 40%

Education

Total retail loans

Housing

Advances against FD

0% 5% 10% 15% 20% 25%

Advances against FD

Vehicle

Education

Total retail loans

Housing

80

100

120

140

160

180

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

Mumbai Delhi Bengaluru Kolkata

Index

8%

9%

10%

11%

12%

13%

14%

15%16%

15%

20%

25%

30%

35%

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

HDFC's loan disbursal (LHS) HDFC's PLR (RHS)

YoY growth


15/144

Section 2: Liquidity situation to remain mixed; Interest rates near peak leve

May 18, 2011 Page

Deposit rates to remain higher in the

system

We estimate deposits to grow 17-

18% CAGR over FY11-13E

Banks remained borrower upto~2.5% of NDTL for the longest

period in FY11

Inflation is a drag on money

multiplier

No further space was available for

the banks in the form of investments

Section 2: Liquidity situation to remain mixedInterest rates near peak levels

The liquidity issues in the system are unlikely to settle down anytime in the ne

future. Issues pertaining to liquidity are more structural than seasonal. With mon

with public being at its peak at Rs9.4tn (22nd

Apr11), negative real return and ri

of other asset classes such as gold/silver, the expansion in deposits remaine

muted during FY11.

In order to attract deposits back in the system, we believe, the deposit rates in t

system to remain firmer. We estimate the banking system to realize a depo

growth of 17-18% over FY11-13E, mainly led by higher growth in term deposits.

However, we do not think the deposit rates will further go up especially after the Q

monetary policy in which the RBI pegged the credit growth lower at 19% for FY12

and with the current deposit rates being where they are, we believe banks shou

be comfortable with 17%YoY growth in deposits to meet 19% credit growth.

Unprecedented liquidity squeeze

During the fiscal 2011, the liquidity situation in the banking system remaine

precarious. The banking system were the net borrower at the RBIs LAF window

an average of ~Rs850bn for over 6mths (2-3% of NDTL much above the comfo

level of +/- 1% as specified by the RBI). This was the longest over the last 10yrs.

As per our understanding we believe, the liquidity was tight due to a) high

currency with the public (partly due to higher inflation) b) negative real rate

return, c) higher government balances and d) emergence of other asset class

such as gold/silver.

Further, the gulf between the credit growth (YoY) and deposit growth (Yo

remained higher in FY11 at ~5.5% (full year avg.). The higher gap between th

credit and deposit growth was not for the first time in the history (fiscal year 0

witnessed credit-deposit growth gap of ~9%). However, during FY05-06 despite

a higher incremental credit-deposit ratio, the banking system was marginally

deficit as it was just marginally investing/winding down investments.

What is different this time is that the system doesnt even have the cushion in th

form of higher investments. The investment to deposit ratio has moderated to 20

(avg. for FY11) from ~40% (avg. for FY10).

Chart 40: Net reverse repo as % of NDTL

Tightness to continue even during

FY12, but not to the extent

witnessed in FY11


-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Mar-04

Sep-04

Apr-05

Oct-05

May-06

Nov-06

Jun-07

Jan-08

Jul-08

Feb-09

Aug-09

Mar-10

Sep-10

Apr-11


16/144


May 18, 2011 Page

Chart 41: Wedge between credit and deposit growth

(YoY) remained higher at 5.5% (avg.) in FY11

Chart 42: SLR has been falling and have come clos

to the statutory requirement (a gap of ~500bps)

-10%

-5%

0%

5%

10%

15%

20%

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

Source : RBI , HDFC Securities Institutional Research Source : RBI , HDFC Securities Institutional Research

Note: RBI further opened another window (MSF) which allows ban

to borrow upto 1% of SLR

Chart 43: Banking system remained in deficit mode in the later part

FY11

The Incremental credit-deposit ratio

was not high for the first time

Last cycle, system was on excess

investments which it utilized to fund

credit growth


Note: Deficit = Incr. Deposits (YoY) Incr. Credit Incr. Investments + Incr. borrowings and

other DTL

Chart 44: Gold imports in I ndia

Rise of other asset classes

Imports of gold was highest ever

(since CY92) in the country at

~960mt.

We attribute this also as one of the

reason for a slower deposit accretion

in the system

Source : WGC, HDFC Securities Institutional Research

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

0

200

400

600

800

1000

CY92

CY93

CY94

CY95

CY96

CY97

CY98

CY99

CY00

CY01

CY02

CY03

CY04

CY05

CY06

CY07

CY08

CY09

CY10

Gold Imports (LHS) YoY growth (RHS)

mt

20%

25%

30%

35%

40%

45%

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

SLR Investments SLR requirement

0%

20%

40%

60%

80%

100%

120%

140%

160%

(3,200)(2,600)(2,000)(1,400)

(800)(200)400

1,0001,6002,2002,8003,4004,000

Apr-04

O

ct-04

Apr-05

O

ct-05

Apr-06

O

ct-06

Apr-07

O

ct-07

Apr-08

O

ct-08

Apr-09

O

ct-09

Apr-10

O

ct-10

Apr-11

Deficit (LHS) Incr. LDR (RHS)

Rsbn


17/144


May 18, 2011 Page

Higher inflation leads to higher

leakage of money in the system

as a result, FY11 witnessed sharper

increase in currency with public at

Rs1.5tn, higher by Rs1tn on an

average

Forex reserves are important tool for

liquidity. In FY11, the net addition to

forex were only US$13bn

Liquidity, a structural issue

The liquidity problem in India appears to be more of a structural issue than

seasonal one which has caused unprecedented liquidity tightness in the system. W

believe there are multiple issues which have caused such a situation. Below a

some of the key ones:

Higher inflation: As per NCAER, an average Indian spends 51% of its incom

on food. Further, it has been observed that in higher inflationary environmen

the currency with the public tends to go up. Similarly, even in fiscal 201higher food inflation caused higher growth in currency with public.

