India Equity Research | Banking and Financial Services Sector Update

BANKING
Repo rate hiked 25bps to 8% June 12, 2008

Vishal Goyal, CFA

The Reserve Bank of India (RBI) has announced a 25bps hike in the repo rate (rate at +91-22-6620 3022
which RBI injects liquidity into the system), taking it to 8%. The move from RBI was vishal.goyal@edelcap.com
on expected lines with inflation expected to move upwards from current levels.
Despite the liquidity window through repo having being used only during the past Ajitesh Nair
fortnight, this hike gives a larger signal that rules out any softening in deposit rates in +91-22-6623 3358

the near future and a probable hike in deposit and lending rates in the coming weeks. ajitesh.nair@edelcap.com

M B Mahesh
Impact: Negative on banks
+91-22-6620 3027
„ Short term mb.mahesh@edelcap.com

• We expect the immediate impact to be negative on banks with:

• High duration AFS investment portfolio.

• Reliance on wholesale market and/or low CASA.

„ Medium Term

• Credit growth to show a slowdown, with interest rate expectation remaining

on the higher side.

• Banks have to raise their deposit rates to compensate the hike in interest
rates.

• Negative impact on asset quality to be witnessed if interest rates are passed

to consumers. Retail asset book could see further deterioration from current
levels. Banks with low provision coverage ratios will remain vulnerable.

• Also, the intervention from government will continue to bear down on State-
owned Banks (SOB).

Outlook: Maintain weak outlook

At current levels, while most banks are trading at their three-four year lows on price-
book multiples, we do not see any immediate trigger to the sector. We continue to
prefer banks with high CASA ratio and cushion of high provision coverage.

Among private sector banks, we like Axis Bank due to its low retail asset book and
high CASA ratio; among SOBs, we like Union Bank of India for having one of the
highest provision coverage.

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 Banking

Investment book to see impact: SOBs more vulnerable than private peers

We believe that the immediate impact is likely to be seen on banks with an exposed
investment book. The estimate on the Street is a 10bps increase in interest rates on Friday,
June 13, across the yield curve. We will see the highest impact on profits for SOBs, mainly
due to the high duration in their AFS book.

Since the beginning of this quarter, we have seen an upward movement of interest rates with
the 10-year yield closing at 8.29% compared to 7.93% in March 31, 2008, a rise of ~36bps.

Interest rate movement since the quarter

8.5

8.2

7.9
(bps)

7.6

7.3

10 Year 1 Year
7.0

3-Jun

10-Jun
1-Apr

8-Apr

15-Apr

22-Apr

29-Apr

6-May

13-May

20-May

27-May
Source: Bloomberg

We have calculated the impact on profit before tax based on a 25bps movement in interest
rates, as we believe that banks will shift securities to HTM and reduce duration. We believe
that the banks that are likely to see maximum impact will be Syndicate Bank, Allahabad Bank,
Federal Bank, and Oriental Bank of Commerce. New private sector banks will be relatively
insulated as they maintain a lower duration in their AFS book.

Impact of 25bps change in interest rates on FY09E PBT for banks

% of book Impact
size Duration Impact FY09E PBT on PBT
Name of the Bank (%) (Years) (INR mn) (INR mn) (%)
Allahabad Bank 47 3.0 831 10,042 8
Indian Overseas bank 26 4.5 788 17,667 4
Oriental Bank of Commerce 49 3.2 953 12,203 8
Punjab National Bank 12 2.1 340 33,864 1
State Bank of India 25 3.0 3,553 112,981 3
Syndicate bank 31 4.1 882 10,036 9
Union Bank of India 28 3.0 721 21,443 3
Federal Bank 35 5.0 438 5,352 8
Karnataka Bank 49 2.5 186 2,522 7
South Indian Bank 60 0.8 57 2,522 2
Source: Company, Edelweiss research

Edelweiss Securities Limited

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 Banking

Impact higher on banks with wholesale funding

The immediate impact will be felt by banks that rely on wholesale deposits as their main
source of borrowing as incremental cost will mirror the rise in interest rates, while banks that
have high CASA ratio and retail deposits will be relatively cushioned. Those likely to see
negative impact will be ICICI Bank, Yes Bank, and Oriental Bank of Commerce. Banks that
will be relatively cushioned due to their high CASA ratio are HDFC Bank, Axis Bank, Punjab
National Bank, and State Bank of India. Also, the medium term impact will be on banks that
have relatively higher deposits of shorter duration as re-pricing of these deposits will be at a
higher rate.

