India: Financial Services: Still Amid Choppy Waters Stocks Not Yet Ready For Upturn

July 27, 2011
India: Financial Services

Equity Research
Still amid choppy waters; stocks not yet ready for upturn
Stocks trading in a narrow range; no significant positive catalysts
Since May 2011, Indian financials stocks have traded sideways due to multiple headwinds: (1) Sticky inflation, (2) policy tightening, (3) Potential growth deceleration, (4) increasing risk to asset quality, (5) weaker earnings outlook on margin pressure. While inflation and interest rates are close to their peaks, we believe earnings would remain under pressure on lower margin, higher NPLs.
COVERAGE SUMMARY
Price Up/downside Rating (July 26) 12-m TP potential (%) 900 389 1165 2442 304 1320 498 1041 269 466 319 694 135 215 202 678 1110 360 1410 2760 340 1460 500 1255 350 460 380 670 150 230 220 710 23% -7% 21% 13% 12% 11% 0% 21% 30% -1% 19% -3% 11% 7% 9% 5%
Stocks peak/bottom before inflation does, but are not overvalued

Our analysis of historical trends indicate that the financials sector displays a high correlation with inflation, interest rates, GDP, IIP and suggest that banking stocks tend to peak/bottom 4-6 months ahead of inflation levels peaking/ bottoming. Our GS Global ECS Research team forecasts inflation to peak in Aug-Sep 2011 and believes there is a high probability that rates have peaked. While investor holdings in the banking sector remain high, current valuations are not at their peak vs. the previous cycle, and hence we do not expect a sharp adjustment. We also believe outperformance is unlikely till we see earnings correction, thereby leading to stocks trading in a narrow range.
Rs. Public Banks BOB BOI PNB SBI Union Bank Private Banks Axis Bank HDFC Bank ICICI Bank IndusInd Kotak Mahindra Yes Bank NBFCs HDFC IDFC LIC HF PFC Shriram
Ticker
BOB.BO Buy BOI.BO Sell PNBK.BO Buy SBI.BO Neutral UNBK.BO Neutral AXBK.BO Neutral HDBK.BO Sell ICBK.BO Buy INBK.BO Buy* KTKM.BO Sell YESB.BO Buy HDFC.BO IDFC.BO LICH.BO PWFC.BO SRTR.BO Sell Neutral Neutral Neutral Neutral
*stock is on our Asia Pacific Conviction List.
VALUATION SUMMARY
P/B (X) FY 2012E FY2013E 1.4 1.2 1.5 1.3 1.2 1.0 1.5 1.3 2.0 1.7 1.6 1.3 1.2 1.0 2.7 2.3 2.4 2.1 4.0 3.5 2.0 1.9 1.7 1.5 2.8 2.4 4.5 3.9 2.8 2.5 2.4 2.0 2.4 2.0 5.2 4.6 4.4 3.7 1.6 1.5 2.0 1.6 1.3 1.1 2.5 2.1 2.1 1.8 P/E (X) FY 2012E FY2013E 7.5 6.7 7.5 7.2 7.3 6.6 7.0 6.1 11.5 9.6 9.1 7.6 6.4 5.8 17.4 14.6 13.3 11.7 24.0 19.9 18.4 15.4 14.9 12.4 17.4 14.3 34.7 30.2 23.0 19.8 11.8 9.6 12.2 10.4 25.0 20.9 18.7 15.5 13.3 11.1 9.2 7.4 8.7 7.0 10.9 10.8 13.0 10.9
Earnings performance to remain under pressure next few quarters

Lower loan growth at 18%-20% vs. over 21% last year, margin decline of 50-100 bps vs. peak in Dec 2010, MTM hit on investment portfolio, and lack of treasury gains will lead to muted profit growth in FY12, in our view. NPLs too will see a cyclical uptick, which will likely have a P&L impact. On the positive front, we find banks have hiked lending rates (PLR at 14.25% vs. 14%) more than deposit rates (9.25% vs. 10.5%) this cycle and margin pressure will likely be less vs. the past. If RBI hikes rates any further, margin compression could be more than expected, in our view.
Public banks Bank of Baroda Bank of India Punjab National Bank State Bank of India SBI standalone valuation Union Bank Private banks Axis Bank HDFC Bank ICICI Bank ICBK standalone valuation IndusInd Bank Kotak Mahindra Bank KMB standalone valuation Yes Bank NBFC's HDFC HDFC standalone valuation IDFC LIC Housing Finance Power Finance Shriram Transport Sector Average
Earnings headwinds likely to persist; we remain selective

While the sector is not overvalued, select sector defensivesHDFC Bank/HDFC/ Kotakare trading at expensive valuations; rated Sell. We suggest being selective and prefer private banks to PSU banks as we believe they are able to manage their spreads better than PSUs through the rate cycle (Sell BOI). Our top picks: IndusInd (Buy, on CL) and Yes Bank (Buy) given their strong earnings growth as we believe margin pressure will be offset by higher CASA ratio; ICICI Bank (Buy) better growth prospects and the international book repricing to help sustain its margins. We revise our 12-m TPs for stocks yet to report 1QFY12 results by 2%-5% as we roll forward our target BVPS to June-2012.
Tabassum Inamdar, CFA +91(22)6616-9052 tabassum.inamdar@gs.com Goldman Sachs India SPL Shyam Srinivasan, CFA +91(22)6616-9346 shyam.srinivasan@gs.com Goldman Sachs India SPL Snigdha Sharma +91(80)6637-8765 snigdha.sharma@gs.com Goldman Sachs India SPL
Source: Company data, Goldman Sachs Research estimates.
Goldman Sachs does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC see the end of the text. For other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.
The Goldman Sachs Group, Inc.
Global Investment Research
July 27, 2011
Stocks not yet ready for a turnaround, to trade in a narrow range