Higher cash balances with public at Rs9.2tn up by Rs1.5tn YoY

compared to an average increase of Rs1tn (YoY) over the last couple of year

owing to 1) negative real interest rates in the system for a larger part of th

year, 2) higher food inflation and 3) rise of other investment avenues such

gold/silver India imported gold to the tune of 963mt.

Slower accretion to forex reserves at US$13bn. historically, the for

reserves accretion in the country has played an important role. Since 2002, t

incremental forex reserves have contributed on an average of 33%

incremental deposits in the system.

Higher government balances with RBI at ~Rs770bn (avg. between Jun1

Mar11) largely due to 3G & BWA auctions. However, the government spendin

continued to remain healthy and grew 28% YoY as on Feb11.

Chart 45: Trend show ing currency with publ ic

Higher inflation pushes up the

currency with public


Chart 46: Trend show ing negative real interest rate Chart 47: Trend show ing correlation between curren

with public and food inflation

Source : RBI, Bloomberg , HDFC Securities Institutional Research

Note: Real interest rate: inflation (WPI)long bond yields

Source : RBI, Bloomberg , HDFC Securities Institutional Research

-4%

-2%

0%

2%

4%

6%

8%

10%

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

0%

5%

10%

15%

20%

25%

10%

12%

14%16%

18%

20%

22%

24%

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Currency with the public YoY growth (LHS)

Food Inflation (RHS)

10%

12%

14%

16%

18%

20%

-

2,000

4,000

6,000

8,000

10,000

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Currency with the public (LHS) YoY growth (RHS)

Rsbn


18/144


May 18, 2011 Page

Chart 48: Wallet share o f an individual

~50% of money is spent on food by

a typical Indian

Source : RBI

Chart 49: Net forex reserves (accretion) averaged 33% of increment

deposits

Incremental foreign reserves

contributed an average of 33% to

incremental deposits of the system

Source :RBI

Note: BOP = (Total current account deficit + Capital Account) or (forex reserve accretion)

Chart 50: Growth (YoY ) in Govt spending Chart 51: Govt balances wi th RBI

Source : CGA Source :RBI

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

(40)

(20)

-

20

40

60

80

100

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

BOP (LHS) BOP as % of Incr. deposits (RHS)

US$bn

Average of 33% of Incr. deposits

5545 51

4

65

55

5

1011

11

69

7

77 7

55 5

8 13 10

0

20

40

60

80

100

Rural Urban All India

Food Housing Health Transport Education Clothing Durables Others

-300

0

300

600

900

1,200

1,500

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

Oct-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Rsbn

-100%

0%

100%

200%

300%

400%

Apr-07

Sep-07

Jan-08

Jun-08

Nov-08

Mar-09

Aug-09

Dec-09

May-10

Oct-10

Feb-11


19/144


May 18, 2011 Page

Liquidity position to remain mixed

The liquidity position in the system will remain mixed over FY12-13E. There a

various factors which will play an important role for liquidity position in the system

We lay down our view on each of the important factors as below.

a) Crude oil prices and current account deficit: Crude oil contributes 30% the total import bill of the country. Higher crude oil prices will put pressure o

the current account deficit which is currently estimated at ~3% for FY1Further, higher crude prices potentially shave off the GDP growth as well.

Chart 52: Trend show ing import bill mix Chart 53: Current account deficit as % of GDP

Source : RBI Source : RBI , HDFC Securities Institutional Research

India received robust foreign flows

but driven by volatile foreign flows

Any slowdown in forex accretion will

have an impact on deposit growth

unless RBI intervenes by way of

printing more money

Cut in reserve requirement, fresh

money printing pushed the deposit

growth in FY09, year of forex

outflows

b) Foreign flows: We understand that foreign flows are dynamic and difficult precisely estimate. During FY10-11(Apr-Dec10), India remained an attractiv

destination for foreign investors and saw inflows of US$53bn (FII + FD

against US$38bn in year ago.

The composition shifted towards volatile flows such as FII investments antrade credits. The RBI mentioned that since net inflows under FDI were low

and as the CAD is expected to be at US$58bn in 2011-12, the sustainability

financing the CAD becomes important.

With developed markets (DMs) showing signs of stability, there could be

possibility of reversal of flows to DMs or may be slower inflows in the countr

In any case, it will have an impact on the liquidity position in the country.

While forex played an important role in easy liquidity conditions during FY0

08, however, during FY09-10, in the event of net forex outflow from th

country, the deposits growth was still healthy with higher OMO buybacks a

MSS de-sequestering (Rs700bn in 1HFY10) by the RBI offsetting the dra

created by thinner foreign inflows. While this supported new money creation

base money growth substantial cuts in the CRR and a pick up in governme

spending also eased system liquidity by boosting the money multiplier.

