Premium [Unlocked]: Banking Sector of FY 2018

In India – the economy which has become a rising beacon of growth among the investors, but the supporting wheel of its economy, the banking sector has been struggling with non-performing assets. Even the 2008 global financial crisis was unable to make a dent on Indian Banking sector, where banks had one of the lowest NPA during those times. But at the current juncture Indian banks are among the top distressed banks in the world.
There have been scams, more distressed assets, writedowns, frauds and what not.
Even the governments mega 2.11 lakh recapitalisation plan for the banks have failed to lift  investor sentiments. PNB at a Market cap of 25,000 Cr is receiving 5,500 Cr as part of recapitalisation. Which essentially is 22% dilution. And one fine day a scam pops up worth some 11,000 Crs. So in total you are taking a dilution of 22% and your condition is still worse than before – all the new capital is wiped out just as you got it.
If you believe it’s only from PSU banks then you are wrong, there are private banks which are taking the hit and have turned loss making.  It takes more than recognising NPAs to overcome this problem. Banks need to step up and put corrective measures in place and start some serious provisioning. Dig deep into their accounts and take prudent steps for checking client’s credibility.
At this point, when most of us have been pondering over whether the worst is over for the banks, we thought we will bring a composite report of all banks on their financial health and see how their financial health is.

Market Prices: P/B And P/E Ratios:

P/B ratio indicates the price to book ratio – or the market cap of the company compared to (Equity plus reserves). P/E or Price to Earnings ratio (market cap divided by net profit) denotes the future earnings expectations of the company.
Last time when we wrote the banking sector report, we said investors are willing to pay higher price only on in either of two conditions viz. the first being cleaner balance sheet (lesser NPA’s) or the bank should have a larger asset or liability size (Deposits and Credit). But now things have changed, Investors are more inclined towards cleaner balance sheet and are not concerned much about the asset base. The asset base only gives a comfort that the bank will not go bankrupt (in case of large banks) because they are too big to fail.
In the current scenario most the P/E values are skewed as most of the banks have turned into loss making. Which doesn’t portray the exact picture. For instance, Axis bank which manged to just stick its head out and made a EPS of 1.86 for the whole year has a P/E of 282.15.

Note: The Stock prices taken are as on Jun 21, 2018. P/E values are negative due to losses.

Most of the private banks are richly valued in contrast with PSU banks owing to their lower NPAs and stable growth. Exceptions are their in terms like ICICI and Axis banks, were NPAs are high and still they got a better valuation.
In terms of drawdown from 52 week high, most of private banks are near their 52 week high and PSU banks just above their 52 week lows. It’s the stark contrast of the valuations of two firms in the same industry and their financial health.
Interesting Facts:

• Nifty Bank P/E stood at 34.57 and P/B at 3.19 as on Jun 21.
• Nifty PSU Bank P/E was negative and P/B at 1.08 on Jun 21.
• Nifty Private Bank P/E was 33.80 and P/B at 3.51 on Jun 21.

Largest And Smallest Banks

SBI Still pips all the banks with a huge margin in terms of its size. Post merger with five other banks, SBI has become huge and can touch 50 lakh crores of turnover anytime soon. Though SBI is the largest of the banks we see in the lot below with nearly 25% of all deposits, but it’s still comparatively small to be projected as a Indian bank for a global platform.

Private banks are increasingly displacing PSU banks in terms of size. Out of the top 12 banks in India, 5 spots are occupied by the private banks. Private banks have been growing at a much better pace and have 24.91% of total deposits and 30.37% of total advances in FY18.