We believe stock prices will likely continue to trade in a narrow range in the medium term till interest rates and inflation reach close to the cycle bottom. Simultaneously, we do not expect stock prices to fall significantly as banks have been more rational this cycle in pricing their loans, and current valuations are not at their historical peaks as has been the case in past cycles. We believe, in such a scenario, focusing on stocks with greater earnings visibility and reasonable valuations would be key. We maintain preference for private banks over public banks as we believe they are able to manage their spreads better vs. PSU banks. Top picks are: IndusInd Bank (Buy, on CL) and Yes Bank (Buy) given their potential to surprise on earnings and strong growth as we believe margin pressure will be offset by higher CASA ratio; ICICI Bank (Buy) better growth prospects and its international book repricing to help sustain margins.
Exhibit 1: Stocks are trading in a range since November-2010

Stock price performance of our coverage universe
Absolute Price Performance between: Rating
Jan '10 - Nov '10 Public Banks Nov '10 - Feb '11 Feb '11 - Apr '11 Apr '11 - May '11 May '11 - Current
Performance since peak levels in Nov'10
Absolute
Relative vs. Sensex
Relative vs. MSCI India
Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Average
Private Banks
Buy Sell Buy Neutral Neutral
99% 36% 60% 76% 48% 64% 59% 50% 61% 100% 30% 59% 60% 59% 48% 84% 50% 81% 64%
-21% -19% -28% -28% -19% -23% -25% -16% -24% -23% -27% -35% -25% -19% -42% -39% -32% -23% -31%
19% 16% 22% 15% 6% 16% 24% 19% 16% 27% 26% 31% 24% 23% 24% 36% -9% 19% 19%
-16% -11% -13% -24% -7% -14% -19% -6% -10% -11% -8% -11% -11% -12% -17% -5% -12% -14% -12%
9% -9% 11% 12% -2% 4% 12% 11% 3% 10% 10% 13% 10% 8% 4% -2% 0% -3% 2%
-14% -24% -15% -30% -22% -21% -15% 4% -18% -4% -6% -15% -9% -6% -37% -22% -45% -23% -27%
-2% -12% -4% -18% -10% -9% -3% 16% -6% 8% 6% -3% 3% 6% -26% -10% -34% -11% -15%
-2% -12% -3% -18% -10% -9% -3% 16% -6% 8% 6% -3% 3% 6% -25% -10% -33% -11% -15%
Axis Bank HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Yes Bank Average HDFC IDFC LIC Housing Finance Power Finance Shriram Transport Average
Neutral Sell Buy Buy* Sell Buy
Sell Neutral Neutral Neutral Neutral
Overall Average Sensex MSCI India *stock is on our Asia Pacific Conviction list. For
62% -26% 20% -12% 5% 29% -17% 12% -9% 6% 27% -18% 12% -9% 8% important disclosures, please go to http://www.gs.com/research/hedge.html.
-18% -12% -12%
-6% -----
-6% -----
Source: Datastream, Goldman Sachs Research estimates.
Stock performance lackluster, turnaround some time away?

Bank stocks have fallen 4% to 45% from their highs in November 2010 (with the exception of HDFC Bank) and have remained in a narrow range since then on macro headwinds. Now that we are coming close to inflation and interest rate peaks, is it time to be overweight banks/financials stocks? We expect stocks to continue to remain in a narrow range till we see a decline in inflation. Key observations from past trends and reasons that lead to our conclusion are:
Goldman Sachs Global Investment Research
July 27, 2011
1.
Historical correlation shows that stock prices are generally correlated with inflation, interest rates, GDP, and IIP. Stocks start underperforming four to six months before interest rates and inflation hit the peak and start outperforming four to six months before inflation and interest rate hit the bottom (see Exhibits 4-9). Past two inflation/interest rate peak cycles were different. The first peak cycle in 1996 was followed by the Asian financial crisis in 1997 and banks have seen significant structural changes in terms of balance sheet and income statement since then. The second one was in 2007, which was followed by the global financial crisis in 2008. We believe the difference in this cycle is that while inflation and interest rates are high, stocks are not trading at high valuations as was the case in the past two cycles and therefore stock prices are unlikely to fall significantly. We note that SBIs PLR is now higher than the last cycle. In the last cycle it was at 13.75% vs. current at 14.25%. For other banks (like BoB), the PLR peaked at 14% in the last cycle, and in this cycle it is at 14.5%. SBIs peak deposit rate was 10.5% in the last cycle, and in this cycle it is lower at 9.25%, which could increase though we do not expect this to touch similar levels. We believe both higher PLR and lower deposit rates are good for banks margins. Similarly, other banks have seen deposit rates peak at 10.5% in the last cycle vs. 9.5% in this cycle. In our view, margin pressure should technically be lower this cycle vs. last due to this combination of higher PLR and lower peak deposits. We believe banks may find it increasingly difficult to pass on further rate hikes from the RBI, if any, implying margin compression could be more than expected.
2.
A key similarity is the real rates, which currently is high at 7% similar to the last cycle, which could mean pressure on corporate Indias profitability could increase.
July 27, 2011
Exhibit 2: Current PLR is higher than from last inflation cycle despite inflation being lower. However, deposit rates are currently lower implying spreads for banks are higher now. These spreads will nevertheless compress as inflation and rates start to decline, although at a relatively lesser pace; we prefer private banks to PSU banks
Key macro variables, Private and PSU bank metrics over market peak (Jan-08), inflation peak (July-08), inflation low (Jun-09), and current (July-2011)
Jan-08 Market peak 7.79 7.45 0.34 7.75 7.50 12.75 7.50 8.75 9.05 4.45 5.26 8.30 7.49 4.60 7.89 36.59 1.37 3.81 2.10 Jul-08/Aug-08 Jun-09 Inflation peak Inflation low 9.32 7.01 9.39 4.25 (0.07) 2.76 9.00 4.75 8.75 5.00 13.75 11.75 8.00 6.25 10.00 7.50 10.83 7.94 11.25 8.02 2.50 5.73 (0.42) 4.95 16.84 0.85 1.79 2.02 (0.71) (1.31) 12.46 13.06 8.64 6.11 16.59 1.00 1.89 1.63 Jul-11 Current 8.31 8.17 0.14 8.00 6.00 14.25 7.25 9.25 9.42 9.44 7.20 4.81 7.05 (0.02) 6.16 17.77 1.13 2.55
Interest rate G-sec yields: 10 yr (%) G-sec yields: 1 yr (%) Spread: 10yr -1 yr Repo rate (%) CRR (%) SBI PLR (%) SBI 6m deposit rate (%) SBI Max deposit rate (%) 5 year AAA bond yield (%) Inflation WPI inflation (%) WPI core inflation (%) Real rates PLR - WPI (%) PLR - Core WPI (%) 5 year AAA bond yield - WPI(%) Valuation PSU banks: 12-m fw PE PVT banks: 12-m fw PE PSU banks: 12-m fw PB PVT banks: 12-m fw PB Profitability PSU bank spreads
Relative to Past Inflation peak Lower Lower Higher Lower Lower Higher Lower Lower Lower Lower Lower Higher Higher Negative rates
Last market peak valuations were higher than this cycle, correction therefore could be limited unless there is another potential financial crisis
2.29 Margins are high now as expected,

