[sbinews] Researchscope- Article on SBI (Economic Times)

  • From: "Rajendra S. Pai" <rajendra.pai@xxxxxxxxx>
  • To: <sbinews@xxxxxxxxxxxxx>
  • Date: Mon, 19 Jan 2004 09:22:08 +0530

State Bank of India
All cleaned up: CLSA Asia Pacific Mkts
(Economic Times)

State Bank of India's (SBI) years of rising NPL provisions are set for a
sharp reversal with an accelerating economic recovery driving asset-quality
improvement. SBI has also made up for past underprovisioning with its NPL
coverage now at 70%. We forecast the bank's core ROE to rise by 250bps over
the next two years thanks to organisational restructuring and a credit-cycle
upswing. The stock's rerating should extend to our consolidated-PB target of
1.25x (currently on 1.1x). BUY

Rising provision charges to reverse
The Indian economy is on an upswing and corporate profitability has seen a
sharp turnaround. Credit upgrades are now outstripping downgrades. With a
25% share of system assets, SBI is a beneficiary of this trend. The bank's
NPL ratio has already fallen to 9% (vs 20% a decade ago) and recovery rates
are also set to rise thanks to the better macro environment and a tighter
legal framework. As SBI ramped up NPL coverage over the last two years,
provision charges soared to more than 2.5% of loans. With coverage now at a
comfortable 70% and the bank's transition to the 90-day-NPL-recognition
norm, provision-charge levels will normalise to 1.5% from FY05CL down a
sharp 30% YoY

ROE set for a boost
We forecast SBI's core ROE to rise by 250bps over the next two years as it
benefits from ongoing organisational and asset restructuring as well as a
credit-cycle upswing. The bank's intermediation costs are in decline due to
reduced manpower costs and productivity gains from new technology
initiatives. A technology upgrade is currently underway and branch
restructuring will start this year. SBI will also benefit from  a pick-up in
system-loan growth as it will  lift loan-to-deposit ratios. A shift in loan
mix in favour of retail will also ease margin pressure.

Valuations remain compelling
SBI's share price is up 124% in absolute terms and 22% relative to the
market over the past year. However, the stock still trades on 1.1x
consolidated book and offers the best value proposition among regional
banks. We believe improved loan-book credibility and rising core ROE will
extend SBI's rerating to our target consolidated-PB multiple of 1.25x, or
Rs750 (US$16.4). An unrealised gain of Rs200bn (or 100% of shareholders.
funds) on its treasury portfolio and potential embedded value in
subsidiaries further enhance the stock's upside potential.

The business
SBI is India's largest bank and together with its associates controls 25% of
total banking-sector assets and has  a similar share in system  deposits.
Customer advances form less than 40% of total assets and the loan-to-deposit
ratio is currently running at 47%. The retail-loan portfolio is currently
only about 20% of advances. While both LDR and margins in the banking
business are currently on a downtrend, we believe they are close to
bottoming out and the first signs of a pick-up are already evident. The
Indian banking sector is on the verge of a credit upturn and SBI is one of
the best plays on this recovery.

Competition and market franchise: SBI has an unparalleled franchise in the
Indian banking sector with over 9000 branches and 90m customer
relationships. The bank also has strong relationships with almost all
companies in the country. This has enabled it to sustain marketshare in the
more profitable segments despite intensified competition. SBI is now looking
to leverage its franchise to grow its retail-asset portfolio. Competition is
also getting tougher with private banks growing larger and some foreign
banks entering the fray.

Rising provisions charges to reverse: SBI's NPL provisions have risen at a
CAGR of 26% over the past four years as tramped up NPL coverage, battled an
economic slowdown and migrated to more stringent NPL-recognition norms. This
trend is set for a sharp reversal and we forecast a 30% reduction in the
bank's provision expense in FY05, even with management targeting a reduction
in net NPL levels to 2%.

Economic rebound to drive asset upturn: India's economic outlook has never
been better with more than 7%  GDP growth in FY04CL. FY05CL growth outlook
is even stronger (our  economics team forecasts 9%). The agriculture,
industrial and service sectors are all seeing solid performance, driven by
rising exports, better domestic demand, turnaround in the investment cycle
and acceleration in new-job creation.