Interesting Facts:

• The total deposits taken by above 35 banks is at Rs 110.25 trillion. Out of which SBI accounts for 24.69%
• The total advances given out by the banks is at Rs 83.37 trillion. Out if which SBI accounts for 23.50%

Deposit And Credit Growth

Deposit growth of Indian banks has been slow for FY18, but the advance growth has picked up in comparison to last year. Meaning they are now back to higher lending growth, while deposits aren’t growing that much.
The growth of private banks have been phenomenal, as they are eating into the share of public banks and also acquiring newer clients and pushing through into newer regions. PSU banks advance growth stood at 2.70% , that of Private banks stands at 20.29%. Similarly deposit growth for FY18 for PSU banks was flat and private banks was at 18.33%.
The advance growth of the most PSU banks are subdued because of cut down on lending, banks are increasingly trying to clean out their books before fresh lending. And 11 banks have been put into PCA (Prompt Corrective Action), which restrict them from fresh lending.

Note : The above chart depicts growth rate YoY basis for FY18.

Yes Bank is definitely the out performer in this segment exceeding the overall industry growth by huge margin.
DCB, Federal, HDFC, Indusind, Kotak, RBL, Vijaya Banka and Yes Bank are the only few set of banks which manged to have advance and deposit growth higher than 15% . PSU banks which are on par with private banks in terms of advance and deposit growth are Indian Bank and Vijaya Bank.
Bank of India, Corporation Bank, Dena Bank, Dhanlaxmi Bank, IDBI, Maharasthra Bank, Oriental Bank and UCO bank are having negative growth both in terms of deposits and Advances.
Interesting Facts:

• The total advance growth of 35 banks was at 7.48%
• The total deposit growth of 35 banks was at 5.78%

Revenue and Profit Growth:

For the year 2018, revenue growth has been irrelevant for most of PSU banks as most of their profit growth was dependant on provisioning factor rather than top line growth or net interest margin expansion.
Revenue growth has been muted for most of the banks for FY18 except few exceptions like DCB, HDFC, Indusind, Kotak, RBL and Yes Bank which have Revenue growth higher than 15%.

Note: RG: Revenue Growth; PG: Profit Growth; P To L : Profit to Loss; L To L: Loss to Loss; L To P: Loss to Profit

There are some banks which made decent profits because of expanding margins and on some base effect (typically previous year they made a lower profit and when compared to the normal year, the percentage stands exaggerated.) played the role.
DCB, HDFC, Indusind, Kotak, RBL and Yes bank have registered greater than 20% profit growth on account of increased top line growth and expanding margins. Other banks which have greater than 20% profit growth but mainly due to base effect increase are IDBI, J&K Bank, South Bank and Syndicate bank.
Interesting Facts:

• The overall revenue collected by 35 banks for FY18 was at 11,72,998 Crs. Revenue Growth of these 35 banks on YoY basis was at 1.56%.
• Out of total revenue of all listed 35 banks SBI accounts for 25.7% of the revenue.
• For FY18, 35 banks together incurred a loss of 16,073 Crs. Last year the profit was at 49,833 Crs.
• HDFC is the highest profit raker at 18,560 Crs and PNB highest loss making at Rs 12,130 Crs. SBI made a loss of Rs 4,187 Crs for FY18.

Net Interest income:

Net interest income (Interest Margin) is the difference of Interest earned and Interest paid out. It gives an idea of how much banks are earning from their core business. The other income might also include processing fees, transaction fees, card fees, commissions etc. Though the fees part appears to be small, but it is the one segment where you are generating revenue without much of a risk. For instance Income for SBI on commission, exchange and brokerage stands at Rs 22,829 Crs and credit card fees itself at Rs 2,126 Crs. The total other income for SBI stood at 77,557 Crs, which is 25% of its total income for FY18.
Net interest income growth can be because of two things one due to top line increase and second from margin expansion.
Banks like RBL, Karnataka Bank, Vijayabank, Indian Bank, J&K Bank, Andhra Bank, City Union Bank and Bank of Baroda have expanded their margins and has resulted in higher net interest income.
Banks like DCB, Indusind, HDFC and Kotak have increased their net interest income on account of higher interest income rather than expansion in margins.

Note: The growth is for FY18, calculated on YoY basis.