but likely to fall as we see inflation and interest rates correct 2.66 Private banks manage spreads better than PSU banks
PVT bank spreads

Note: SBIs peak deposit rate was 10.5% in October 2008.
2.21
2.20
2.24
Source: Company data, Datastream, Bloomberg, Goldman Sachs Research.
3.
However, stock prices are unlikely to move up significantly as they are above historical averages. Simultaneously, banks have to face earnings headwinds from lower margin, lower loan growth, higher NPLs, and MTM hit on investment portfolios. We believe all these factors could lead to stock prices remaining in a narrow range. Investor holdings in the banking and finance sector have not reduced despite macro headwinds indicating that the sector has remained overweight.
4.
July 27, 2011
Exhibit 3: Valuation summary

Price Market Cap Reuters ticker Public banks BOB BOB.BO BOI BOI.BO PNB PNBK.BO SBI SBI.BO SBI standalone valuation Union Bank UNBK.BO Private banks Axis AXBK.BO HDFCB HDBK.BO ICICIB ICBK.BO ICICI Bank standalone valuation IndusInd Bank INBK.BO KMB KTKM.BO KMB standalone valuation Yes Bank YESB.BO NBFC's HDFC HDFC.BO HDFC standalone valuation IDFC IDFC.BO LIC Housing Finance LICH.BO Power Finance PWFC.BO Shriram Transport SRTR.BO Rating Buy Sell Buy Neutral Neutral Neutral Sell Buy Buy* Sell Buy Sell Neutral Neutral Neutral Neutral (US$ mn) 7,927 4,786 8,397 34,983 3,589 12,245 26,185 26,977 2,820 7,742 2,505 22,979 4,443 2,298 5,213 3,454 3m ADVT (US$ mn) 7.3 10.4 6.4 129.1 5.1 47.6 41.8 87.2 4.3 11.7 18.4 42.1 23.8 32.3 17.0 13.2 7/26/2011 (Rs) 900 389 1,165 2,442 1,812 304 1,320 498 1,039 779 269 466 286 319 694 453 135 215 202 678 Target Price/ Valuation (Rs) 1,110.0 360.0 1,410.0 2,760.0 2,129.9 340.0 1,460.0 500.0 1,255.0 975.0 350.0 460.0 278.0 380.0 670.0 429.0 150.0 230.0 220.0 710.0 Total Return Potential (Rs) 26% -5% 23% 14% 15% 12% 1% 22% 31% -1% 20% -2% 13% 9% 12% 6% P/B (X) FY 2012E 1.49 1.17 1.51 2.04 1.58 1.19 2.44 3.98 2.01 1.70 2.82 4.47 2.80 2.41 5.22 4.42 1.65 2.01 1.27 2.52 FY2013E 1.27 1.01 1.25 1.74 1.34 1.02 2.09 3.45 1.85 1.55 2.44 3.92 2.45 1.98 4.57 3.75 1.48 1.65 1.12 2.11 P/E (X) FY 2012E 7.5 7.3 7.0 11.5 9.1 6.4 13.3 24.0 18.4 14.9 17.4 34.7 23.0 11.8 25.0 18.7 13.3 9.2 8.7 10.9 FY2013E 7.2 6.6 6.1 9.6 7.6 5.8 11.7 19.9 15.4 12.4 14.3 30.2 19.8 9.6 20.9 15.5 11.1 7.4 7.0 10.8 Historical P/B (X) Median 0.8 0.7 1.3 0.8 0.9 1.4 3.1 1.7 0.9 2.5 3.2 2.8 2.7 0.8 2.0 1.0 Peak 1.9 2.1 1.8 2.0 1.5 4.6 5.0 3.3 2.9 11.2 5.1 7.0 5.7 1.7 3.1 3.8
*stock is on our Asia Pacific Conviction list. All target prices mentioned above are on a 12-month basis. For important disclosures, please go to http://www.gs.com/research/hedge.html. Source: Company data, Goldman Sachs Research estimates.
Strong correlation to inflation, interest rates, GDP, and IIP

The limited historical trends over the past cycles indicate that bank stocks peak before inflation and interest rates. Our GS Global ECS Research team expects inflation to peak in 2Q at 9.6% and then start correcting to around 6% by March 2012. We note stock performance is usually strong in the initial phase of policy tightening, reflecting higher loan growth, and margins on the back of recovery. However, unlike in the past when inflation has swung down sharply, our GS Global ECS Research team expects inflation to bottom at around 4.9%-5.1% in 3QFY13. Further, they estimate repo rates at 8% have likely peaked for now, and would remain stable before falling marginally by December 2012 to around 7.5%. While we do not expect inflation/rates to collapse, we believe stocks may start outperforming as rates/inflation decline even though the bottom is at higher levels vs. the past cycles.
July 27, 2011
Exhibit 4: PSU banks stocks are highly correlated with inflation, and have tended to react 6 months ahead of peak and bottom
PSU bank stocks performance (yoy) vs. headline, and core inflation
140% 120% 100%
8.0%
Exhibit 5: a trend that is evident in private bank stocks too