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

26% 27% 29% 31% 32% 31% 30%

74% 73% 71% 69% 68% 69% 70%

0%

20%

40%

60%

80%

100%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Oil Non-oil


20/144


May 18, 2011 Page

Chart 54: Trend showing balance of payment as % of

incr. deposits

Chart 55: Trend showing BOP growth (YoY) an

deposits growth (YoY )


Chart 56: Trend showing forex reserves as % of

reserve money

Chart 57: Trend showing currency in circulation as %

of forex reserves


Chart 58: RBI maintained a ratio of fresh printing of money in-line wit

forex accretion except in Jun10


0%

5%

10%

15%

20%

25%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Overall BOP as % of Incr. Deposits (LHS)

Deposits YoY growth (RHS)

0%

5%

10%

15%

20%

25%

-200%

-150%

-100%

-50%

0%

50%

100%

150%

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

BOP growth YoY (LHS) Deposits YoY growth (RHS)

-200%

0%

200%

400%

600%

800%

1000%

1200%

1400%

1600%

-

200400

600

800

1,000

1,200

1,400

1,600

Jun'05

Jun'06

Jun'07

Jun'08

Jun'09

Jun'10

Mar'11

Notes printed by RBI (LHS) Notes printed as % of incr. forex (RHS)

Rsbn

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

M

ar-00

M

ar-01

M

ar-02

M

ar-03

M

ar-04

M

ar-05

M

ar-06

M

ar-07

M

ar-08

M

ar-09

M

ar-10

M

ar-11

0%

20%

40%

60%

80%

100%

120%

140%

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07

Mar-08

Mar-09

Mar-10

Mar-11


21/144


May 18, 2011 Page

Inflation remains a critical issue

RBI to continue with its hawkish

stance

Deposit growth will be at risk if

inflation remains high

c) Inflation: Inflation continues to remain on the higher side and came in at ~9in Mar11 1% higher than the RBI target. The RBI took a hard stance a

raised the benchmark policy rates by aggressive 50bps (v/s expectations

25bps). The RBI has clearly mentioned that its priority is to control inflatio

and therefore we expect it to maintain its hawkish stance. Economist at HD

Bank expects rates to harden by 50-75bps in FY12.

Based on NCAER survey, food accounts for 51% of an individuals wallet a

therefore higher food prices would cause the money to move out of the systemAs seen historically, higher inflation has resulted in higher growth in curren

with public. Therefore, we believe higher inflation will be a drag for depo

growth in the banking system.

d) Currency with public: Currency with public increased by a whopping Rs1.5talmost Rs500bn higher than an average increase of Rs1tn over the last tw

years. We believe, with higher interest rates on deposits (at 7.5-9%), som

part of excess cash will return to banking system, even from other asset cla

such as gold. As observed historically, in higher interest rate environment th

currency with public growth slows down.

Chart 59: Higher interest rates pulls money into

banking system

Chart 60: Higher inflation increase the currency wit

public

Source : RBI, Bloomberg, HDFC Securities Institutional Research Source : RBI, Bloomberg, HDFC Securities Institutional Research

RBI will ensure just enough liquidity

in the system

New liquidity window introduced as a

option of last resort

RBI frequently used OMOs to

manage liquidity situation

RBI w ell equipped to manage liquidity

While we expect the liquidity position to remain tight in FY12-13E due to the facto

discussed above, the RBI has got sufficient tools with it to manage liquidity in th

system. The selection of the tools would be dependent on the inflationary position

the system. In its 4Q credit policy, the RBI introduced another facility calle

Marginal Standing Facility (MSF) which will provide liquidity upto 1% of SLR but at

higher rate of 8.25% (pegged at 100bps above Repo rate).

The tools that the RBI can potentially use are:

a) Open market operations: The most direct and effective tool available withe RBI is to control the liquidity flow by conducting open market operatio

(OMOs) which effectively buys back the government securities from the ban

hence infusing cash in the system. Historically, RBI had been quite active

controlling liquidity in the system through OMOs. During FY10 and 10MFY1

RBI bought back the bonds worth ~Rs1.4tn while during FY06-07 it sold bon

worth Rs90bn to sterilize excess flow in the system.

b) Reduction in reserve ratios: Given RBIs stance against inflation, reduction reserves looks difficult, but temporary relaxation in meeting SLR requireme

(upto a limit) might be possible. A cut in CRR can only happen if the inflatio

4%

5%

6%

7%

8%

9%

10%

15%

16%

17%

18%

19%

20%

21%

22%

Mar-99

May-05

Oct-05

Apr-06

Sep-06

Mar-07

Aug-07

Feb-08

Jul-08

Dec-08

May-09

Nov-09

Apr-10

Oct-10

Mar-11

Currency with public as % of deposits (LHS)

SBI 1yr TD rates (RHS)

0%

5%

10%

15%

20%

25%

10%

12%

14%

16%

18%

20%

22%

24%

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Currency with the public YoY growth (LHS)

Food Inflation (RHS)


22/144


May 18, 2011 Page

comes within RBIs comfort zone. We believe that either of these things ca

happen only in 2HFY12 given that government needs to finish 60% of i

borrowing program in the 1H only. And any reduction in SLR would reduce t

demand for G-Secs from the banking system which will push the yields u

making the borrowing expensive for the government.