Allahaband Bank, Bank of India, Central Bank, IDBI, Orient Bank, PNB, UCO Bank and United Bank have shown degrowth in net interest income. That’s mainly because of lower growth or no growth in advances (can essentially be higher NPAs as well, where technically interest payments stop) and contraction in margins.
Interesting Facts:

• The total net interest income of 35 banks put together for FY18 stood at 3,36,609 Cr.
• A growth of 7.14% YoY.

Net Interest Margin:

Net interest margin is just interest earned (loans) minus interest paid (deposits) divided by the average outstanding advances during that period. It’s different from net interest in that it’s shown as the net interest as a percentage of advances. It typically boils down to their efficiency in revenue; Higher the net interest margin, better the bank. The industry average lies between 2.4-2.8%.
Interest margin typically varies from bank to bank. And it depends on the type of lending the bank does. Usually retail lending gives a better interest margin than corporate lending (in corporate lending the ticket size is huge and interest offered will be lower than retail). That’s the reason most of the retail lenders like HDFC, DCB, CUB, Indusind, Kotak and RBL have high net interest margins.
RBI plays a vital role in setting the interest rates for banks by changing the repo rate. The ideal scenario commands the banks to increase/decrease their lending rates at the same rate of increase/decrease by RBI. But, it never has been ideal world, when RBI decreases repo rate by 25 basis points, banks reduce lending rates by 15 bps. In all expanding their interest margins by 10 bps.
Also increased defaults hurt banks interest margin, as they will not be receiving interest on the outstanding advances, but will be paying for the deposits they are taking in.

Note: Net Interest Margin figure was not available for Dhanlaxmi Bank

In most cases banks margins have expanded, except for few where they have seen spike in NPAs. Allahabad Bank, Bank of India, IDBI and UCO Bank have interest margins below 2%, where in actually you are not making much of money in the business.

Non Performing Assets:

Non-performing assets have been the root cause of all the massacre happening in the banks. It was started as a clean up process by then RBI governor Raghuram Rajan, but now it has turned out to be a major hurdle for the banks.
For the first-time readers lets make it clear what NPA means. An account is considered NPA if no payment has been made towards loan servicing (either principal or interest) for more than 90 days. Gross/Net NPA % is percentage of Gross/Net NPA towards the gross advances. NPAs indicate the quality of loan book. The higher NPA is a double whammy for the bank, as they do not get income on loans classified under NPA (lesser revenue) and they need to set aside provisions (lower profits) for the NPA identified.
The overall NPAs of the listed banks for FY18 account for 12.24% of their advances. Out of the total advances 6.12% is provisioned and rest is not. The number has increased only higher where the gross NPAs where 9.05% and provisioned NPAs were just 4.08%.

The other way to look at Gross NPA is as percentage of the deposits instead of advances. This gives an idea on how much of the depositors money is at risk. For the current year, 9.17% of the total deposits have been turned (post lending) to gross NPA out of which 4.63% is not provisioned. Last year the Gross NPA as percentage of deposits stood at 6.74%, out of total deposits 3.70% was not provisioned.
Growth in NPA has been staggering high for the year. All the banks put together has given a consolidated growth in gross NPA of 44% and that of Net NPA at 32.31% on absolute basis. Private banks growth in gross NPA at 40.55% and Net NPA at 32.97%, where as for PSU banks it is at 44.47% and 32.22% on absolute basis.

While in term of Gross NPA % increase, numbers are bit high for PSU banks as the credit growth for PSU banks are comparatively lower than gross NPA growth. And that of private banks credit growth was higher which has masked the NPA growth.
The maximum recognition of Gross NPA on QoQ has come from PNB (627 bps), Lakshmi Vilas (432 bps), United Bank (400 bps), UCO Bank (400 bps), Central Bank (340 bps), IOB (333 bps) and IDBI (323 bps). Higher recognition of NPAs doest mean, the worst is over. It only means banks are pro actively recognising NPAs. And more NPAs might come in future as well.
The least additions to Gross NPA were done by following banks: YES bank (-44 bps), Bank of India (-35 bps), CUB (-27 bps), RBL Bank (-16 bps), J&K bank (-12 bps), DCB bank (-10 bps) and Kotak Bank (-6 bps). Now the above figures show that the banks had NPA de growth, it’s not true. Its only the advance growth is so high thane NPA growth that, it starts showcasing as de growth when compare to advances.