Private bank stocks performance (yoy) vs. headline, and core inflation
Correlation - PSU (6M lead) to Headline inflation: 78.2% Correlation - PSU (6M lead) to Core inflation: 63.5%
12.0%
200%
Correlation - PVT (6M lead) to Core inflation: 65.1% Correlation - PVT (6M lead) to Headline inflation: 64.9%
12.0%
Forecasts
10.0%
Forecasts
10.0%
150%
8.0%
80% 100% 60% 40% 20% 0%

0.0% 0.0% 6.0% 6.0%
4.0%
50%
4.0%
2.0%
2.0%
0%
-20% -50% -40% -60%

-2.0% -2.0%
-4.0%
-100%
-4.0%
Oct-10
Oct-10
Jul-06
Jul-12
Jul-06
Jul-07
Jul-08
Jul-07
Jul-08
Jul-09
Jul-09
Jan-07
Jan-11
Jan-07
Jan-08
Jan-09
Jan-11
Jan-08
Jan-09
Oct-06
Jan-12
Apr-10
Oct-06
Oct-07
Oct-08
Oct-09
Oct-07
Oct-08
Oct-09
Jan-12
Apr-10
Oct-11
Oct-11
Apr-12
Apr-06
Apr-06
Apr-07
Apr-08
Apr-09
Apr-07
Apr-08
Apr-09
PSU Banks stock performance (6M Lead)
Headline (RHS)
Core (RHS)
PVT Banks stock performance 6M lead
Headline (RHS)
Core (RHS)
Source: Bloomberg, Datastream, Goldman Sachs ECS Research estimates.
Exhibit 6: Banking stocks tend to peak 5 months before repo rates

PSU bank stocks performance (yoy) vs. repo rate
140% 120% 100% 80%
8.0% 10.0%
Exhibit 7: and start outperforming 5 months before repo rates hit the bottom
Private bank stocks performance (yoy) vs. repo rate
200%
Correlation - PVT (6M lead) to Repo rate: 27.5%
10.0%
Correlation - PSU (6M lead) to Repo rate: 19.9%
Forecasts
9.0%
Forecasts
9.0%
150%
100%
Apr-12
Apr-11
Jan-10
Jan-10
Apr-11
Jul-12
8.0% 7.0% 6.0% 5.0% 4.0%
Jul-11
60% 40% 20%

6.0% 7.0%
Jul-10
50%
0%
0% -20%
5.0%
-50%
-40% -60%
4.0%
-100%
Oct-10
Jul-10
Oct-10
Jul-06
Jul-07
Jul-08
Jul-09
Jul-12
Jul-06
Jul-07
Jul-08
Jul-09
Jul-11
Jan-11
Jan-07
Jan-08
Jan-09
Apr-10
Jan-12
Jan-07
Jan-08
Jan-09
Apr-10
Jan-11
Oct-06
Oct-07
Oct-08
Oct-09
Oct-06
Oct-07
Oct-08
Oct-09
Apr-12
Jan-12
Oct-11
Oct-11
Apr-06
Apr-07
Apr-08
Apr-09
Apr-06
Apr-07
Apr-08
Apr-09
PSU Banks stock performance 6M lead
Repo rate(RHS)
PVT Banks stock performance 6M lead
Repo rate(RHS)
Apr-12
Apr-11
Jan-10
Jan-10
Apr-11
Jul-12
Jul-11
Jul-10
Jul-10
Jul-11
July 27, 2011
Exhibit 8: PLR, RR, and inflation currently moving in tandem

PSU bank stocks performance (yoy) vs. PLR
16% 14% 12% 10% 12.5% 8% 12.0% 6% 11.5% 4% 2% 0% -2% 11.0% 10.5% 10.0% 14.0% 13.5%
Exhibit 9: which is being reflected in banks stock price performance

Private bank stocks performance (yoy) vs. PLR
150% 14.5% 14.0% 100% 13.5% 13.0% 50% 12.5% 12.0% 0% 11.5% -50% 11.0% 10.5% -100% 10.0%
13.0%
Jun-01
Jun-00
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Dec-01
Jun-09
Jun-10
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-01
Dec-00
Dec-10
Jun-00
Jun-01
Jun-02
Jun-03
Jun-04
Jun-05
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Jun-11
Repo Rate
Inflation
PLR (RHS)
PVT bank stock performance
Dec-00
PSU bank stock performance
Dec-09
PLR (RHS)
Source: Bloomberg, Datastream.
Correlation high even vs. GDP and IIP

We believe performance of banking stocks is highly correlated with IIP and GDP as well. We expect GDP growth to moderate to 7.5% in FY2012 from 8.5% in FY2011, but to improve to 7.8% in FY2013. A strong economy leads to higher loan growth, margin, fee income, and lower NPLs, which in turn is reflected in the stock price performance.
Exhibit 10: Private banks show relatively higher correlation with GDP vs. PSU banks
GDP and banking sector performance
200% 12.0%
Exhibit 11: a fact corroborated by IIP numbers as well

IIP and banking sector performance
200%
Dec-10
Jun-11
18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2%
Correlation Public Sector to Real GDP: 33.5% Correlation Private Sector to Real GDP: 56.8%
150%
Correlation Public Sector to IIP: 53.7%