Chart 61: Trend show ing the movement o f reserve ratios

25bps of reduction in CRR can free

upto Rs145bn. A multiplier of 4x will

create deposits of Rs580bn, 1% of

outstanding deposits as on Apr11


c) Fresh money printing: The RBI undertakes the exercise of printing fremoney depending upon the situation. During the year ending Jun09 and Ju

10, RBI printed a cumulative of Rs2.3tn in order to ensure sufficient liquidity

the system, partly due to outflow/slower accretion to forex reserves.

We compare this metrics with the forex reserves and realize that the RBI h

maintained a ratio of notes in circulation to forex reserves at 58% (avg.) ov

the last 6yrs. During year ending Jun10, the ratio picked up to 66%, mu

higher than the last six year average of 58%.

Chart 62: RBI printed sufficient money in 2010 when

forex reserves declined

Chart 63: Notes in circulation as % of forex reserve

increased consecutively to 66% (v/ s 5yr avg. of 56%


4%

5%

6%

7%

8%

9%

10%

23%

24%

24%

25%

25%

26%

26%

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

SLR (LHS) CRR (RHS)

-200%

0%

200%

400%

600%

800%

1000%

1200%

1400%

1600%

-

200

400

600

800

1,000

1,200

1,400

1,600

Jun

'05

Jun

'06

Jun

'07

Jun

'08

Jun

'09

Jun

'10

Mar'11

Notes printed by RBI (LHS)

Notes printed as % of incr. forex (RHS)

Rsbn

40%

45%

50%

55%

60%

65%

70%

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

Jun'05

Jun'06

Jun'07

Jun'08

Jun'09

Jun'10

Mar'11

Notes in Circulation (LHS)

Notes in Circulation as % of forex res. (RHS)

Rsbn


23/144


May 18, 2011 Page

Chart 64: Money supply (M3) / Reserve Money (M1)

Multiplier expanded from 2.8x to

4.0x by Mar11

During FY09-11, M3 grew by

~16.6% while in FY11 by 15.9%

RBI pegs growth of M3 in FY12 at

16%


Therefore, we believe that the RBI would try and maintain enough liquidity in t

system so that it can ensure smooth transition of its monetary policy to count

inflationary pressures while not choking the liquidity taps in the system.

Interest rate on deposits unlikely to

come off

But neither are they expected to

go up further (not more than 50bps)

Inflation to remain in the range of 9-

10% during 1HFY12

Deposits rates are near peak levels

While higher inflation (core) prompted the RBI to continue to take policy action b

raising policy rates ninth increase since Mar10, cumulatively at 225bps, t

interest rates are unlikely to come-off in a jiffy.

Per our HDFC Banks economics team, the inflation is likely to remain in doub

during 1HFY12 and 6-7% by FY12, which makes us believe that the RBI w

maintain its hawkish stance and therefore the rates will remain higher in th

system.

In its 4Q monetary policy, the RBI has pegged the credit growth at 19% Yo

(against 21.5% YoY in FY11), deposit growth at 17% YoY (v/s 16% YoY in FY11)

FY12E. With growth outlook moderating, we do not expect banks to rush to tie-uliabilities before spotting asset growth opportunities. Hence, we do not expect t

deposit rates (retail) to go up sharply (not more than 25-50bps).

Deposits to grow 17-18% CAGR over FY11-13

The banks in order to attract deposit flow, raised deposit rates by 200-300bps sin

Sep10. Despite that the growth remained subdued at 16% as on 25th

Mar1

Therefore, we expect deposit growth to gather momentum as the real rate of retu

improves due to a) moderation in inflation (from 9.4% in Jan11 to 8.66%

Apr11), b) higher deposit rates in the system and c) peak prices of other ass

classes such as silver/gold/property etc.

Deposit rates went up by 200-

300bps since Sep10

Table 4: Deposit rate hikes by banks since Sep'10Bank


24/144


May 18, 2011 Page

Chart 65: Trend showing deposit rate movement and deposit growt

(YoY)

Higher interest rates to attract

deposits

1yr term deposits rates are higher at

7.75% as compared to 5-yr average

of 6.5%

Source : RBI, Bloomberg ,HDFC Securities Institutional Research

Further, with other asset classes such as gold & silver being on their life time high

the probability of generation of absolute returns looks difficult hence maki

deposits an attractive investment avenue.

Chart 66: Gold historic p rice Chart 67: Silver historic price

Source : Bloomberg Source : Bloomberg

350

550

750

950

1,150

1,350

1,550

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

US$/OZ

-

10

20

30

40

50

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Oct-06

Apr-07

Oct-07

Apr-08

Oct-08

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

US$/OZ

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

10%

15%

20%

25%

30%

Apr-04

Oct-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Deposits growth YoY (LHS) SBI 1 Yr TD rate (RHS)


25/144

Section 3: Earnings grow th to remain healthy; Cherry pick the stock

May 18, 2011 Page

Earnings to grow 22% CAGR over

FY11-13E

Lower opex and lower credit cost to

drive earnings growth while NII

growth to moderate

Section 3: Earnings grow th to remain healthy; Cherrpick the stocks

The earnings for the banking system is likely to grow at 22% CAGR over FY11-13

(v/s 24% CAGR over FY06-10) with lower operating costs and lower credit costs

offset some pressure on earnings growth from margin compression.