IDBI is the worst hit in terms of NPA. It has got gross NPA to the tune of 27.95%. It means that out of Rs 100 loan given Rs 27.95 has come under default, in total. (Likely to be concentrated in a few borrowers) Even the best banks out there have only 4% interest margin, but when 27.95% of your loan have vanished, it means you are bleeding out more than you can afford.
Private banks which have most of exposure towards retail have almost come out unscathed from this NPA saga. Next time you enter a private bank for loan and start cursing for that enormous documentation they ask, don’t curse, it’s just a safety precaution they take.

Gross NPA

IndusInd bank is having the least gross NPA% at 1.28%. The other banks with gross NPA below 3% (which we believe are comfortable in terms of NPA) are RBL, Kotak, Yes Bank, HDFC and DCB. Federal and CUB are at borderline with 3% and 3.03% respectively.

Note: We have shown advances of SBI as 8,00,000 Crs in the chart. The actual numbers of SBI would have skewed the chatrt Where as it actual advances are at 19,60,119 Crs. 

The banks which have a very high level of NPA (above 18%, even 10% for that matter is very high) are United Bank of India, UCO Bank, PNB, Maharashtra Bank, IOB, IDBI, Dena Bank and Central Bank.
With all this happening around, RBI has put 11 banks under PCA (Prompt Corrective Action). The 11 banks under PCA are Allahabad Bank, Bank of India, Central Bank of India, Corporation Bank, Dena Bank, Indian Overseas Bank, IDBI Bank, Maharashtra Bank, Oriental Bank, United Bank of India, and UCO Bank. For these banks, there’s no fresh lending without permission and they can’t do certain types of loans anyhow.
Interesting Fact:

• The total Gross NPA at the end of FY18 is at 10,11,225 Crs. Out of which SBI accounts for 22.09%
• Absolute Gross NPA growth at the end of FY18 on QoQ basis is at  15.76% and YoY basis is at 44.01%.
• Lakshmi Vilas Bank (88.79%) and PNB (50.59%) have highest absolute Gross NPA growth QoQ basis.
• Lakshmi Vilas Bank (320.85%) and SBI (98.88%) have highest absolute Gross NPA growth YoY basis.
• RBI expects Gross NPA% of 11 banks under PCA to shoot up to 22.3% by end of this year from existing 21%.

Net NPA

Net NPAs are NPAs which have not been provisioned according to the RBI guideline. And the chances are there, they might actually turn to loss on the books of banks.
Net NPAs of private banks are way lower than the public sector bank.  HDFC Bank has the lowest The best bank which have comfortable (below 2%) Net NPA% are HDFC Bank (0.4%), Indusind Bank (0.51%), Yes Bank (0.64%), DCB Bank (0.72%), RBL Bank (0.78%), Kotak Bank (0.86%), Federal Bank (1.69%) and CUB (1.70%)

Note: We have taken advances of SBI as 8,00,000 Crs in the chart. The actual numbers of SBI would have skewed the chatrt Where as it actual advances are at 19,60,119 Crs. 

The highest Net NPA (above 10%) banks are IDBI (16.69%), United Bank (16.49%), IOB (15.33%), UCO Bank (13.10%), Dena Bank (11.95%),  Corporation Bank (11.74%), PNB (11.24%), Maharasthra Bank (11.24%), Central Bank (11.10%) and Oriental Bank (10.48%).
Interesting Facts:

• The total Net NPA of 35 banks together is at 5,10,516 Crs. Out of this 21.71% is accounted by SBI.
• Absolute Net NPA growth at 10.49% QoQ and 32.31% YoY.
• The highest absolute Net NPA growth QoQ came from PNB (42.87%) and Axis Bank (40.97%).
• The highest absolute Net NPA growth YoY  came from Lakshmi Vilas (248.43%) and South Indian Bank (109.88%)

