HDFC Secs bullish on HDFC BK, Axis bank

Here is a verbatim transcript of the exclusive interview with Sanju Verma on CNBC-TV18. Also watch the accompanying video. 

Q: What is the case you would set out now for some of these private sector banks, is it looking like a buy to you or an avoid?

A: It would be very simplistic to just classify the banking space into public and private as most of us are prone to doing. Historically private sector banks have always traded at a premium to their lesser privileged public counter parts. But that said and given that public sector is no longer a much abused word, given the state intervention apparently is in these days, in that context public sector banks seem to be back with a vengeance.

However, in private sector banks there have been winners. The last quarter numbers are anything to go by and there have been laggards and losers as well. Within the private sector space the two banks, which stands out spectacularly on the back of a whole host of parameters like the growth in net interest income, in operating profit, advances growth, deposit growth, the ability to contain NPAs etc are Axis Bank and HDFC Bank.

Within the private sector space, I think two banks which disappointed sorely are ICICI Bank and Kotak Mahindra Bank. Particularly with respect to Kotak Mahindra Bank, it has had a scorching pace of growth between 2006 and 2008 the compounded growth in operating  profits has been in excess of 70%, the advances and deposits have grown compounded in excess of 50%. But last quarter numbers say it is a case of too much too soon, perhaps gone wrong while the advances have continued to grow at a robust more than 30%, in the last quarter deposits actually degrew by 4% and profits have gone down by 17%. So I think the fall in deposits is not just specific to Kotak Mahindra Bank it is an indication of things to come. Going forward, I think the big differentiator for banks across the spectrum; be it public sector or private sector will be the ability to mobilize deposits, will be the ability to contain the addition to gross NPAs, which has been rising at an alarming rate and I think more than anything else the ability to maintain a healthy credit to deposit ratio. If you notice some of the private sector banks like an ICICI Bank for instance had an incremental credit to deposit ratio for last quarter at 99%, whereas ideally speaking it should not be more than 75-80%.

The last quarterly numbers, told you one thing that while growth in advances may have been robust and healthy, the growth in deposits seems to be faltering and that is precisely firstly because of lack of healthy capital markets, given that lot of these banks, particularly a Kotak Mahindra Bank relies on IPO money, which is float money on these banks. Also the fact that until the government infuses more liquidity banks will actually start digging into their internal accruals and investments, given that they do not have too much of a deposit base to lend out from.

So now going forward, if there are rate cuts be it a repo cit or a CRR cut, it is only then that there will be a material impact in easing liquidity, which will then play out in terms of a positive impact on banks. And the fact that liquidity is in a crunch is evidence from the fact that the repo will be in low transaction have been happening with the tune of Rs 10,000-15,000 crore on an average for the last week, whereas in the reverse repo window transactions have been as minuscule as just about Rs 15-30 crore.

Q: The two points of concern which have been raised one of course is the fear of defaults and couple of names have been mentioned over the last week on companies which are unable to pay back their loans to private sector banks and the tapering of credit growth, ICICI Bank is on record this morning saying that credit growth will only be 15% compared to 30% last year, which of these two would be the bigger concern for you while looking at or evaluating private sector bank stocks?

A: I think the concerns are manifold. Having to manage asset quality without compromising on credit growth I think for most of the banks that is the tight ropewalk that they will have to manage and it is easier said that done.

Historically if the economy is growing at X then assuming the credit multiplier of anywhere between 2.5-3 times, you get the credit growth number. Now if we are to assume that the economy will grow at 7-7.5% and if you were to give a credit multiplier of 2-2.5 times, you are basically saying that the credit growth would be anywhere between 16 or 17 or 18% at best.

So yes, credit growth of 18% is still healthy but for that to happen you need liquidity in the system, you need deposit cost to come down.

If you notice after the slew of CRR cuts that we have seen including the 150 bps repo rate cut that we saw few days back, a lot of public sector banks have reduced their lending rates. But I cannot think of too many who have undertaken any significant reduction in deposit rates.

The point I am trying to make is that for lending rates to actually come down on a prolonged and sustainable basis for it to make commercial sense to corporates first deposit cost needs to come down and deposit costs will come down if there is surfeit of liquidity in the system.

Therefore, we are back to square one, the government needs to infuse liquidity and I think that will perhaps happen now because the government borrowing programme is nearing its end. Tomorrow we have the last leg of the government borrowing programme of Rs 9,000 crore. Once it is out of the way I would assume that government borrowing programme would be over and done with and then perhaps the government and the RBI can together concentrate on infusing liquidity, which will help banks rather than serving the vested interest of the government, which has been borrowing aggressively.

Infact the official borrowing programme for the government was Rs 122,000 crore after which it announced an additional Rs 39,000 crore two-two and a half months back.

So I think there is reason to believe that if we are to sustain a credit growth of 16-17 or 18% assuming a GDP growth next year of anywhere between 6.5-7.5%, CRR cut of 50-100 bps and a repo rate cut and a reverse repo rate cut of anywhere between 100-150 bps is surely on the cards.

Q: Just on that other subject of defaults though because even on a year-on-year (YoY) basis, non-performing assets for many private sector banks have inched higher. What kind of NPA levels would you foresee happening for some of the key ones now?

A: With respect to NPAs, the biggest surprise last quarter has been the fact that barring a State Bank of India which perhaps saw gross NPAs rising because of its merger with State Bank of Saurashtra and an exception like an Indian Overseas Bank gross NPA growth for public sector bank YoY has actually been a decline materially speaking. Again gross NPAs for public sector banks have been maintained in the region of 2.3 to 2.5%.

In the case of private sector banks, again their NPA management has always been superior to public sector banks and last quarter was no exception but the big spoiled spot has been ICICI Bank. If you include ICICI Bank then the gross NPAs for the private sector universe stands at 3%.

If you strip that out then it falls to just about 2.2-2.3%. So I think if you look at it in the right perspective, asset quality will be a concern more so from the SME sector. SBI providing for Rs 911 crore last quarter is a clear indication of the fact that two quarters down the line, asset quality concerns which have been brushed under the carpet now for a lot of these players would perhaps come to the forefront and NPA management would be a big differentiator.

We like Axis Bank, the interesting thing again to notice that for a lot of these banks, the growth in NPAs has more or less been in sync with the growth in advances.

So somewhere I think banks will have to draw a line. The growth in credit offtake should not come at the cost of adding bad quality assets to your portfolio. I am slightly surprised that the RBI has actually put a bit of caution off the winds and reduced risk weightage on real estate loans because there are still a lot of concerns with respect to the sector.

So I think we will have to watch this space very carefully but yes, asset quality concerns more so when the economy is on a bit of a downturn and a downward spiral would be a big differentiator for a lot of banks.