We believe banks with higher proportion of low cost deposits will continue to sco

above banks with lower proportion even though the interest rate on savings produhas gone up by 50bps , hurting NIMs by 10-15bps (without considering any chan

in yields).

Asset quality concerns though largely abated, but higher interest rates will certain

put the financial health of small and medium enterprises (SMEs) under-check a

banks with higher exposure to SMEs/mid-corporate might face some pressure

interest rates go up by another 50bps or so.

Earnings growth to remain healthy

The banking system closed FY11 with an earnings growth of 15% YoY. The grow

was driven by improved margins (expanded 40bps YoY), lower credit costs an

uptick in loan growth. However, going into FY12, we see the profit grow

remaining healthy but the drivers would change.

While volumes are estimated grow at 18-20% YoY, core spreads in FY12 will rema

under pressure (YoY) due to higher cost of deposits. However, lower operati

costs (due to lower pension cost) and lower credit cost will enable a health

earnings growth.

Table 5: Consolidated Income Statement (Our coverage) Rsm FY11 YoY growth FY12E YoY growth FY13E YoY grow

Interest income 2,936,694 20% 3,791,673 29% 4,608,056 22

Interest on Advances 2,137,374 20% 2,818,747 32% 3,447,217 22

Income on Investments 721,877 19% 872,582 21% 1,053,098 21

Interest on bank balances 74,349 33% 85,442 15% 91,348 7Other Interest Received 13,548 11% 14,902 10% 16,393 10

Interest expense 1,819,566 11% 2,505,789 38% 3,076,703 23

Net interest income 1,117,128 36% 1,285,885 15% 1,531,352 19

Other income 491,157 2% 575,162 17% 690,284 20

- Fee income 305,940 12% 369,530 21% 446,087 21

- Treasury Gains 49,263 -48% 44,209 -10% 54,249 23

- Other Gains 136,930 21% 161,423 18% 189,948 18

Total income 1,601,316 23% 1,869,579 17% 2,233,156 19

Operating expenses 713,024 22% 811,942 14% 970,847 20

-Employee Expenses 427,260 29% 465,908 9% 557,620 20

-Others 291,462 16% 346,032 19% 413,226 19

Pre-provision Profit 888,292 23% 1,057,637 19% 1,262,308 19Total Provision 274,514 33% 306,031 11% 350,077 14

-Provision for NPL 226,131 13% 241,090 7% 283,170 17

- Provision for Investments 15,899 -199% 30,725 93% 26,344 -14

- Provision on Std Assets 23,781 324% 19,789 -17% 26,135 32

- Others 11,693 -30% 14,427 23% 14,429 0

PBT 613,779 19% 751,606 22% 912,231 21

Provision for Tax 195,257 27% 239,549 23% 290,349 21

PAT 418,522 15% 512,057 22% 621,882 21



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May 18, 2011 Page

Margins to contract 17bps YoY in

FY12

Treasury gains could be a wild card

C/I ratio to moderate ~200bps

ROEs to be healthy at 18-19%

Table 6: Consolidated sector Du Pont Analysis (Our coverage)

FY11 FY12E FY13

Interest income 7.3% 7.9% 8.0

Interest on Advances 5.3% 5.9% 6.0

Income on Investments 1.8% 1.8% 1.8

Interest on bank balances 0.2% 0.2% 0.2

Interest expense 4.6% 5.2% 5.4

Net interest income 2.8% 2.7% 2.7%Other income 1.2% 1.2% 1.2

- Fee income 0.8% 0.8% 0.8

- Treasury Gains 0.1% 0.1% 0.1

- Other Gains 0.3% 0.3% 0.3

Total income 4.0% 3.9% 3.9

Operating expenses 1.8% 1.7% 1.7

-Employee Expenses 1.1% 1.0% 1.0

-Others 0.7% 0.7% 0.7

Pre-provision Profit 2.2% 2.2% 2.2%

Total Provision 0.7% 0.6% 0.6

-Provision for NPL 0.6% 0.5% 0.5

- Provision for Investments 0.0% 0.1% 0.0

- Provision on Std Assets 0.1% 0.0% 0.0

PBT 1.5% 1.6% 1.6%

Provision for Tax 0.5% 0.5% 0.5

PAT 1.0% 1.1% 1.1%

Equity / Assets 6.6% 6.3% 6.0

ROAE 15.9% 17.0% 18.0%


Note: Banks under coverage universe

Easing liquidity conditions have

cooled off the rates of late

Lag effect of higher deposit cost to

impact the margins

Margins to remain under pressure

The net interest margins of the banking system peaked out in 3QFY11. Due

higher inflationary environment the Reserve Bank of India (RBI) raised rates ni

times in a row by 225bps to 7.25% (repo). That coupled with tighter liquid

environment saw the deposit rates moving up faster. Banks raised deposit rates

75-225bps in 1-3yrs maturity bucket while on the shorter end the rates went up

almost 200-250bps during the last six months. However, rates at the shorter e

have cooled off with 3m CP and CD rates coming off by ~70bps, mainly due

seasonal phenomenon and reduced government balances with the RBI.

While banks raised the lending rates by ~150bps over 6-7mths. Large part

higher lending rates got factored in NIMs as the average floating rate loan book

70% but the lag effect of higher deposit costs will flow in FY12, will keep th

margins under pressure.


