India: Economic analysis

GDP growth projections:

India has been growing at a steady rate of about 6-8% in the past decade and the reports from Mckinsey (figure 1)
suggest a healthy growth rate for the next 15 years.

GDP growth projections for India, a report from Mckinsey

Income growth projections for India, a report from Mckinsey

Shift towards private sector banks in India

Banking Sector View
Though every sector in any Economy is affected by changes taking place in the economic scenario, the Banking
Sector especially moves in very close tandem with any movement in the Economy. With the expected GDP figures
looking healthy and with anticipated revival of the economy, the Banking sector is all geared to look up in the
coming years.

There are words of caution flying around, with reports of slackening credit growth over stronger deposit growth
(15% vs. 22%). Loan to GDP ratio is an indicator which suggests the credit growth which could take place. India,
among the other Asian countries has a high Loan to GDP multiplier of 2. This suggests that a pickup in credit
growth could be more moderate than expected.

However, there is an air of optimism too. Bankers feel that firms will start lifting money in the next few months.
Loans to companies by Public Sector Banks have risen by 50%, compared with a corresponding period a year earlier
and this momentum is likely to continue.
Demand for mortgages and auto loans is rising and the pace may soon pick up with healthy increase in auto sales.

Deposit-Advances on The Downtrend

Over the last two fiscals, both Deposit and Advances fell in terms of growth figures. The expectation going forward
looks positive with bank credit expected to go up by 19-20%
35 31 in the next year. This impact however, combined with an
30 27 26 26 expected hardening of interest rates by at least 100-125 bps
24
25 22 by second half of 2010 is going to affect NIM’s of the
20 16 15 16 16 banking sector on the whole.
15
10
5 Bond Portfolio Hedged Against Rising
0
FY 07 FY 08 FY 09 FY 10E FY 11E
Rate Scenario.
Deposit Advances
OBC’s bond portfolio is relatively immune to bond losses up
to a yield of 8.25%. Hence, even if bond yields were to rise
to 9%, OBC’s earnings would be impacted by 13-14%. Note
that there would be some offsetting cushion in the form of higher yield on investment book. Roughly 25%-28% of
the assets comprise of investments. (Table below)

2006 2007 2008 2009 2010 2011E

Investments 16818 19808 23951 28489 33000 38000

Total Assets 58937 73968 90729 112608 127480 148970

Investments as % of TA 28.5 26.8 26.4 25.3 25.9 25.5

Bondsvs Govt Sec as %of
Investments
86% 87%

It can be also noted that about 85% of the banks investments

Gsec%of inv comprise of Government Securities and only 8-10% in Bonds
and debentures. As a result of which, the bank stands to gain in
Bonds%of investment income in the event on rising interest rates.
10% 8% inv

2008 2009
Years
Moreover, the bank is already immune up to a yield of 8.25% along with lower exposure in bonds and debentures.
Hence, it is protected against an upside risk.

AFS Pared Down

OBC has over the years reduced its proportion of Available for Sale (AFS) investments and simultaneously
increased its Held To Maturity (HTM) investments. This is quite a positive sign, as a higher AFS amplifies the point
that a bank’s investments serve mainly a liquidity role. Earnings from those investments are of secondary
importance. The net profit from the secondary market operation has increased from Rs.153 crore to Rs.482.84 crore
during the year 2008-09 due to aggressive rate cut by the RBI
to boost the economy. The bank shifted Government securities
HTM vs AFS having Book value of Rs.1958.02 crore from ‘Available For
Sale’ (AFS) category to ‘Held To Maturity’ (HTM) category
6 3 and booked depreciation of Rs.122.07 crore.
FY 09 6 4

5
1
4
9
Any increase in yields will reduce asset values and impact the
FY 08 income statements as well. Thus, any bank, which reduces its
3 6 exposure in AFS and transfers it to HTM is largely protected
FY 07 6 4
through higher HTM portfolios as it is not required to be
2 7 marked to market.
FY 06 7 3
Government Securities and Bonds are extremely vulnerable to
0 50 100 150 interest rate movements. While a fall in rates work wonders
HTM %of Total Investments for the margin, an upward rise hammers the margins down. In
2007-2008, roughly 45% of OBC’s investments were in
Government Securities and Bonds, in the AFS segment. OBC
reduced its exposure on both accounts, bringing the proportion to 30%.

Net Interest Margins Decline Year On Year, Uptrend Expected

Net Interest Income (NII) grew roughly 20% YoY, however Net Interest Margin (NIM) has declined over the years.
The current PLR of OBC is 12% and deposits earn around 7%. With around 1-1.5% decline in lending rates, the
growth rate of interest income came down from 32% in FY 08 to 30% in FY 09 and again fell to 28% in Fy 10, that
too after rising phenomenally from 25% in FY 07 to 32% in FY 08. The bank’s NIM is also very low, and the bank
is aiming to bring its NIM to over 2% by December 2010.
The Bank has taken conscious decision of shedding high
NII TREND cost bulk deposits and substituting the same with normal
rate and lower cost deposits so as to contain the level of
bulk deposits.The measures taken up by the bank to
3055 improve yield on advances through lending to SME, Mid
2566 Corporate and Retail sector besides raising the rate of
1996 interest at the time of sanction/renewal will further
1605 1691 1671 improve yield on advances.