Forecasts
10.0%
Correlation Private Sector to IIP: 71.5%

150%
Forecasts
100%
8.0%
100%
50%
6.0%
50%
0%
4.0%
0%
-50%
-50% 2.0%
-100%
-100% 0.0%
Public Sector
Private Sector
Real GDP growth (RHS)
Public Sector
Private Sector
IIP growth (RHS)
July 27, 2011
Exhibit 12: We expect GDP growth to moderate over FY2011, and believe consumption rather than investment is likely to drive growth going forward
Growth in GDP and components in % change yoy
Growth (%) Q1FY12E Q2FY12E Q3FY12E Q4FY12E Q1FY13E Q2FY13E Q3FY13E Q4FY13E Real GDP 7.6 7.7 7.4 7.5 7.9 7.9 7.7 7.9 Production Agriculture 2.0 2.0 3.0 3.2 3.0 2.0 3.0 2.6 Industry 7.4 7.4 7.3 7.3 7.3 7.4 7.3 7.1 Services 8.9 8.7 8.6 8.5 9.0 9.0 9.0 9.2 Expenditure Consumer 7.5 6.7 6.2 6.2 8.2 8.4 8.1 7.5 Domestic demand 8.6 8.3 7.7 7.6 8.4 8.5 8.2 7.7 Exports 17.4 17.2 16.8 16.7 14.4 14.2 13.9 13.6
Source: Goldman Sachs Global ECS Research estimates, Goldman Sachs Research estimates.
We correlate PSU and private banks stock price performance with a cross section of macro indicators that include growth in real GDP and industrial production, repo/reverse repo policy rates, and finally headline and core inflation on a quarterly basis. In the first scenario, we assume no lag between the indicators: Real GDP and industrial production shows significant positive correlation (34%-76%) with stock price performance. In the second scenario, we assume a lag in stock price performance by a quarter and have captured metrics that records maximum correlation: Repo/reverse repo and Inflation (more so core) show higher negative correlation (-40% to -58%) vs. the first scenario implying that they could be potentially viewed as useful leading indicators to banks stock prices. Exhibit 13: Real GDP and IIP have the highest positive correlation with PSU, and private bank stocks
Correlation of PSU, and private bank stocks performance vs. key macroeconomic indicators with no lag assumed
Exhibit 14: Repo and inflation also serve as good leading indicators with a 1 quarter offset
Correlation of PSU, and private bank stocks performance vs. key macroeconomic indicators with lag for max. correlation
Correlation Matrix with no lag Real GDP IIP Prime lending rate Repo Rate Reverse Repo rate WPI Core Inflation
Stock price performance PSU Banks Private banks 34% 57% 58% 76% -23% -38% -38% -29% -33% -18% -13% -9% -34% -25%
Correlation Matrix With offset Offset -1 Real GDP -1 IIP -1 PLR -1 Repo Rate -1 Reverse repo -1 WPI -1 Core Inflation
Stock price performance PSU Banks Private banks 7% 25% 45% 64% -24% -47% -58% -52% -54% -40% -40% -40% -52% -47%
Source: Goldman Sachs Research estimates.
Source: Goldman Sachs Research estimates.
Slower economic activity to impact earnings trajectory

For the near term, we expect core earnings to be muted as: (1) Credit growth moderates to 18%-20% in FY12E vs. 19% in 1HFY11 and 21%-23% in 2HFY11, (2) NIMs fall 50-100bps from the peak of December 2010, as deposit cost moves up, while lending rates stabilize, (3) fee income remains under pressure on slowing industry/retail loans and product sales, (4) banks take MTM hit or report lower gains given rising GSec yields, and (5) we see a cyclical uptick in NPLs. We see downside risks to our loan growth, margin assumptions and potentially higher NPLs if RBI continues to tighten further. For now, our GS Global ECS Research team believes that the rates have peaked.
July 27, 2011
Exhibit 15: Slower economic activity could result in slower profit growth
Growth in PBT in %: FY09-FY13E
Growth in PBT (%) Public Banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private banks Axis Bank HDFC Bank ICICI Bank Indusind Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC Housing Finance Power Finance Shriram Transport FY09 55.8 55.1 44.6 35.8 16.4 69.2 44.8 1.2 99.1 -69.7 52.0 -4.6 3.5 36.5 11.8 52.1 FY10 23.3 -40.1 23.9 -1.8 21.3 38.3 29.8 4.5 134.4 90.4 55.9 21.7 37.9 25.4 51.4 46.2 FY11 33.3 40.2 11.2 7.3 4.3 33.3 35.7 26.4 65.0 32.2 56.1 24.3 24.5 42.3 17.5 37.3 FY12E 13.8 23.0 19.8 38.0 21.4 18.6 22.1 29.2 24.7 33.1 23.8 16.6 19.8 17.6 17.2 14.4 FY13E 4.1 11.5 16.1 19.0 11.1 15.5 21.9 21.9 23.3 15.6 23.7 19.4 20.0 23.1 24.2 0.5
Exhibit 16: and core earnings growth

Growth in PBT less treasury inc, provisions in %: FY09-FY13E
Growth in PBT (Less treasury, provs) Public Banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private banks Axis Bank HDFC Bank ICICI Bank Indusind Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC HF Shriram Transport Finance
FY09 36.4 41.3 41.0 26.3 12.9 70.1 36.0 25.3 39.6 12.2 30.2 23.1 7.7 38.5 56.3
FY10 21.3 -12.7 29.8 5.6 12.2 28.6 27.0 3.6 140.3 83.3 101.8 16.4 46.1 27.7 48.4
FY11 58.3 23.1 34.2 50.6 24.5 36.9 27.8 17.2 69.6 -10.4 67.2 22.0 61.9 33.1 39.0
FY12E 18.5 8.9 20.2 14.8 17.1 12.7 19.2 13.8 24.9 36.2 17.6 20.6 22.4 44.4 14.3
FY13E 8.2 20.9 20.4 18.7 21.5 24.0 22.6 18.2 36.0 27.8 30.8 20.8 33.5 27.0 0.4
Credit growth will likely slow

