Sector Specific - Banking Sector                

Banking Stocks              (updated - 10 July 2009)
The sell-off in banking stocks after the Budget announcement was only logical — higher government borrowings are expected to push up bond yields and hurt banks’ bond portfolios. Moreover, the Budget sidestepped reforms in insurance, disinvestment in state-owned banks and the housing sector hardly found a mention. Higher government borrowings could also crowd out private sector borrowings and bankers anticipate that interest rates will move up over the next six months. While the yield on the tenyear benchmark is currently at around 7 per cent, this could rise by at least 50 basis points, they say.

Despite a big fall in interest rates, credit has grown by just about 16 per cent between April and mid-June, which seems somewhat sluggish even if the requirements of oil companies have fallen and the manufacturing sector is holding smaller inventories.

Individuals clearly have no appetite to borrow and if the trend continues, banks assets may not grow beyond 18-19 per cent this year. Also, while the economy appears to be recovering, banks’ assets remain vulnerable with a fair share of companies still highly leveraged and not generating adequate cash flows to keep their gearing in check. Moreover, there has been a fair amount of restructuring of nonperforming assets and the real damage will be known only about a year down the line. Most of the companies that have been given a reprieve are in vulnerable sectors such as real estate.

In the June 2009 quarter, net interest margins could be under pressure because although the benefits of lower deposit costs continue to get priced in, banks have been lowering their prime lending rates. Moreover, liquidity has been fairly high with deposits having grown a robust 20 per cent year-on-year.

Going ahead, those banks that rely more on wholesale borrowings could feel the pinch as the money market gets tight. Valuations for banks may appear somewhat stretched. But at lower levels banks, with relatively clean books such as HDFC Bank and others with high loan loss coverage such as Union Bank, make for a good play on a recovering economy.
source - BS

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