Strong Bonding

Expect banks to make huge treasury gains on bonds as the Reserve Bank of India cuts rates
Sowmya Kamath | Print Edition: April 2013

When interest rates fall, bank stocks rise. The Bank Nifty index rose 4 per cent in the month before the Reserve Bank of India's (RBI's) meeting on January 29 where it cut the rate at which it lends to banks by 25 basis points or bps. Let's look at the complex relationship between banks and interest rates and see which banks will gain the most from the turning interest rate cycle.

In India, banks have to hold at least 23 per cent demand and time liabilities in gold or government or other approved securities. Time liabilities have a fixed period while demand liabilities, for instance savings account balances, are payable on demand. The ratio, called the Statutory Liquidity Ratio, or SLR, is decided by the RBI.


A cut in the repo rate lowers banks' borrowing costs. This makes them cut both lending and fixed deposit rates. Falling rates across the debt markets increase the demand for instruments that pay higher interest. At this stage, prices of bonds which banks had bought when interest rates were high rise, as there is a scramble among investors to lap up these higher-yielding securities.

Hence, the value of government securities that banks have bought for the SLR requirement rises. This increases profits as banks record the market value of these securities in their books. Under this process, called marking to market, organisations record profits/losses in their books on a daily basis without actually booking any profit or loss. So, more SLR bonds the bank holds, the higher its mark-to-market profit.

The other reasons bank profits rise when interest rates fall are pick-up in growth as companies borrow at lower rates as well as improvement in liquidity. Market analysts, however, say that profits from rise in the value of bonds do not come from banks' core operations and are, therefore, unstable. "Profits from government securities or other investments are considered unhealthy," says Clyton Fernandes, banking analyst, Anand Rathi Securities.

However, any profit is good for investors . Keeping in mind business growth and treasury profits, we analyse banks that have clocked the entire 2012-13 profit in the first nine months of this financial year. With their business on track and growing, a look at their SLR holdings will reveal if there are some extra profits that these banks may make if the RBI starts cutting interest rates.

Jammu and Kashmir bank:
The bank posted a profit of Rs 805 crore in April-December compared to Rs 803 crore in 2011-12. Its net interest margin, or NIM, was a healthy 4 per cent. NIM is the difference between interest earned and paid. The bank posted a net profit of Rs 2,890 crore in the December quarter, up 36 per cent from Rs 213 crore in the corresponding quarter last year.

The bank's SLR is close to 23 per cent.

"Assuming a rate cut of 100 bps in 2013, we expect treasury gains of Rs 105 crore in 2013-14 (5.1 per cent of preprovisioning profits) and Rs 75 crore (3 per cent of pre-provisioning profits) in 2014-15," says Fernandes of Anand Rathi.

The bank has been outperforming peers of late and expanding outside its home state of Jammu & Kashmir. One of its biggest growth drivers has been lending to companies with high credit rating. "The bank has been outperforming peers and government banks. We recommend accumulating the stock," says Kavan Soni, analyst at Monarch Projects, an Ahmedabad-based broking firm.

"We expect faster business growth, improvement in productivity and stable credit costs to support profitability between 2012-13 and 2014-15. Our target price is Rs 1,608," says Fernandes. The stock was at Rs 1,270 on March 4.

Development Credit Bank:
This small but fast-growing bank clocked a profit of Rs 68 crore during the April-December period compared to Rs 55 crore in 2011-12. "We expect the bank's loan book to grow at a 25 per cent compounded annual growth rate (CAGR) between 2011-12 and 2014-15, faster than the 17.3 per cent growth between 2008-09 and 2011-12. Growth is likely to be driven by the bank's focus on secured loans in small and medium enterprise (SME), micro SME, retail mortgage and commercial vehicle segments," says Fernandes.

However, the bank is not likely to register high treasury profits as it does not have too many securities available for sale, say analysts. In December 2012, the bank's SLR was nearly 28 per cent of the net demand and time liabilities. "We recommend a buy on the stock with a target price of Rs 51," says Soni of Monarch Projects. It was at Rs 39 on March 4

Bank of Maharashtra:
The Pune-based bank posted a net profit of Rs 500 crore in the first nine months of the financial year compared to Rs 430 crore in 2011-12. It has been growing its loan book aggressively. This, however, has not impressed analysts. "This aggressive loan growth increases concerns about future asset quality," says Vaibhav Agrawal, vice president, banking research, Angel Broking.

In 2011-12, the bank's SLR was 23 per cent, and while it can mark to market its profits, it doesn't stand to make exceptional gains.

In the December quarter, the bank's NIM was 2.9 per cent, about 10 bps less than in the previous quarter. A major concern for investors is the bank's capital adequacy ratio (CAR), which measures a bank's ability to meet its time liabilities and other credit risks. "The bank's CAR is 10.7 per cent, which warrants caution. This, and concerns about future asset quality, prevents us from recommending a buy on the stock," says Soni of Monarch.

Agrawal of Angel Broking has a neutral rating on the stock.

Central Bank of India:
The bank posted a net profit of Rs 845 crore in April-December compared with Rs 533 crore in 2011-12. Its NIM was 2.6 per cent in the December quarter, four bps less than the previous quarter. The SLR was 25.90 per cent on March 12. "Central Bank of India holds long-term bonds worth Rs 33,242 crore, 66 per cent of its total SLR holdings," says Soni of Monarch.

Analysts, however, do not expect big treasury gains. "While the stock has corrected over the past year, it is still trading higher than some other mid-sized PSU banks with better asset quality outlook and return ratios," says Angel Broking's Agrawal, who has a neutral rating on the stock.

Syndicate Bank:
The bank earned 7.5 per cent more profit in the first nine months of 2012-13 than the whole of 2011-12. The NIM during the period was 3.3 per cent. It has been growing business at a steady pace and with stable asset quality. Its SLR was 23 per cent in 2011-12. It holds longterm bonds worth Rs 27,487 crore, 75 per cent of the total SLR holdings. This will increase its book profits if interest rates fall.

The bank is in its growth phase, which along with falling rates bodes well for it. "We recommend a buy with a target of Rs 150. It is available at a cheap valuation," says Soni of Monarch Projects. Several analysts have a target of Rs 140-165 for the stock. It was at 117 on March 4.

Karnataka Bank:
The bank reported a profit of Rs 280 crore in the April to December quarter compared with Rs 246 crore in 2011-12. "It has grown faster than the average over the last six quarters, driven by retail lending, whose share in the total loan book is now 47.8 per cent compared with 43.5 per cent a year ago. The share of gold loans rose from 4.5 per cent in December 2011 to 8 per cent in December 2012. We expect the bank to continue to grow faster than the average at 21 per cent CAGR between 2011-12 and 2014-15 with focus on SME and retail loans," says Kaitav Shah, an analyst who tracks the bank at Anand Rathi Securities.

If the RBI cuts rates by 100 bps in 2013, the bank stands to make treasury gains of Rs 61.3 crore in 2013-14, says Kaitav, who has a buy rating on the stock with a target of Rs 188. It was trading at Rs 130 on March 4.

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