Credit growth has moderated with slowing economic activity, and we believe will likely come off further to around 18%-20% in FY2012. RBIs own target for non-food gross credit growth for FY12 is 18%, although the current credit growth trend is above the indicative trajectory of the RBI. The incremental credit deposit ratio has also come off sharply this year to 52% from 98% last year and would likely impact margins, in our view. We estimate incremental CD ratio between 76%-84% for FY2012.
Exhibit 17: Sector growth is currently at 20%, we expect system credit growth between 18%-20% for FY12E
System credit growth
Exhibit 18: Incremental CD ratio has been one of the lowest in recent past
Incremental credit deposit ratio
30% 25% 20% 15% 10%
2008
2009
2010
2011
2012
140%
131.0
120%
21 20
100%
99.5 85.8
97.5
80%
72.8 64.4
71.7
60% 50.4 40%
52.0
Aug
Sep
Feb
Jun
Oct
Jul
Jan
May
Nov
Dec
Mar
Apr
20%
0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 Jul-11
Source: RBI.
Source: RBI.
July 27, 2011
Exhibit 19: Deceleration in infrastructure credit growth as telecom loans run down; slower off take in power/road credit will likely pull down the system credit growth, in our view
Sectoral deployment of credit (Rs bn), split of total (%) and growth in these segments (yoy) in %
Growth (y-o-y) Non-Food Gross Bank Credit Agriculture Services Commercial real estate Retail Industry Food Processing Textiles Petroleum, Coal & Nuclear Chemicals and Chemical Products Basic Metals and Metal Products All Engineering SME Infrastructure Power Telecom Road Industry excluding infrastructure
Source: RBI.
FY08 22.7 18.9 30.7 37.4 11.0 26.1 26.9 22.5 17.7 16.1 25.5 20.9 33.3 41.4 28.4 89.2 31.7 22.1
FY09 18.1 23.8 18.3 47.0 11.3 20.9 7.1 7.0 63.3 17.3 23.0 25.5 66.9 33.5 32.5 35.6 42.6 17.1
FY10 16.8 22.9 12.4 0.5 4.2 24.2 21.3 6.9 14.0 26.2 26.8 12.3 44.3 40.8 51.2 17.9 55.4 18.5
FY11 20.6 10.6 23.9 21.4 17.0 23.6 29.3 19.2 (26.6) 10.3 28.8 26.3 21.8 38.6 43.3 69.2 25.8 17.7
May-11 22.1 12.0 24.1 19.9 18.4 26.7 26.2 20.7 5.0 15.7 29.9 27.2 20.6 38.7 42.4 53.7 31.2 16.8
Rs bn % of Total 36,836 100.0 4,508 12.2 8,819 23.9 1,147 3.1 6,932 18.8 16,577 45.0 857 2.3 1,456 4.0 662 1.8 924 2.5 2,139 5.8 939 2.5 4,560 12.4 5,502 14.9 2,875 7.8 977 2.7 982 2.7 11,311 30.7
Deposit growth has been modest despite rising rate while CASA growth is slowing
Exhibit 20: System deposit growth has picked up in FY12, likely due to higher rates
System deposit growth
Exhibit 21: on term deposits, while CASA has declined during the same period as depositors shift to term deposits
Time and demand deposit growth
30% 25% 20% 15% 10%
2008
2009
2010
2011
2012
26.0% 24.0% 21.6% 22.0% 20.0% 18.0%
25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -1.8% -5.0% -10.0% -15.0%
18 16
16.0% 14.0% 12.0%
Aug
Sep
May
Feb
Jun
Oct
Jul
Jan
Apr
Nov
Dec
Mar
10.0%
Time deposits (yoy)
Demand deposits (yoy) (RHS)
Source: RBI.
Source: RBI.
10
July 27, 2011
NIM pressure likely to remain till rates bottom, fees too will be under pressure as economic activity moderates
We believe banks will likely see margin pressure over FY12 and 1HFY13, signs of which were reflected in 4QFY11 and 1QFY2012 results as deposit rates continue to rise, while lending rates start to stabilize and then fall subsequently. Margins will also be impacted by slower growth in loans both due to slowing economic activity and moderation in infrastructure lending. We have seen both the wholesale borrowing cost and the PLR rise a lot more in this cycle vs. the last cycle. SBIs PLR peaked at 13.75% in the last cycle, vs. 14.25% currently. Retail deposit rates are still lower than the last peak. Exhibit 22: PLR has been raised between 200-250bps...
Prime lending rate progression
Exhibit 23: while base rates have gone up by 200-225 bps