The rebound in the industrial sector is even more dramatic as the  current
economic upswing has followed corporate restructuring. During the downturn,
the Indian corporate sector undertook a severe belt tightening by cutting
costs, debt and even employees. The  benefits of this are now bearing fruit
with aggregate corporate profits in FY03 up 68%. This improvement in
corporate profitability bodes well for banking-sector asset quality as
interest coverage levels at 3x, are now at their highest level in a decade.

Latest data from credit-rating agencies indicate that upgrades are
outstripping downgrades. Over the past six months there has been a
perceptible slowdown in credit-rating downgrades and our talks with Crisil
(S&P affiliate and largest rating agency in India) reveal that there has
been little deterioration in corporate credit during this period.

Indian banks are a natural beneficiary of this economic upturn and with 25%
of system assets SBI is one of the best plays on the asset quality upswing.

NPL accretion has slowed: Over the past two years, SBI has already been
witnessing an improvement in asset quality as NPL accretion has slowed. For
the first time in a decade, the absolute level of NPLs registered a
significant decline in FY03. As a percentage of loans, NPLs have
consistently fallen since FY99 and now stand at 9% of loans - a stark
contrast to the >20% NPL levels in FY94-95.

Treasury profits used for balance-sheet cleanup: Though the bank has booked
significant treasury gains over the past two years, it has used it to
aggressively clean up the balance sheet. Over FY01-04, SBI's total NPL
provisions were equivalent to 50% of shareholders. equity.

Higher coverage levels: SBI's NPL coverage exceeds 70% and surpasses that of
most banks  in  the region. The bank has stepped up its coverage levels even
as NPL recovery rates are set to improve on the back of an improving macro
environment as well as a tightening of the legal framework. In December
2002, a new regulation, namely the Securitisation, Reconstruction of Finance
Assets and Enforcement of Security Interest, came into force, which has
significantly enhanced the power of Indian banks/financial institutions to
foreclose the assets of defaulting borrowers. The new law is aimed at
strengthening the regulatory framework, facilitating secured lenders to
foreclose assets. It allows a secured creditor to do the following: take
possession/sell the secured asset; take over management control; appoint a
manager and recover any money payable by a third party to the borrower.
Another positive development has been the formation of asset-recovery
companies (ARCs) by the banks, which will also lower the stickiness of NPLs.

SBI has seen improved asset quality even though it has migrated to
international best practice of NPL recognition.

Provision charges set to fall: As SBI ramped up coverage levels, provision
charges to loans that have historically averaged 1.5% soared to over 2.5%.
With coverage now at comfortable levels and the bank having undertaken a
transition  to the 90-day-NPL-recognition norm, we expect provision charges
to the P&L to normalise to 1.5% of total loans in FY05.

Given the improved macro economic environment and cyclical upturn in
commodity sectors that constituted a large share of NPLs (steel, textile and
chemicals), the bank could see significant provision writebacks in FY05.
This would drive a steeper reduction in SBI's NPL provision expense than our
current estimate of a 30% decline.

Asset recovery to drive earnings: This significantly benefits earnings as
NPL provisions have been eroding roughly 40% of SBI's pre-provision profit.
It will also ensure that the bank sustains robust earnings momentum even as
treasury profit tapers off.

Roe set for a boost: SBI's core ROE is set to rise by 250bps over the next
two years as it benefits from simultaneous organisational and asset
restructuring as well as the credit-cycle upswing. The bank's intermediation
costs are in decline thanks to a reduction in manpower costs and
productivity gains from new technology initiatives. Massive operational
restructuring, which is also underway, will enhance its competitiveness. SBI
has already implemented technology upgrades and branch restructuring will
start this year. These will result in a 20bp reduction in the operating
cost-to-asset charge to 2.1%.

Email From ""Rajendra S. Pai" <rajendra.pai@xxxxxxxxx>" was security checked by 
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