Costs and fees beat forecast

Updated: November 24, 2014 2:13:40 AM

NPL delinquencies are now at a multi-quarter low

Rating: Overweight

Q2FY15 PAT: R31 bn, + 31% y-o-y, 13%>JPMe (JP Morgan estimates). SBI reported a significant beat on costs and fees. Asset quality stress persists but incremental delinquencies seem to have stabilised. Operationally, the main positive signs were the improvement in fees and costs—the weak loan growth was expected and looks transient. We remain OW (overweight) and this stays our top PSU pick—we raise our price target by 10% to R3,400, backed by 3%/4% EPS (earnings per share) hikes for F16e/F17e.

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Fundamentals bottoming out. Some key long-term weak points have started to improve. Fee growth was a strong 18%, with some granular retail components gathering momentum. Opex growth—a major drag between FY10-FY13—moderated to 3%. Asset quality is still weak but incremental delinquency is stabilising and a rates rally could drive an early recovery. Gross delinquencies during the quarter declined by 70 basis points and stood at 2.5%; however, restructuring was higher at 1.4% vs. 1.2% in the previous quarter. The management is de-risking the balance sheet by reducing exposure to mid corporate & SME segment.

Constructive management action: At the core of our positive stance is a number of management initiatives which are long-term positives. Three main focus areas: (i) Cost focus—both at the big picture level with technology-driven efficiency, and with granular cost-cutting initiatives, (ii) exercising pricing power on fees, deposits and lending—may take time to harvest but upside is large, and (iii) introducing more rigour in credit procedures—too late for this cycle but would strengthen the bank long term and drive better structural valuations.

EPS/PT changes: Our EPS hikes of 3%/4% for FY16/F17 are mainly due to lower credit costs. Our revised PT (price target) of R3,400 is based on a P/B (price-to-book multiple) of 1.3x (Sept-16 book) for the banking business and R105 for the insurance.

Asset quality: Incremental asset stress still high and unsustainable over the medium term. The silver lining was that NPL (non-performing loan) delinquencies were at a multi-quarter low. Restructuring was elevated but flat q-o-q—the medium-term trend clearly indicates that the momentum is flagging.

Mid-corporate and the SME segment remain the sore points– the management sees a recovery only when the economy starts doing better. Low capacity utilisation and high receivables are clogging the cash pipes for many of these borrowers. Agri NPLs spiked this quarter but the management expects it to ease in H2 on resolution of AP/Telengana issues and a good winter crop.

Fee income: Core fee growth was quite strong at 19% y-o-y. The retail components like remittances were the key drivers, overcoming the drag from loan origination fees which is linked to corporate lending. Forex income was up very strongly, largely due to a low base. Bond profits spiked quite sharply driven by benign yields—the momentum should continue into H2. Recoveries from written-off accounts were strong—the management is focussing on this area and expects the momentum to quicken in H2F15e.

Opex: Wages were flat, driven by retirements—replacements are at a lower cost incidence. As the bank leverages technology in the coming years, this could be a major value creator. Pensions were down sharply y-o-y—there still is some risk of a year-end spike on falling bond yields. Overheads were up 14% y-o-y—10% ex-ATMs. The new regulations limiting free ATM usage could drive costs down for the bank—the management sees it from this perspective rather than a revenue generation one.

Margins: Domestic margins were slightly down q-o-q, driven by falling LDRs (loan-deposit ratio) and derisking of the book. COF (cost of funds) remained sticky as flows into retail TDs (term deposits) were strong. International margins were up 12bp q-o-q, largely due to a weak base effect. There is some momentum and there should be a 20 bp uptick in H2F15e, according to management. There was a 2 bp q-o-q downtick in aggregate NIMs (net interest margins) because of the higher funding costs. SA momentum was quite strong; the CASA (current account savings account) ratio remained muted due to higher growth in retail term deposit.

Loan growth: Headline loan growth was weak at 9%, while system loan growth was slow, SBI’s deceleration was more pronounced. Domestic growth was especially weak at 7% y-o-y. The management attributed it to (i) derisking of the book and an overall cautious approach of the bank (ii) weak demand, reflecting the overall economy and (iii) aggressive recovery attempts leading to some shrinkage of exposures and (iv) a base effect as Q214 had seen a switch by large corporates from CPs (commerical paper) to loans—the reverse happened in Q2FY15. Segmental trends: the large corporate book grew, a bit surprisingly—draw downs by existing projects was a key reason. The SME/mid-corporate book continues to consolidate, hit by weak demand and stretched credit metrics.

Capital: Thanks to the low loan growth, CAR (capital adequacy ratio) was very comfortable at 10%. The bank has been given clarifications by the RBI on AT1 bonds—some of these issues have been resolved. The bank has taken an enabling resolution for a capital raise but is non-committal on the timing and format.

—JP Morgan

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