FY06 FY07 FY08 FY09 FY10E FY11E

The sectoral credit is expected to grow at a healthy rate of

19-20% on YoY basis in FY2010 based on the premise that GDP sustains a growth rate of 6.7% in the current fiscal,
thereby taking the loan growth to a real GDP multiplier of 2.8x (average multiplier of last 3 years). A recent study
by CRISIL that has exhaustively compiled planned capex across various industry segments, debt funding required
for such capex, and expected repayments during the year also points to credit growth of 20% YoY growth in FY10.

We thus believe that going forward the Bank’s NIM could rise, on account of the measures taken to improve its
yield and the positive credit scenario.
 Indian banks have not suffered much NIM decline from
NIM TREND falling interest rates (primarily on account of treasury
3.00 gains). We expect some margin recovery into 2H10,
2.72 mainly driven by lower funding costs and a generally
2.50
2.29 supportive rising interest rate environment. However, the
2.00 1.84 2.05
benefit of rising NIMs is likely to be more than offset by
1.50 1.77 1.98 a) bond revaluation losses given large bond portfolios and
1.00 NIM relatively long durations (generally 4-5 years), b) lower
expected loan growth and c) higher asset risk perceptions.
0.50
0.00
PSU banks are more negatively impacted than the private
banks given their longer bond portfolio durations.
FY06 FY07 FY08 FY09 FY10E FY11E
Interestingly, usually Indian banks start underperforming
the market about 6 months before policy rate hikes (with
underperformance moderating as we get closer to the actual rate hike). A policy change is expected in March, 2010,
thus the trend seen now, of Banking sector stocks underperforming. Also, historically banks have underperformed in
rising rate environment.

CASA Ratio Portray A Negative Outlook

A healthy CASA ratio is very important for any bank.
CASA Ratio and GrowthTrend CASA ratio reflects what part of a Banks total deposit are
35 33 30 20 the Current Account and the Savings Account deposits. A
18 28
) 30 ) healthy ratio shows that the bank pays little interest on the
% 24 15 %
( 25 12 ( deposits which again leads to a better NIM, as Current
O
IT H
T
20
A 8 10 W Account hardly attracts interest.
R 15 O
A R
S 10 5 G
A A
C 5 S
A The banks CASA ratio is lower than other public sector
0 0 C
banks. The bank’s target is to reach a ratio of 25-26% by
FY06 FY07 FY08 FY09
YEARS the end of the current financial year. The bank’s next
Ratio CASA g% target is to take the share of CASA deposit to 28% by
December 2010.

GDP & Book Value Correlation

The Book Value of a Bank is positively correlated with the economic growth. As expectations about the economy
improve, book values of a bank also tend to increase. It can be gauged clearly from the jump in the book value from
110 crore in FY 05 to 165 crore in FY 06 (50% YoY growth), when the GDP increased from 7.5% to 9.4%.

Similarly, when the GDP fell from 8.7% in FY 08 to 6.7% in

GDP & B.V. CORRELATION FY 09, the growth rate of book value was just 12%.
350 318 12
300 9.4 9.6 8.7 254 283 Looking ahead, the Planning Commission has said that the
). 10
r 250 7.5 194 227 8 economy may recover to 8% in 2010-11 and perhaps 9% in
.C
s 200 165 ) 2011-12, thus averaging an annual GDP growth of 7.8%
R 6.7 6 7 6 (%
.( 150 110
P during the 11th Plan period as against the target of 9%. This,
.V100 4 D of course, is on the assumption of normal monsoons in the
B 2 G
50 next two fiscals. Recent reports however, project a GDP
0 0
growth of 6.0% in the next fiscal.

Thus, if the GDP grows at 6.0% and 7% in 2010 and 2011

BV GDP YEARS respectively, OBC’s Book Value could also grow at 11.5%
and 12.5% respectively.
 2005 2006 2007 2008 2009 2010 201
1

GDP 7.5 9.4 9.6 8.7 6.7 6.0 7.0

G% of BV 50.08 17.77 16.81 12.18 11.5 12.5

Income statement
FY 08 FY 09 FY 10 FY 11E
Interest Earned 6827 8856 10051 11690
Growth % 32 30 13 16
Interest Expended 5165 6860 7485 8635
Growth % 48 33 9 15
Net Interest Income (NII) 1671 1996 2566 3055
Other Income 628 1071 1125 1181
Total Income 2299 3068 3691 4236
Operating Expenses 1080 1383 1439 1650
Operating Profit 1219 1685 2252 2586
Provisions and Contingencies 378 780 815 850
Net Profit 841 905 945 1018
Capital 25.05 25.05 25.05 25.05
EPS 33.6 36.12 37.72 40.64

Balance Sheet
FY 08 FY 09 FY 10 FY 11E
Share Holder Equity 5776 7403 8100 8800
Deposits 77857 98369 114000 132000
Borrowing 1840 722 780 870
Other Liabilities & Provision 5233 6088 6600 7300
Capital Employed 90705 112583 129480 148970
Cash & Balance with RBI 7322 6880 6000 7100
Balances with Bank 2892 5345 5880 7000
Investments 23951 28489 33000 38000
Advances 54566 68500 79000 92000
Fixed Assets 387 1384 1400 1450
Other Assets 1587 1984 4200 3420
Capital Deployed 90705 112583 129480 148970