Monday, February 21, 2011

Have the banks bottomed out?

Have the banks bottomed out?

Over the last 10 days, there have been 5 reports suggesting the worst is over for banking stocks and it’s time to buy. The main points being spoken are: The worst of inflation pressure is over, interest rates have peaked and valuations have reached value zone and in some cases are at historic low. While prima facie, all of them look valid arguments, one fact that worries me is that banks are easily the most over-owned stocks in India and there is bound to be some vested interest from these brokerages to see the bottom of these stocks. In this piece, I am wondering if there is a possibility of double dip in banking stocks. Just to illustrate this over-ownership, I am presenting some of my research.

The Bankex is a composition of 18 leading banking stocks in the country. The combined FII holding at 2009-end for these 18 banks was 166 cr shares. By the end of September quarter of 2010, this had gone up to 198 cr shares, an increase of 32 crore shares. If I take the average share price of all these stocks individually during this period, this would have led to buying worth Rs 23,293 cr. This was led by Rs 4,715 cr in case of ICICI Bank and Rs 4,308 cr in case of SBI.

Despite the recovery in markets, it’s still down 13% from November levels and during the same period, the Bank index is down 17%. The big boy SBI is down 22% and some stocks like IDBI and Dena Bank are down as much as 31%. So there has been more punishment for banking stocks than for markets overall. And considering the starting point for the market correction was inflation worry, this underperformance is justified.

First up, let’s look at the valuations of banking stocks. Let’s begin with the PSU banks. SBI is trading at 1.5x adjusted FY12e book value. Here are the valuations of other PSU banks:

PSU BankPrice/FY12e Adj BV
Bank Of India1.3
Canara Bank1.2
Corporation Bank1.0

Now SBI has fallen from recent peak of Rs 3515 to the current price of 2750 odd. The valuation has fallen from 1.90x to 1.50x. But is it attractive enough?

The only reason I am uncomfortable with this cheap valuation argument is the fact that the current scenario is looking a bit like early 2008, when we had the big inflation scare led by Crude’s surge towards $140/bbl. It’s worth noticing that from Jan 2008 to April 2008, the SBI stock fell from 2463 to 1605. From FY09 book value perspective, the P/BV fell from2.3x to 1.5x. It then had a brief rally towards 1795 and it looked like bottom was in place, and then we had that big fall to 1078, taking its P/BV to 1x. Under current circumstances, a 1x P/BV would be if stock hits 1850. I am not saying this will happen, just saying it can happen.

Now, let’s talk about this inflation bit. The only component that has come down is the vegetable prices. But we need to see one to two months of stable prices before concluding that the worst is over on that aspect. On the other hand, we have seen milk prices going up twice this month and milk forms a large part of consumption basket in India. Sugar prices too have started showing signs of firming up and the non food inflation remains quite high.

And finally the interest rate situation. Evidence suggests rates are yet to peak. We have seen a retail bond issue from SBI which is giving as high as 9.75% interest. Now I find it hard to fathom that SBI would come out with such a large issue if this is the peak. Clearly they expect some more hardening of rates and there is a chance that the NIMs of banks will take a hit and that will have an impact on profitability as well.

In India, the banking sector has a massive advantage in terms of the regulated savings rate of 3.5%, which is almost criminally cheap. However, there is a likelihood of significant shift in deposits from savings to fixed deposits. There is also competition from the fixed maturity plans (FMPs) being launched by the mutual funds. And as banks become for aggressive in lending, there is a risk of that impacting the asset quality and the NPA ratios.

Conclusion: While the valuations may look attractive, there is no rule which says they can’t become more attractive especially if the headwinds are pretty strong.


  1. Hi Anuj, could you do a study of inflation history in the indian markets and how it affected the nifty. Also any insights of which sectors would lead the sell off if the nifty was to go to 4000-4500. I have it down as metals, IT & pharma & autos in respective index percentages. Your thoughts on the same.

  2. And in that order i.e metals falling the highest in % terms and followed by IT and so on

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