Sell rating to State Bank of India: Ambit

Updated: Jun 2 2014, 16:24pm hrs
State Bank of India (SBI)'s Q4FY14 profit after tax of R30.4bn (down 8% year-on-year) was 13% ahead of our estimate, owing to controlled operating expenses (flat y-o-y). Asset quality improved, with higher-than-expected upgradations and recoveries, driving total stressed assets to 8.4% (vs 9.1% at end-Q3). The increase in provision coverage and write-offs, however, kept credit costs high at 230bps.

Given that the fourth quarters over the last three years have seen a significant seasonal improvement in asset quality, we await the banks performance in H1FY15

before calling it a turnaround on asset quality.

We expect only a gradual RoA (return on assets) improvement over the next two years before the significant capital requirement from Basel-III will begin kicking in, which would cap sustainable RoEs (returns on equity) to 12-13%. A more durable catalyst for a re-rating, in our view, is governance reforms at PSU banks, as suggested by the PJ Nayak committee, but the political will to implement these reforms remains questionable. We remain SELLers with a target price of R1,560 (vs R1,430 earlier, a 9% upgrade).

Results overview: SBI reported Q4 net profit of R30.4bn, 8% ahead of consensus estimate. Asset quality improved quarter-on-quarter, with total stressed assets declining to 8.4% of loans vs 9.1% at end-Q3. Upgradations and recoveries (R84bn) outpaced fresh NPAs (R79bn) during the quarter. Trends on loan growth (16% y-o-y), net interest margins (3.1% in Q4FY14) and core non-interest income (up 12% y-o-y) were in line with our expectations.

Whilst the gross addition to NPAs (3.1% of loans) remained

elevated, upgradations and recoveries were higher than our expectations and drove a 9% q-o-q reduction in NPAs (non-performing assets). The bank sold NPAs worth R36bn during the quarter (R17bn in recoveries and R19bn in write-offs). Mid-corporate (19% of total loans) continues to be the most-stressed segment, accounting for 81% of fresh NPAs. Despite the negative net delinquencies, increase in provision coverage (to 50% from 45% at end-Q3FY14) and high write-offs led to credit costs being elevated at 230bps vs 115bps in 9MFY14.

The additions to restructured loans remained high at R74bn vs R228bn in 9MFY14. Total stressed assets (gross NPA + standard restructured) thus stand at 8.4% of loans (vs 9.1% at end-Q3FY14 and 7.8% at end-FY13).

Loan growth was at 16% y-o-y. Corporate loans (up 24% y-o-y) and international loans (up 27%

y-o-y) drove the loan growth.

Retail loans were up 13% y-o-y, driven by home loan growth of 18% y-o-y. Domestic NIMs (net interest margins) were unchanged q-o-q

at 3.5%. The domestic CASA

(current account savings account) ratio was stable at 44.4%. Forex income (up 36% y-o-y) and recoveries (up 67% y-o-y) supported non-interest income growth of 19% y-o-y. Fee income growth was 15% y-o-y.

A highlight of this quarter was the controlled operating expenses (flat y-o-y) driven by lower employee expenses (down 6% y-o-y). A net reduction in employees (down 3% y-o-y), write-back of excess provisions being made, the benefit of higher interest rates on pension liabilities and control of discretionary cost items, helped the bank lower its cost to assets to 2% (vs 2.3% in Q4FY13 and 2.2% in 9MFY14). Operating profit was thus up 37% y-o-y.

Whilst the management appeared optimistic of an improvement in the macroeconomic environment, the near-term outlook on asset quality remains uncertain. Hence, the management continues to focus on structural improvements at the bank by addressing the cost base, cross-selling opportunities and recovery efforts.

Where do we go from here The 4QFY14 results were a positive surprise on two fronts: (i) lower net additions to NPAs and (ii) cost control. On asset quality, we believe it is early to call a turnaround, given: (i) the macroeconomic stress (low growth and high interest rates); and (ii) a traditionally seen sequential improvement in Q4. We would thus wait to see the banks performance in H1FY15 before calling it a turnaround in asset quality. We expect average net additions of 2% in FY15-16e (vs 2.3% in FY14) to drive average credit costs of 125 bps (vs 140bps in FY14).

We have cut our operating expense estimate by 5% for FY15 and we expect operating expenses to record a CAGR of 11% (FY14-16e) vs 15% CAGR for assets. Overall, our FY15 and FY16 EPS (earnings per share) estimates are largely unchanged. We expect RoA to only gradually improve to 0.75% in FY16e from 0.65% in FY14.

Despite an expectation of a gradual economic recovery, we believe the profitability would remain subdued over the next two years (average RoE of 11.8%), as margins have peaked and credit costs would remain elevated due to rising provision coverage. Whilst RoAs might inch up to the long-term average of 0.85% beyond FY16, capital requirement would also begin to materially inch up after FY16 due to the more stringent implementation of Basel-III requirements, lowering the leverage capacity of the bank.

Ambit