State Bank of India, or SBI
SBI's second quarter was fairly subdued. The result did not change our long-term view on the bank.
Net interest income was flat as a slight uptick of 1.2% in loan growth was offset by compressing margins, while asset quality also slipped.
Deposit growth was strong at 4.3% and we expect the pace of growth to sustain in the medium term.
The bank has a strong and wide retail presence, underpinning its large deposit base in India and competitive advantage in low cost funding with rupees. While return on equity will continue to be weighed down by rising provisioning on rising NPAs, we forecast the bank to generate return above its cost of equity at the end of our explicit forecast period.
Asset quality continues to slip in the second quarter with nonperforming assets of total loans rising to 7.14% from 6.94% last quarter.
Positively, the pace of increase is in line with last quarter and at a slower pace in the second half of fiscal 2016, which saw a quarterly increase of 100 basis points.
Management noted the increase in NPAs were from a list of NPAs previously identified, indicating the deterioration in asset quality has not broadened across its loan book. We continue to see rising NPAs in the near term at pace in line with this quarter as economic conditions remain challenging.
Net interest margin fell 3 basis points against last quarter to 2.8%. With the Reserve Bank of India maintaining its easing stance, we believe net interest margin will remain pressured in the near term. A further cut in policy rates is dependent on the impact from the potential decline in economic activities from the note exchange program above, and the overall inflation level, which has been favorable over the past year, but may vary depending on economic conditions.
HDFC Bank
HDFC Bank posted another strong quarterly result in line with our expectations. Second-quarter net profit increased 4% against last quarter to Rs 34.5 billion, or 20% against the same period last year. The result was propelled by accelerating loan growth on the first quarter, a largely steady net interest margin, or NIM, and sustained high asset quality.
The solid result does not change our long-term view and underpins the bank's premium valuation.
The bank is trading in line with our unchanged Rs 1,240 fair value estimate, representing fiscal 2017 price/book value per share of 3.6 times. The price/book multiple is one of the highest among banks globally, reflecting the high growth India market, the bank's pristine balance sheet and in turn, its annualized second-quarter return on equity of 18.3%. However, its bright prospects are priced into the current share price and any deterioration of the above will see its valuation multiple compress. As such, we require a larger margin of safety before recommending the bank.
The bank is favorably positioned to leverage India's strong long-term economic growth prospects, generating higher than peer return on equity.
Net interest income increased 2.8% against last quarter and we attribute the slower growth to a decline in NIM. We estimate a second-quarter annualized NIM was 4.35%, compared with 4.41% in the first quarter. We continue to expect NIMs to be pressured in the near term as the Reserve Bank of India maintains its easing stance, with one more interest rate cut expected before year-end. Management also noted competition for better quality corporates and in the retail segment in general it is further pressuring margins. However, we believe lower margins should be offset by higher loan growth, which remains robust.
Loan balance increase of 5.1% on the last quarter to Rs 4.9 trillion was ahead of the seasonally weak first quarter. Deposits grew at a slower pace at 3.1% on the last quarter to Rs 5.9 trillion. While deposit growth lagged system growth and the increase in loans, the bank's liquidity remains high with a loan/deposit ratio of 83%. Slippage in its asset quality was a slight negative in the first quarter but the bank reversed the trend this quarter. Asset quality improved with nonperforming loans as a percentage of total loans declining by 2 basis points to 1.02%.
Provisioning coverage on nonperforming loans is healthy and steady at 70% while its capital adequacy ratio declined by 10 basis points to 15.4% on the last quarter. The bank's asset quality remains ahead of peers, particularly against publicly owned banks. With lower NPAs and a strong liquid and capital position, we maintain our view that HDFC Bank can focus purely on growth and is in a good position to capture market share from publicly owned banks.
ICICI BANK
ICICI Bank's second-quarter result was fairly subdued.
The result benefited from a one-off Rs 56.8 billion gain for selling its 12.63% stake in its insurance arm, ICICI Life, through an IPO. Excluding the gain, the bank would have posted a quarterly loss from higher provisioning for NPAs, which has continued to deteriorate in the second quarter. NPAs increased both on an absolute basis and as a percentage of total loans; they now make up 6.8% of total loans, versus 5.8% in the prior quarter.
The bank continues to alter its portfolio mix to reduce its exposure to vulnerable sectors. While a higher contribution from the retail portfolio is likely to improve credit quality in the long term, we expect NPAs to remain elevated in the near term, as the change in portfolio mix will occur gradually. We lift our provisioning forecast to account for the higher-than-expected provisioning in the second quarter, and our earnings forecasts are adjusted lower.
The bank will continue to gain market share from public-sector banks in India, and that it is positioned well for the country's long-term economic growth prospects. However, the bank's NPAs remain elevated, and we expect its growth rate to lag that of its higher-quality peer HDFC Bank.
Positively, ICICI Bank reaffirmed its cost advantage with strong deposit growth of 5.9% against the prior quarter, which underpins its unchanged narrow economic moat rating. We expect the contribution from deposits to its total funding base to continue to increase as the bank maintains its investments in its branch and ATM network. The branch network saw moderate expansion in the quarter of 18 branches to 4,468, while around 200 ATMs were added.
Top-line growth was soft, with net interest income rising 1.8% against the prior quarter, or flat against the year-ago period. Loan growth was soft at 1.1%, but this was enough to offset a compression in net interest margin, which we estimate at an annualized 3.12%, versus 3.18% in the prior quarter. The decline was expected, as the Reserve Bank of India lowered interest rates and the level of NPAs remains elevated. This is set to continue in the medium term, and there is no change in our margin assumptions.