Base rate progression
PLR (%) Dec-09 Aug-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 Jul-11 Change from 2009 (bps)
Source: Company data.
SBI 11.75 12.25 12.50 12.50 12.75 12.75 13.00 13.00 13.25 14.25 250
BOB 12.00 12.50 12.50 12.50 13.25 13.25 13.75 13.75 13.75 14.50 250
BOI 12.00 12.50 12.50 12.50 13.25 13.25 13.75 13.75 13.75 13.75 175
PNB 11.00 11.75 11.75 11.75 12.50 13.00 13.00 13.00 13.00 13.50 250
UNBK 11.75 12.25 12.25 12.75 13.25 13.25 13.75 13.75 13.75 14.50 275
HDFCB 15.75 15.75 16.25 16.25 16.50 16.50 16.50 17.25 17.25 17.75 200
ICBK 15.75 16.25 16.25 16.25 16.75 17.00 17.50 17.50 17.50 18.25 250
Base rate (%) SBI Union BOB BOI PNB HDFCBank ICICIBank AxisBank IndusInd Kotak Yesbank
Initial 7.50 8.00 8.00 8.00 8.00 7.25 7.50 7.50 7.00 7.25 7.00
Dec-10 7.60 9.00 9.00 9.00 9.00 7.50 7.75 8.00 7.75 8.00 8.00
Mar-11 8.25 9.50 9.50 9.50 9.50 8.70 8.75 8.75 8.75 8.75 8.50
Apr-11 8.50 9.50 9.50 9.50 9.50 8.70 8.75 8.75 8.75 8.75 8.50
Jul-11 9.50 10.25 10.25 10.00 10.00 9.50 9.50 9.75 10.00 9.25 10.25
Change since July 2010 (PP) 2.00 2.25 2.25 2.00 2.00 2.25 2.00 2.25 3.00 2.00 3.25
Exhibit 24: Wholesale borrowing cost i.e., CD/CP rates have moved up 340-500bps from the bottom in December 2009
CD, CP rates progression
% CD 3M CD 6M CD 12M CP 3M CP 6M CP 12M Dec-09 Mar-10 3.85 4.95 4.87 5.20 5.85 6.05 4.25 5.75 5.50 6.00 6.55 6.75 Jun-10 6.50 6.65 6.90 6.88 6.98 7.37 Sep-10 7.13 7.61 8.07 7.53 7.99 8.48 Dec-10 Mar-11 9.00 9.45 9.38 9.45 9.48 9.50 9.48 10.36 9.73 10.58 9.95 10.74 Jun-11 8.38 9.07 9.73 8.90 9.54 10.10 Change in Jul-11 2010 (bps) 8.75 515 9.27 451 9.57 363 9.13 523 9.58 423 9.98 340 Change in 2011 (bps) -25 -11 9 -34 -15 3 Change from peak (bps) -138 -91 -61 -157 -125 -80 Change since Dec 2009 490 440 372 488 408 343
Source: Bloomberg.
11
July 27, 2011
Exhibit 25: Retail deposit rates have increased but still not at the same level as the last cycle; the difference is more likely on short-term deposits where some banks like SBI are offering very high rates
Summary of deposit rates across maturities
Current Deposit rates 7 days to 14 days 15 days to 45 days 46 days to 90 days 91 days to 180 days 181 days & above but less than 1 year 1 year & above but less than 2 years 2 years and above upto 749 days Above 750 days but less than 3 years 3 years and above but less than 5 years 5 years and above but less than 8 years 8 years and above up to 10 years BOB 4.25% 4.25% 4.25% 6.50% 7.25-7.50% 9.00% 9.00% 9.00% 8.50% 8.50% 8.50% PNB 4.00% 4.50% 5.50% 7.00% 8.00% 9-9.05% 9.00% 9%-9.15% 8.5-9.25% 8.75% 8.75% SBI 7.00% 7.00% 7.00% 7.25% 6.5-7.75% 9.25% 9.25% 9.25% 9.25% 9.25% 9.25% Axis 2.5-3.0% 3.5-4.0% 6.25-6.75% 7.75-8.50% 9-9.25% 8.50% 8.50% 8.50% 8.50% 8.50% ICICI HDFCB 3.75% 3.50% 4-5% 4-5% 6.25-6.50% 6.25-6.50% 7.00% 6.75% 7-7.75% 7.25-7.75% 8.25-9.25% 8.25-8.50% 8.50% 8.50% 8.5-9.25% 8.50% 8.75% 8.25% 8.75% 8.25% 8.75% 8.25% Union BOI 4.00% 4.00% 4.75% 4.50% 5.25% 5.50% 7-7.25% 7.00% 8-8.15% 8.00% 9.15% 9-9.25% 9.15% 8.00% 9.15% 8.00% 9.15% 7.75-8.25% 8.5-9.00% 8.50% 8.50% 8.75% Indus Yes 3.00% 4.00% 4.00% 4-4.50% 5.5-5.75% 6.00% 6.25% 7.25% 7.75-8.50% 8.25-9.00% 9-9.50% 9-9.60% 8.75-9.50% 8.75% 8.75-9.50% 8.75-9.30% 8.75% 8.75% 8.75% 8.75% 8.75% 8.75% Kotak 4.00% 5-5.50% 6.25% 7.50% 8.25-8.75% 9.25-9.60% 9.50% 9.50% 9.25% 9.25% 9.25%
Exhibit 26: Retail deposit rates have moved up across most maturities
Deposit rate trajectory for key banks
Tenure 6M Dec-09 Dec-10 Mar-11 Jul-11 Change Dec-09 Dec-10 Mar-11 Jul-11 Change Dec-09 Dec-10 Mar-11 Jul-11 Change SBI 5.25 7.75 7.75 7.75 250 6.00 9.00 9.25 9.25 325 6.50 8.25 8.25 9.25 275 BOB 5.50 7.00 6.75 7.50 200 6.50 8.35 9.10 9.35 285 7.00 7.50 8.50 8.50 150 BOI 5.00 6.75 7.25 7.50 250 6.50 8.25 9.25 9.25 275 7.00 8.25 8.25 8.25 125 PNB 4.50 7.50 7.75 9.00 450 6.50 8.25 9.05 9.50 300 7.00 8.25 9.25 9.25 225 UNBK HDFCB 4.50 5.50 7.00 6.50 7.50 7.75 8.00 7.75 350 225 6.75 6.50 8.10 7.25 8.10 8.25 9.00 8.50 225 200 7.00 6.50 7.50 7.50 9.15 8.25 9.15 8.25 215 175 ICBK 5.25 6.50 7.00 7.75 250 6.25 8.00 9.00 9.25 300 7.50 8.50 8.50 8.75 125
1 - 2 Years
3 - 5 Years
12
July 27, 2011
Exhibit 27: We assume lower NIMs in FY13E on the basis of (1) interest rates likely peaking in 1HFY13E, and (2) the full impact of the recent 50bp hike in saving bank deposit rate
Change from annualised 3QFY11 NIMs, spread change from 3QFY09-1QFY10
Declineinspreadsduringlastcycle DeclineinNIMsover (Q3FY09Q1FY10),wheninterestrates Q3FY11annualized annualizedQ3FY11 weredeclining(SBI'sPLRdown125bp NIMs FY13E and12yrdepositratedown200bp) 3.26 2.97 4.26 3.53 3.35 4.01 5.08 2.62 4.09 5.57 3.24 3.61 4.74 3.34 10.80 (76) (49) (83) (56) (64) (111) (90) 12 (24) (10) (49) (15) (49) (67) (204) (97) (97) (66) (136) (118) 12 (46) 6 80 (21) 74 (91) (45) (47) 193
NetinterestMargins(%) PSUBanks BankofBaroda BankofIndia PunjabNationalBank StateBankofIndia UnionBankofIndia PrivateBanks AxisBank HDFCBank ICICIBank IndusIndBank KotakMahindraBank YesBank NBFCs HousingDevelopmentFin. IDFC LICHousingFinance ShriramTransport*
FY11
FY12E
FY13E
2.83 2.59 3.61 2.97 2.97 3.19 4.44 2.59 3.56 5.04 2.72 3.51 4.47 2.94 9.52
2.69 2.48 3.40 2.92 2.68 2.84 4.24 2.70 3.60 4.63 2.57 3.49 4.12 2.65 9.10
2.50 2.48 3.43 2.97 2.71 2.90 4.18 2.75 3.85 5.46 2.75 3.47 4.24 2.67 8.77
*For Shriram, NIM is calculated as Net interest income/Average asset under management. Source: Company data, Goldman Sachs Research estimates.
Exhibit 28: We expect NII to come under pressure due to margin compression
Growth in NII
Growth in NII (%) Public Banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private banks Axis Bank HDFC Bank ICICI Bank Indusind Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC Housing Finance Power Finance Shriram Transport FY09 31.0 28.2 27.0 15.7 23.6 37.3 42.0 2.0 52.6 -17.1 51.8 16.7 30.6 29.2 24.8 50.2 FY10 15.9 0.6 21.2 13.4 9.9 35.8 13.0 -3.0 93.1 22.4 54.1 12.1 87.4 20.5 28.8 27.4 FY11 48.2 35.7 38.5 37.4 48.3 31.1 25.7 11.1 55.3 14.6 63.6 24.6 28.7 54.8 22.7 40.1 FY12E 16.4 3.4 18.0 12.7 8.7 14.3 17.5 17.8 29.0 18.5 26.8 19.4 17.3 16.6 21.5 16.9 FY13E 10.9 23.0 23.1 17.4 20.6 26.2 22.7 17.2 34.6 27.5 36.3 20.2 22.8 24.9 24.3 12.9
Exhibit 29: while other income remains muted

