State of Indian Banks: Public v/s Private ::Kotak Sec

Global economy continues to tread an uncertain path with growth faltering in developed economies, especially in Euro zone. Finance ministry and Reserve Bank of India are trying to snap the growing inflation in India. Indian capital markets are heading south due to the global uncertainty, slower domestic growth and rising inflation. Banks are the major contributors in development of economy and they serve as a proxy to the state of economy. Such times raises question on how the banks are performing.

We analyzed few public sector and private sector banks on some key operational parameters to understand their health.

Ratios for Evaluating Banks		Closing Price as on November 17, 2011	P/E	P/BV	Dividend Yield	Return on Assets	Net NPA ratio
Public Sector Banks	State Bank of India	1757.50	15.03	1.67	1.75%	0.68%	1.56%
	Bank of Baroda	742.25	6.18	1.34	2.30%	1.18%	0.35%
	Punjab National Bank	873.85	6.03	1.39	2.51%	1.18%	0.85%
	Canara Bank	436.00	5.34	1.07	2.55%	1.21%	1.11%
	Bank of India	334.75	8.28	1.12	2.15%	0.71%	0.91%
	Union Bank of India	207.80	6.55	1.17	3.89%	0.89%	1.19%
	IDBI	98.70	5.21	0.75	3.63%	0.66%	1.06%
	Federal Bank	384.20	9.82	1.25	2.27%	1.14%	0.60%
Private Sector Bank	HDFC Bank	458.85	23.78	4.20	0.72%	1.42%	0.19%
	ICICI Bank	777.25	15.36	1.60	1.83%	1.27%	0.94%
	Axis Bank	985.00	10.43	2.07	1.47%	1.40%	0.26%
	Kotak Mahindra Bank	476.85	36.80	5.11	0.11%	1.61%	0.50%
	IndusInd Bank	251.00	16.91	3.10	0.79%	1.27%	0.28%
	Yes Bank	271.50	11.15	2.48	0.93%	1.23%	0.03%

Source: Market Data – BSE as on November 17, 2011
Company Data – Annual Reports of respective bank; Kotak Securities as on March 31, 2011

Price to Book Value: A higher P/B value indicates management expects to create more value from the assets. In banks, this ratio is generally close to one as their assets are marked to market. Private sector banks on average have a higher ratio compared to public sector banks, signifying the higher expectations the investors hold for privately managed banks. 

Dividend yield is attractive in public sector banks, especially Union Bank of India and IDBI. In private sector, ICICI Bank and Axis Bank look generous when considering dividend yield compared to their counterparts.

Return on Assets indicates the efficiency by which bank deploy their assets. ROA has been improving steadily for private banks, while it remains flat for public sector banks over the last few years. Kotak Bank, Axis Bank and HDFC have earned higher ROA over their peers in FY11. India’s largest bank, State Bank of India has amongst the poorest ROA within the banking index.

Net NPA ratio: It is a key metric to understand the non-performing assets. With rising interest rates over the past two years, banks have started provisioning for higher NPA. State Bank of India has the poorest Net NPA ratio 1.56%. It would be interesting to see SBI’s outlook with high NPAs on its book. Observing the low net NPA ratios for HDFC bank, Axis Bank, and IndusInd bank, they look to manage their assets and lending activities better then their peers. Yes Bank stands out from the group with a negligible 0.03% net NPA ratio.

Ratios for Evaluating Banks		Advances / Deposit ratio	Capital Adequacy ratio	Cost of funds ratio	Return on Advances adjusted to cost of funds	Interest Expenses / Interest Income	Net Profit Margin
Public Sector Banks	State Bank of India	0.81	11.98	4.63	3.29	0.60	8.55%
	Bank of Baroda	0.75	14.52	3.99	3.09	0.60	17.18%
	Punjab National Bank	0.77	12.42	4.40	4.31	0.56	14.56%
	Canara Bank	0.72	15.38	4.94	3.08	0.66	15.65%
	Bank of India	0.71	12.17	4.34	2.93	0.64	10.25%
	Union Bank of India	0.75	12.95	4.74	3.22	0.62	11.27%
	IDBI	0.87	13.64	6.15	2.60	0.77	8.12%
	Federal Bank	0.74	16.79	5.13	4.78	0.57	12.88%
Private Sector Bank	HDFC Bank	0.77	16.22	4.20	5.22	0.47	16.09%
	ICICI Bank	0.91	19.54	5.05	2.95	0.65	15.91%
	Axis Bank	0.75	12.65	3.98	3.32	0.57	17.20%
	Kotak Mahindra Bank	1.00	19.92	5.02	6.32	0.47	17.19%
	IndusInd Bank	0.76	15.89	5.54	5.29	0.59	13.43%
	Yes Bank	0.75	16.50	5.31	3.38	0.69	15.56%

Source: Market Data – BSE as on November 17, 2011
Company Data – Annual Reports of respective bank; Kotak Securities as on March 31, 2011

Advances / Deposit Ratio: Advances have grown in past few years indicating economic growth and aggressive lending practices by banks, but as lending rate increases, it becomes difficult to sell loans and in return has a negative effect on bank’s ability to earn interest income. Ratio close to one indicates bank can earn high income on advances at the cost of liquidity and too low ratio has an opposite effect.
 
Capital Adequacy Ratio: Banks have raised CRAR to support advances growth. However, few public lenders have CRAR - I below prescribed 8% limit. The RBI guidelines on Basel II require the Bank to maintain a minimum capital to risk-weighted assets ratio (CRAR) of 9.0%. Overall, Indian banks have maintained high CRAR. Private sector banks are better than public sector banks on this parameter too.

Return on Advances adjusted to cost of funds: Return on Advances – Cost of Funds; this figure indicates the difference between money made on lending and money paid on deposits. Kotak Bank and HDFC Bank are managing to earn higher returns then other banks. 

Interest Expense/ Interest Income: With strong interest earning growth, private banks have sharply improved the net interest income. 

Investment Recommendation:
Based on operational parameters, we shortlist Bank of Baroda in public sector banks and HDFC Bank and Kotak Mahindra Bank in private sector banks, which could be considered while investing in banking sector. However, with Kotak Mahindra Bank trading at 36.8x FY11 earnings it looks expensive compared to its peer HDFC Bank trading at 23.78x FY11 earnings.