27/144


May 18, 2011 Page

Chart 68: RBI aggressively raised rates to counter

inflation

Chart 69: Rates at shorter end have cooled o ff

4.0%

6.0%

8.0%

10.0%

12.0%

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

Oct-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

3mth CP 3mth CD

Source :RBI , Bloomberg, HDFC Securities Institutional Research Source : Bloomberg ,HDFC Securities Institutional Research

Chart 70: Cost of deposits quarterly trend Chart 71: Yields on advances quarterly trend

Source : HDFC Securities Institutional Research Source : HDFC Securities Institutional Research

Chart 72: NIM s quarterly trend

NIMs peaked in 3Q


0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

Oct-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Repo rate (LHS) Reverse repo (LHS) WPI (RHS)

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

Q4FY10 1QFY11 2QFY11 3QFY11 4QFY11

PNB BOB Canara Bk BOI SBI

7%

8%

9%

10%

11%

12%


PNB BOB Canara Bk BOI SBI

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%


Axis Bk ICICI Bk PNB BOB SBI


28/144


May 18, 2011 Page

Growth in term deposits picked up

Proportion of CASA to moderate~200bps over FY11-13

Moderating CASA ratio and slow ing credit growth to hurt margins

On the back of higher interest rate, the low cost deposits (CASA) growth of t

banks to falter while that of term deposits to pick up. Since Sep10, the growth

term deposits stood strong at 17% (YoY) while that in low cost deposits moderat

from 27% to 25%.

Even the proportion of CASA deposits declined in total deposits by ~50bps to 35%

As we expect the rates on deposit to remain higher for a large part of the year, wexpect CASA ratio to moderate by 150-200bps over FY12-13.

Moderating CASA, higher cost on savings product at 4% and moderation in cred

growth to impact the margins adversely. We expect the margins to contract by 1

30bps over FY11-13E, depending on banks growth in CASA deposits. The mo

impact banks would be banks with lower CASA ratio such as BOI, Corp Bk, OBC a

Union Bank.

Chart 73: Trend showing growth (YoY) in term

deposits

Chart 74: Trend show ing grow th in term deposits (Yo

growth) for sector


Note: Data as per RBI. This also includes certain proportion of

savings and current deposits


Note: For banks under coverage universe

Chart 75: Trend showing growth in CASA deposits -

YoY

Chart 76: Trend show ing proportion of CASA deposits





10%

12%

14%

16%

18%

20%

22%

Jun-10

Jul-10

Jul-10

Aug-10

Sep-10

Oct-10

Oct-10

Nov-10

Dec-10

Dec-10

Jan-11

Feb-11

Feb-11

Mar-11

Apr-11

0%

2%

4%

6%

8%

10%

12%

14%16%

18%

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

15%

20%

25%

30%

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11

30%

32%

34%

36%

38%

4QFY09

1QFY10

2QFY10

3QFY10

4QFY10

1QFY11

2QFY11

3QFY11

4QFY11


29/144


May 18, 2011 Page

Chart 77: Margins to con tract in FY12 to flatten out in

FY13

Chart 78: Core spreads to moderate




Note: 1)For banks under coverage universe

2) Core spreads: Diff. of yield on advances and cost of deposits

Table 7: Changes in cost/ yields assumptions in FY12EParticulars (bps) Yield on advances Cost of deposits NIMs CASA rat

Allahabad Bk 68 89 -14 -1

Axis Bk 72 79 -27 -1

BOB 57 81 -16 -1

BOI 52 74 -18 -

Canara Bk 67 76 -19 -

Corp Bk 67 74 -26 -

ICICI Bk 64 60 -3 -1

IndusInd Bk 76 62 -9

ING Vysya Bk 70 82 -10 -

IOB 88 85 -28 -

OBC 72 86 -21 -1

PNB 75 78 -18 -1

SBI 66 69 -6 -1

Union Bk 70 66 -16 -

United Bk 68 68 4 -1

Yes Bk 68 81 -19 1

Source: HDFC Securities Institutional ResearchNet interest income growth to moderate

Having witnessed a disappointing FY10 (16% growth), the profitability of th

system improved in FY11 with the system logging 36% growth in net intere

income (our coverage universe), driven by higher net interest income growt

expansion in margins and stable credit cost. However, going forward, we expect t

growth to moderate due to under pressure core spreads and moderating volum

growth.

We expect the net interest income growth in the system to come at 15% main

driven by private sector banks which will grow at 17% while PSU banks will grow

~15%. Banks that are likely to log higher growth in NII over FY11-13E are Ax

Yes, IndusInd, Allahabad Bank and United Bank.

2.5%

2.6%

2.7%

2.8%

2.9%

3.0%

FY08 FY09 FY10 FY11 FY12E FY13E

3.0%

3.2%

3.4%

3.6%

3.8%

4.0%

FY08 FY09 FY10 FY11 FY12E FY13E


30/144


May 18, 2011 Page

Chart 79: Trend showing NI I grow th



Fee income to grow in tandem with

balance sheet growth

Fee income growth

Fee income growth of the banking system is largely linked with the growth in lo

book. With an expected moderation in loan growth, we expect the fee income growto also moderate. Moreover, banks with higher proportion of fee income from thi

party distribution would further witness pressure due to regulatory changes o

commission charged.

We expect fee income for the sector to grow at ~21% CAGR over FY11-13E, in-lin

with loan growth of 21%. In our view, banks with all round presence such as

international presence, b) syndication capabilities, c) investment banking etc. wou

have an edge over other banks.