CASA ratio of banks as of Q4FY08

60

48

36
(%)

24

12

Federal

South Indian
Union
Allahabad
Axis

Yes
SBI

Karnataka
PNB

IOB

Syndicate
HDFC

OBC

ICICI
Source: Company

On the premise that lending rates are hiked, we believe loan growth will come down…

Credit growth looks set to moderate from the current 25%-levels of the previous fortnight
(high due to low base in the previous year), as banks hike deposit rates to ensure liquidity
and pass on the increased cost to borrowers. We are building in credit growth estimate of 18-
20% in FY09E in expectation of a tight monetary condition and we maintain our belief that
growth will moderate to the same range. For a while, banks with excess SLR (PSU banks) and
those with recent equity issuances (notable SBI) will be able to tide over the liquidity crunch;
however, this will eventually run off the balance sheet and rates will need to be touched upon.

…while retail asset quality can come under pressure

Retail asset quality will be under stress, particularly the mortgage portfolio, as ~71% of the
mortgage portfolio has been formed in FY05-07 (Source: Cris Infac) where the average
lending rate has been 8% (Considering HDFC’s lending rate as benchmark). Against that,
current lending rate of 10.5% will result in EMI increasing ~20% from the initial amount as
further increase in tenure is difficult. Further upward revision in rates will put pressure on
repayment capacity. We continue to prefer banks that have higher provision coverage ratio.

Edelweiss Securities Limited

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 Banking

Provision coverage ratio of banks as of Q4FY08

100

80

60

(%)
40

20

Federal

South Indian
Union

Allahabad

Axis

Yes
Karnataka

SBI
PNB

IOB
Syndicate

HDFC

OBC

ICICI
Source: Company

Edelweiss Securities Limited

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 Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021,
Board: (91-22) 2286 4400, Email: research@edelcap.com

Naresh Kothari Co-Head Institutional Equities naresh.kothari@edelcap.com +91 22 2286 4246

Vikas Khemani Co-Head Institutional Equities vikas.khemani@edelcap.com +91 22 2286 4206

Shriram Iyer Head Research shriram.iyer@edelcap.com +91 22 2286 4256

Coverage group(s) of stocks by primary analyst(s): Banking and Financial Services:

Allahabad Bank, Axis Bank, Centurion Bank of Punjab, Federal Bank, HDFC Bank, ICICI Bank, IOB, Karnataka Bank, Kotak Mahindra Bank,
OBC, SBI, Yes Bank, IDFC, HDFC, LIC Housing Finance, PNB, Power Finance Corporation, Reliance Capital, SREI Infrastructure Finance,
Shriram City Union, Syndicate Bank and Union Bank.

Recent Research

Date Company Title Price (INR) Recos

3-Jun-08 BFSI Reduced leverage;

increased disclosures
Result Update

23-May-08 Federal Higher provisions 236 Buy

Bank depress earnings;
Result Update

21-May-08 Karnataka Muted business 208 Accum.

Bank performance;
Result Update

15-May-08 Punjab Robust performance; 537 Accum.

National Result Update
Bank

Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe Rating Interpretation

Buy Accumulate Reduce Sell Total Rating Expected to

Rating Distribution* 105 59 14 2 194 Buy appreciate more than 20% over a 12-month period

* 14 stocks under review / 0 rating withheld

Accumulate appreciate up to 20% over a 12-month period
> 50bn Between 10bn and 50 bn < 10bn
Reduce depreciate up to 10% over a 12-month period
Market Cap (INR) 94 68 32
Sell depreciate more than 10% over a 12-month period

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