Provision Coverage Ratio

Every bank needs to actively recognise its NPA. The task just doesn’t end here, Once the NPAs are recognised they need to appropriately provision it. For instance sub standard assets (more than 3 months but less than 6 months of default) have to be provisioned 15%, Doubtful (beyond the sub-standard status for less than one year) should be provisioned 25%, 1-3 years should be provisioned 40% and more than three years 100%. (To view RBI circular on provisioning click here).
While RBI sets the prescribed provisioning standards at minimum of 75% (PCR), most banks fail to do that. When RBI says 75%, it is 75% of the total provisions, which bank should have done according to RBI guidelines. For instance if bank lends Rs. 100,000 and its in doubtful for more than 2 years and bank provisions Rs. 40,000 for the loan, bank is effectively at 100% PCR on this loan. In few months bank might recover Rs. 80,000 from the collateral, then bank will “write back” Rs. 20,000 as excess provisioning since bank didn’t lose as much as it thought it would.
As PCR at 75% is a guideline only, the rule cannot be forced upon the bank. The higher the provision coverage ratio the safer the banks are (meaning they have already provisioned for the losses they will be taking, once the loans are recovered write backs starts happening).
Higher PCR is good for banks, but it comes with a cost. Higher provisioning results in lower CAR and the banks need to raise more money to be at comfortable CAR. Also, higher provisioning eats away your profit, you will be setting aside money for provisioning from your operating profits.
There are only two banks which meet RBI guidelines i.e DCB Bank and Dhanlaxmi Bank, both are above 70%.
Most of the banks are near in the range of 58% – 65% in terms of provision coverage ratio. Though well below the 70% mark, but better than last year, where in most banks were below 60% (even though the NPAs have shot up drastically this year)

Note: PCR was not available for Karnataka Bank and HDFC Bank

South Indian Bank stands out here with its low PCR at 41.2%. It needs to do a lot more to cover its existing NPAs. Meaning more losses will follow on its income statement and CAR will start dropping. It might need to raise fresh funds to support its adequacy ratio. Yes Bank and United Bank PCR is below 55%, well below industry average. They will need to do more in terms of provisioning.
The rest we feel are in better position than in last year, but let’s not stop at this, every time we need to raise the benchmark so that we are better off in case of more NPAs start to tumble.
Interesting Facts:

• The total provisions done for FY18 by all 35 banks is at 3,50,652 Crs. A growth of 68.73% YoY.
• SBI (71,526 Crs) and PNB (52,265 Crs) were top provision providers for FY18
• For quarter ending Mar-18 the total provisions were at 1,41,607 Crs. A growth of 104.5% QoQ.

Capital Adequacy Ratio

Capital Adequacy ratio (CAR) is the risk weighted capital the banks need to maintain. The current RBI mandate puts it at 9.6%. If the banks CAR is below that level, then they have too little capital to support their operation – and RBI could enforce restrictions on it.
Anything above 14% is considered good, but a higher CAR gives an extra buffer to absorb the NPA shocks. Apparently to improve the CAR ratios, banks need to raise additional funds from the market. To support these kind of funding, last year Government Of India has planned to infuse capital to the tune of 2.11 lakh Cr which is still a ongoing process. Effectively the capital infused will dilute the stakeholders.
Banks like DCB are in comfortable position as they have, more than sufficient CAR to boast about and their provision coverage ratio is above 75%, meaning they need not have to provision more (unless new NPAs are recognised).
Allahabad bank requires some urgent capital infusion as its CAR is below 9.6. Stakeholders will be taking more dilution going forward. Its just not enough to have 9.6, but you need to have more than at least 12 to be in that comfort zone. Allahabad bank has done a lot of provisioning in last quarter of FY8 thus the drop in CAR.
Other banks below the red line (9.6) are Central Bank, Corporation Bank, Indian Overseas Bank, Punjab National Bank. Banks which are about to breach the minimum level of CAR are IDBI, Oriental Bank, Lakshmi Vilas Bank and UCO Bank.
Yes Bank which is having a CAR of 18.40 (highest in the lot) is reluctant to do more provisioning. Its PCR still stand at 50% (one of the lowest in the lot).