Chart 80: Trend showing fee income as % of

advances

Chart 81: Trend show ing fee income growth (YoY )





1.0%

1.2%

1.4%

1.6%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

FY06 FY07 FY08 FY09 FY10 FY11 FY12E FY13E

Sector PSU Banks Pvt. Bank

5%

10%

15%

20%

25%

30%

35%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E


31/144


May 18, 2011 Page

Chart 82: Trend showing fee income growth and

advances growth (Y oY)

Chart 83: Fee income from TPD as % of total fe

income (FY10)




Trading income potential wild card

In a higher interest rate environment, the long-bond yields will move up, impacti

the earnings of the banks that have higher AFS portfolio. With the governme

pegging its net borrowing lower at Rs3.5tn, higher crude oil can disturb t

equation. This along with the RBIs hawkish monetary policy stance might not aug

well for the yields.

Our HDFC Bank economics team expects the RBI to further hike rates by 50-75b

over the full year in order to rein in inflation.

The state owned banks are more vulnerable to higher yields due to high

classification of investments in available for sale (AFS) category. Banks that hav

higher proportion of AFS in investment book are BOI, AllBank and Corp Bank. W

estimate that 50bps increase in yields would impact the FY12E pre-provisionin

profit for banks by 1.7-6.4%.

Chart 84: Proportion of AFS portfolio in investment book (FY11)

BOI, AllBank and Corp Bank have

higher proportion of AFS in

investment book


0%

10%

20%

30%

40%

50%

60%

IndusIndBk

INGVysya

CanaraBk

SBI

ICICIBk

OBC

AxisBk

YesBank

CorpBk

PNB

10%

15%

20%

25%

30%

35%

40%

0%

10%

20%

30%

40%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12E

FY13E

Fee income growth YoY (LHS)

Advances growth YoY (RHS)

0%

5%

10%

15%

20%

25%

30%

35%

40%

BOI

Allahabad

Bk

CorpBk

UnitedBk

OBC

CanaraBk

SBI

UnionBk

PNB

BOB


32/144


May 18, 2011 Page

Table 8: AFS portfolio of banks with duration

(FY11) SBI BOB BOI Canara Bk Corp Bk PNBUnionBank

OBCAllahabad

BkUnited

HTM book (%) 76% 84% 65% 73% 67% 75% 75% 71% 65% 72

AFS book (%) 24% 16% 35% 26% 32% 22% 24% 28% 35% 28

Duration (Yrs) 3.8 2.8 0.8 2.2 1.5 2.7 1.8 4.4 2.5


Table 9: Impact of 50bps increase in yields(FY11)

AFSInvestments

Proportion of AFS Duration (Yrs)Change in Yields

by 50bpsImpact (Rsm)

Impact on FY1operating pro

OBC 116,420 28% 4.4 0.50% 2,532 6.4

SBI 718,000 24% 3.8 0.50% 13,534 4.9

Allahabad Bk 151,510 35% 2.5 0.50% 1,917 4.9

Corp Bk 140,570 32% 1.5 0.50% 1,075 3.5

Canara Bk 218,300 26% 2.2 0.50% 2,434 3.2

PNB 210,670 22% 2.7 0.50% 2,855 2.6

Union Bk 141,100 24% 1.8 0.50% 1,249 2.4

BOB 112,663 16% 2.8 0.50% 1,583 1.8

BOI 290,834 35% 0.8 0.50% 1,192 1.7


Chart 85: Rising bond yields to result in MTM losses on banks' MTM portfol

Source : Bloomberg , HDFC Securities Institutional Research

Operating efficiency to improve

During FY11, banks provided ~Rs174bn towards pension liability for both existin

and retired employees (for our coverage universe). While the RBI permitted banks

amortize the liability over the term of five years (FY11 being the first year) f

existing employees, it mandated banks to provide against retired employees in FY

itself.

As a result, the growth in operating expenses was whopping 22% YoY to Rs713b

(our coverage). The liability for retired employees formed 20% of total liability. Withis one-off component not there in FY12, the operating expenses will grow by ju

14%. Hence, cost/income ratio will improve from ~46% in FY11 to 44% by FY12.

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

FY0

1

FY0

2

FY0

3

FY0

4

FY0

5

FY0

6

FY0

7

FY0

8

FY0

9

FY1

0

FY1

1

Trading income as % of G-Sec Bond yields


33/144


May 18, 2011 Page

Table 10: Second pension option liab ility for existing and retired employee

Particulars (Rsm)Second pension

liabilityProvision for retire

employee

PNB 27,577 5,57

BOI 22,122 7,07

BOB 18,299 5,54

IOB 7,587 1,88

Union Bk 16,902 3,75

Canara Bk 23,731 5,20

OBC 8,545 1,50

Corp Bk 5,525 N

Allahabad Bk 7,081 2,50

United Bk 2,682 1,00

Total 140,051 34,03


Chart 86: Tend showing operating expenses growth (Y oY)



Chart 87: Trend show ing cost/ income (ex-treasury) ratio

C/I to improve by 200bps as one-off

related to second pension liability

towards retired employees wont be

there in FY12


Note: Banks under coverage universe

12%

14%

16%

18%

20%

22%

24%

FY08

FY09

FY10

FY11

FY12E

FY13E

40%

45%

50%

55%

FY08

FY09

FY10

FY11

FY12E

FY13E


34/144


May 18, 2011 Page

Chart 88: Cost/ income (ex-treasury) ratio FY12E Chart 89: Change in Cost/ Income ratio over FY1

FY3E


Maintain cautious stance on asset

quality

Asset quality issues to subside, but risk remains

Having seen the worst year during FY10, the asset quality has improved since th

and as a result the gross NPAs for the system has declined from 2.7% to 2.6%

advances. However, the fresh delinquencies were marginally lower during FY11

1.90% v/s 1.92% in FY10 (of average advances) for the system; state owned ban

an average slippages ratio at 1.90% with select PSU banks having delinquencies a

high as ~2.7%.

