strong capital base

8/6/2019 Strong Capital Base

http://slidepdf.com/reader/full/strong-capital-base 1/3

Strong Capital Base

A strong capital base is the number one issue to consider before investing in a lender.

Almost all the private banks managed to raise adequate funds in 2007 and thus maintain Capital Adequacy ratios

in FY08 well above the mandatory nine percent stipulated by RBI. None of the banks seem to be very highly

leveraged either, with SBI being on the higher side. (An average bank has a Financial Leverage of 12x as

compared to 2x or 3x for a non-financial company.)

However the NPA (Non-Performing Assets) levels tell a story as well. ICICI Bank ( IBN) stands out with the

poorest record on NPAs, and given the overall deteriorating credit quality scenario (due to the slowing

economy), should give investors cause for concern. On the flip side, Yes Bank in particular, Axis Bank, and

HDFC Bank (HDB) are managing NPA levels nicely.

The provisioning coverage ratio (Provision Expense/Gross NPAs) reveals much more. While HDFC Bank

(HDB) lives up to its conservative image with a high provision cover of 241 percent, ICICI Bank ( IBN) has the

lowest provision coverage at ~54 percent, lower than even PSU State Bank of India. However the best record

here belongs to the smallest, Yes Bank.

Return on Equity (RoE) and Return on Assets (RoA)

These metrics are the de-facto standards for gauging bank profitability. Generally investors should look for mid-

to high-teen returns on equity. It is easy to boost a bank's earnings in the short term by under-provisioning or

leveraging up the balance sheet, which can be unduly risky over the long term. For this reason, it is good to see a

high level of return on assets as well. For banks, a top RoA is in the 1.2 to 1.4 percent range

There are only three levers for boosting ROE: Net Margin, Asset Turnover and Financial Leverage. Again,

among all the private banks, ICICI Bank ( IBN) has the poorest record. As we can see, it is the dismal net margin

(~5% ) that has resulted in such poor Return on Equity (~8%) and Return on Asset (~0.7%) ratios. Again, Yes

Bank shines bright with the best RoEs and the best ROAs followed by HDFC Bank ( HDB), closely followed by

surprisingly, State Bank of India.

Efficiency Ratio

The efficiency ratio, or cost to income ratio, measures non -interest expenses, or operating costs, as a percentage

of income. Basically it tells you how efficientl y the bank is managed. Many good banks have efficiency ratios

under 55% (the lower the better).

Again, Yes Bank presents the best record on cost efficiency among the private banks. What is remarkable is the

way Yes Bank has shown significant improvement in cost-efficiency levels over the years. From a high of 83%

in FY06, Operating costs as a percentage of Total Income has progressively come down, year on year, to 29.5%

in FY08. State Bank is the biggest surprise here, coming in second at ~36%, with Axis Bank following closely

behind. Both HDFC Bank (HDB) at 48% and ICICI Bank (IBN) at 51% are way behind the others in this sector.

Net Interest Margins (NIM)

Another simple measure to watch is net interest margin, which looks at net interest income as a perc entage of

average earning assets. Track margins over time to get a feel for the trend.

This is where HDFC Bank's (HDB) NIM record is unmatched. It's the reason why it is valued so highly. A

consistently high NIM of over 4% for several years takes some doing, especially in the rising interest scenario

that we witnessed in the last few years in India. What is also n otable is how Net Interest Income as a percentage

of Total Assets has improved over the years.

Axis Bank comes in a creditable second, followed by what is no longer a surprise, State Bank of India.

Strong Revenues



Historically many of the best-performing bank investments have been those that have proven capable of above-

average revenue growth.

Yes Bank has been growing at a scorching pace for the last four years, albeit on a much smaller base. This

shows in the overall growth track record of over 225 percent CAGR over four years. What is also commendable

is that Interest Income as a percentage of Total Assets has been steadily rising. FY08 levels are at 7.72%,

beating HDFC Bank's (HDB) 7.6%.

Other private banks like HDFC Bank (HDB) and Axis Bank have maintained a very decent growth rate in

excess of 40%. ICICI Bank has also clocked a growth rate of over 44%. However that growth has come at the

cost of rising NPAs and declining margins and profitability.

Price to Book

Because a bank¶s balance sheet consists mostly of financial assets with varying degrees of liquidity, book value

is a good proxy for the value of a banking stock. Also, many of the assets included in their book value are

marked-to-market±in other words, they are revalued every quarter to reflect shifts in the marketplace, which

means that book value is reasonably current. So the base value for a bank should be the book value. Any

premium over that, investors are paying for future growth and excess earnings. Typically big reputed banks

trade at 2x to 4x book value.

Yes Bank is currently (Mar 30, 2009) trading at 1.12 Book Value, historically at its lowest levels in the last 4

years. Similarly on a price-to-earnings measure, it is quoting at 5x TTM earnings, again historically the lowest

levels in 4 years. State Bank of India too is quoting at 1.05x Book Value.

It is significant to note that the two banks - Yes Bank and SBI - have the best RoE records, with 18.34% and

16.78% respectively. With low P/B relative to their peers but with t he highest RoEs, Yes Bank and SBI are

potential bargains, but we will want to do some gold digging. P/BV and RoE have a very strong correlation for

Bank stocks as mentioned in -

1. Valuing Financial Services Firms Fig 216, pp 37-38 and

2. The Five Rules for Successful Stock Investing, Valuation -The Basics chapter, pp 130-131

While we need to dig deeper to make sure, it is promising to see that Yes Bank in particular, and State Bank too,

have impressive records on some of the most important metrics for bank stocks, as we have seen from the above

Indian private banks comparison.

Overall Verdict

There might be some big concerns on derivatives exposures and other contingent liabilities that are not reflected

in this snapshot.

However, if you are to choose between the two U.S. -listed Indian banks, ICICI Bank ( IBN) and HDFC Bank

(HDB), HDFC Bank is the clear winner. It has grown at a similar 40% plus five -year CAGR to ICICI bank,

maintaining high RoEs. In fact, it has the best RoA record, at 1.42%, among all Indian banks. Its NIM record is

unmatched, and to its credit, it has proven conservative in managing and provisioning for NPAs.



http://www.docstoc.com/docs/27469538/analysis-of-Banking-Sector-_-ICICI-and-HDFC

strong capital base

Documents