ICICI, RBL Bank, Axis Bank which have good CAR can take the benefit and push the provisioning to improve their PCR and are in a better position to protect themselves from NPA shocks.
Interesting Fact:

• RBI expects CAR of 11 banks under PCA to drop to 6.5% by the end of the current fiscal year from 10.8% at the end of 2017-18. It assumes no capital infusion by government.

Divergence

Technically we believe this as a lie-o-meter. What happens when a bank release its result at the year end is, RBI audits its account books and tries to find discrepancies. RBI comes out with its own recognition of NPAs and amount of provision which has to be done. This report is provided to the bank. The bank needs to take corrective steps in next one year and start recognising those NPAs. If the difference is greater than 15% of what is reported and what RBI finds, then banks need to disclose it in their result report.
To know the guidelines for divergence report click here.
While most of the banks have given out divergence report irrespective of the greater than 15% clause, but some banks Axis, ICICI, HDFC have not shared the divergence figures. In that case, we can only assume, their NPA divergence are below 15%.
Divergence majorly happen as the banks are unwilling to recognise some accounts into NPA, but RBI says you need to.
The divergence of NPA is highest for Yes Bank. The actual gross NPAs for the last year (FY17) were 4 times reported by Yes bank in its financial results. Its Net NPA is almost 5.5 times higher than reported. Also the provisioning should have been at 2.62 times higher than reported.
Previous year was no different for Yes Bank. In FY16, the RBI reported gross NPA was 5 times higher than what bank reported. Read our article on Yes Bank divergence here
Below is the list of the divergences by the bank.

If you observe, the top five banks with maximum divergence are private banks. And the divergence is also huge. The other interesting note is SBI, which sometimes provides the overall banking picture with its massive size has a divergence of 20.69% in its Gross NPA. We believe that their can be some mismatch with RBI reported and company reported, but it cannot be in the way like the differences are greater than the number itself.
Interesting Fact:

• The banks have not disclosed 79,000 Cr worth of Gross NPA last year
• In terms of Net NPA the number stands at 52,818 Crs
• Banks should have done actual provisioning of Rs 2,33,334 Crs, but they did only 2,06,303 Crs.

Note: The numbers will be way higher as the data is only of disclosed banks.

The “Performers”

In our Earlier Report we noted HDFC Bank, Indusind Bank, Yes Bank, DCB Bank, CUB,  Kotak Bank and  Federal Bank. This time we have excluded CUB, Kotak and Federal out of private banks (even though they look promising). Among public banks Vijaya Bank and Indian Bank appear to be the better. But remember the so called good banks might pay penalty for being good. If the bank merger happens, these banks might get merged eventually.

Our View:

The banking sector is in flux. There are challenges in NPAs – the bad loan situation is likely to get worse as more companies waddle through the bankruptcy process. And then, there will be more NPAs because of another factor: rising interest rates.
A rising rate situation creates NPAs because when some companies overleverage themselves, they can pay interest in low interest times. But rates going up makes them insolvent.
This also reduces treasury income for banks, because banks have a ton of bonds and those bond prices fall when rates go up.
Overall, we’d be careful of taking too much exposure to the banking system. However, we do believe that now prices have fallen enough for opportunities within to arise. And it’s important to understand one thing: credit growth is returning. If credit flows back into the economy, it’s very healthy for banks and definitely for geographically diverse banks. We just have to ensure they report and divulge their bad loans properly. This is not a report for action, so we’re not recommending any banks; it’s just a note to see the entire banking sector in a single place.
We believe that the banking space continues to have scope, but with the emergence of small finance banks (Equitas, Ujjivan, AU etc) we might see banks finally compete for deposits and for better technology based solutions. Let’s see how that goes.
We hope this report was informative. All data is from public sources. If you notice any errors, please do comment on this post.

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.
Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.