The restructuring of advances slowed down post the special dispensation schem

which ended in Jun10.

Chart 90: Gross NPA Y oY grow th - FY11

Gross NPA increased 21% YoY in

FY11 v/s 25% in FY10

-20%

-10%

0%

10%

20%

30%

40%

PNB

UnionBk

AllahabadBk

YesBk

BOB

OBC

SBI

CorpBk

AxisBk

CanaraBk

ICICIBk

IndusIndBk

INGVysyaBk

UnitedBk

BOI

IOB


25% 35% 45% 55% 65%

ING Vysya Bk

SBI

IndusInd Bk

United Bk

ICICI Bk

Union Bk

Axis Bk

BOI

PNB

Allahabad Bk

Yes Bank

Corp Bk

Canara Bk

BOB

OBC

-10% -5% 0% 5% 10%

SBI

Yes Bank

IndusInd Bk

ICICI Bk

Axis Bk

Corp Bk

PNB

United Bk

OBC

ING Vysya Bk

BOB

Canara Bk

Union Bk

Allahabad Bk

BOI


35/144


May 18, 2011 Page

Chart 91: Restructured assets YoY grow th - FY11 Chart 92: Restructured assets as % of total advances

FY11

-80%

-60%

-40%

-20%

0%

20%

40%

IndusIndBk

BOB

PNB

SBI

CorpBk

CanaraBk

YesBk

BOI

OBC

AxisBk

ICICIBk


Chart 93: Delinquency r atio


CRISIL noted that asset quality

might peak out

We expect that higher commodity prices and higher interest rates will keep th

profitability of manufacturing companies under pressure. CRISIL, credit ratin

agency, in its latest review has noted that the credit quality might peak out.

upgraded 605 ratings and downgraded 269 ratings in FY11, on a base of arou

6200 ratings as on March 31, 2011.

0%

1%

2%

3%

4%

5%

6%

7%

PNB

OBC

BOI

UnitedBk

SBI

CanaraBk

UnionBk

CorpBk

AllahabadBk

BOB

AxisBk

ICICIBk

IndusIndBk

YesBk

0%

1%

2%

3%

UnionBk

SBI

AllahabadBk

UnitedBk

PNB

CanaraBk

OBC

BOI

ICICIBk

IndusIndBk

AxisBk

ING

VysyaBk

CorpBk

BOB

YesBk

FY10 FY11


36/144


May 18, 2011 Page

Chart 94: Trend showing interest rate movement and systems NP

movement


Asset quality to improve..

..on the back of lower slippages and

higher recoveries and up gradations

While we expect the asset quality of the system to improve as compared to that in

FY10 and FY11, but significant improvement is not expected if a) interest ratesfurther goes up by more than 50bps, b) debt-related crisis in some of the European

nations and c) higher commodity prices.

During FY10-11, the delinquency ratio for the system peaked at 1.9-2.1% - highe

since FY05. However, we do not expect the slippages to be so high in FY12-13 an

building in a lower delinquency ratio at ~1.7-1.8%, 20bps lower than previous 2y

average. On the other hand, while recoveries and upgradations could be healthy

FY12, but will slowdown in FY13 owing to slowdown in economic growth, which w

headline gross NPAs higher at elevated levels. We estimate the gross NPAs to be

the range of 2.6-2.7% over FY12-13E.

Chart 95: Trend show ing Gross NPA YoY grow th Chart 96: Trend show ing Gross NPA ratio





-20%

-10%

0%

10%

20%

30%

10%

12%

14%

16%

18%

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

SBI PLR (LHS) Gross NPAs growth YoY (RHS)

0%

5%

10%

15%

20%

25%

30%

FY

08

FY

09

FY

10

FY

11

FY1

2E

FY1

3E

2.0%

2.5%

3.0%

FY

08

FY

09

FY

10

FY

11

FY1

2E

FY1

3E


37/144


May 18, 2011 Page

Chart 97: Trend show ing delinquency ratio Chart 98: Trend show ing coverage ratio





Select sectors still under stress, shows latest CDR report

The latest corporate debt restructuring tally shows that during the quarter that t

accounts restructured increased by Rs35bn during 4QFY11 even as number

proposals increased by 5% to 242, mainly led by sectors such textiles (11%), sug

(11%) and cement (27%).

Chart 99: Sectors that reported an increase in CDR

(QoQ 4QFY11)

Chart 100: Large contributors to outstanding balan

of cases referred under CDR

Source : CDR India Source : CDR India

0%

5%

10%

15%

20%

25%

30%

Cements

Paper/

Packaging

Textiles

hdfc sector

Documents