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Spark Capital: Banks - Forecasting treasury gains




Spark Capital Advisors(India) Private Limited


12 Mar 2013





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Forecasting treasury gains Potential treasury gains not to offset credit costs Interest rates have fallen ~20bps across the yield curve since end of Dec’12 and while we believe that room for further easing is limited to 30bps more for CY13, the broad trend is likely to be downwards. In this note, we analyze investment portfolios of banks to forecast treasury gains and understand the extent to which they can offset base case and stress case credit costs. Treasury gains have historically been a strong counter-cyclical shock absorber in periods of elevated credit costs. They contributed to as much as 60% of pre-tax earnings during FY04, when credit costs were a high 1.2% of total assets, both much higher than current levels. Key conclusion: In the current cycle, we do not see treasury gains playing a significant earnings balancing act given (1) likely monetary environment and (2) the fact that, on a portfolio basis, almost the entire HTM bond book of the banking sector is sitting on significant MTM losses having yields atleast 50-75bps lower than current market yields. Our analysis suggests that the 9 PSU banks and 4 old gen Pvt banks in our coverage are sitting on HTM losses of Rs. 240bn, amounting to ~12% of their current ABVs. Moreover, rates across the shorter end of the yield curve need to decline ~125bps from end of Dec’ 12 for AFS gains to positively impact FY14E earnings by ~10%. A 50bps reduction in rates would result in average treasury gains offsetting only 12% of FY14E base case provisions; however on our stress case, the impact almost halves to 7%. Given the above, we continue with our polarized views with a heavy bias towards Pvt Banks, select NBFCs and against PSU Banks. While the AFS book is a high yield book, where coupon rates are above benchmark yields, the converse is true for the HTM book, given its high duration. Breakeven rates on the HTM book are 20-100 bps below benchmark yields. Banks who score high on (1) yield on investment, (2) AFS proportions and (3) modified durations viz. KVB, CBK, PNB and INBK stand to benefit the most, while BOB, SIB and CUBK are likely to witness the least gains. Most banks have positioned their AFS portfolios away from the shorter end of the yield curve, possibly indicating expectations of a continued flattish yield curve; if the yield curve were to steepen, SBIN, FB and INBK stand to benefit the most - potential treasury gains for these banks would average ~20% of FY14E provisions (10% stress case). AFS modified durations vary widely across banks (1.8 – 4.4 yrs), indicating diverse risk appetites. PNB, KVB and CBK have m.durations >4yrs, comparable to their HTM portfolios, a strategy which could prove less beneficial if the yield curve were to steepen. Only SBI has an AFS m.duration less than 2yrs, a strategy which has paid off recently. A 25bps drop in interest rates could potentially mean a ~2% impact to PPOP through treasury gains, while bond prices would only rise 1.5%, given an average AFS m.duration of 3yrs. Banks with low YoI such as SIB, BOB and FB tend to have low AFS proportions given that yields are higher than coupon rates, negating the possibility of gains.

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