Growth in other income
Growth in Other income (%) Public Banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private banks Axis Bank HDFC Bank ICICI Bank Indusind Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC Housing Finance Power Finance Shriram Transport
FY09 63.4 44.2 46.2 46.1 19.5 60.0 44.1 -13.3 53.3 -91.1 22.7 -60.1 7.0 27.2 41.7 -21.2
FY10 -1.2 -14.3 16.9 18.0 34.0 36.2 15.7 -1.4 21.3 75.6 32.3 86.5 -21.1 34.1 1.8 39.3
FY11 3.1 1.0 5.9 5.7 3.2 17.4 13.9 -11.1 28.9 0.8 8.3 19.3 3.7 114.2 38.9 57.0
FY12E -6.3 0.7 10.1 11.6 0.3 18.2 25.5 19.6 19.3 54.6 20.3 -0.9 10.8 -49.3 9.4 -63.1
FY13E 18.9 3.7 11.5 13.4 3.0 26.8 21.6 23.9 29.5 16.6 28.4 13.6 18.3 12.4 9.5 14.0
13
July 27, 2011
Treasury income could take a hit

GSec yields have moved up by 39-88 bps in 2011 over and above the 33-290 bps increase in rates in 2010. Our GS Global ECS Research team expects 10-year Gsec yields to reach 8.5% by March 2012. We believe this will likely impact banks ability to book gains in order to offset margin pressure, and in most cases will also lead to MTM hit for banks as yields are currently at 8.3%. Exhibit 30: Banks tend to book treasury gains when the yields start declining and vice versa
Net treasury income for our coverage universe vs. 10-year Gsec yields
Rs bn
100 80 60 40
12.0% 11.0% 10.0% 9.0%
20 8.0% 0 -20 -40 -60

FY00 FY01 FY02 FY03 FY04 FY05 FY06 Q1FY07 Q2FY07 Q3FY07 Q4FY07 Q1FY08 Q2FY08 Q3FY08 Q4FY08 Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 Q1FY11 Q2FY11 Q3FY11 Q4FY11
7.0% 6.0% 5.0%
Net treasury income
10 Year Gsec yields (RHS)
Source: Company data, Bloomberg.
Exhibit 31: Rates have risen by 88 bp on the short end much more than the long end likely leading to MTM hit for banks
Gsec yields (%)
Change in Jul-11 2010 (bps) 8.17 290 8.31 33 Change in 2011 (bps) 88 39
% 1 yr G Sec 10 yr G Sec
Dec-09 Mar-10 4.39 5.15 7.59 7.83
Jun-10 5.42 7.55
Sep-10 6.51 7.95
Dec-10 Mar-11 7.29 7.56 7.92 8.01
Jun-11 8.22 8.33
Source: Bloomberg.
14
July 27, 2011
Exhibit 32: Treasury income contribution has been substantially lower in FY11 as Gsec yields have moved higher
Net treasury income in FY10-FY13E as % of PBT
Net Trading income Public banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private banks Axis Bank HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Bank Yes Bank FY10 11,040 3,501 5,844 31,048 6,901 8,594 3,451 18,377 1,113 517 832 Rs mn FY11 FY12E 4,347 1,848 1,548 2,789 4,374 2,670 -527 -4,060 685 379 -392 1,100 1,037 660 2,800 2,970 884 -413 0 578 597 -150 FY13E 2,000 2,000 2,000 7,000 2,500 3,500 1,000 1,500 400 350 100 FY10 26.0 14.0 9.9 22.3 24.4 22.3 8.0 34.4 20.9 6.4 11.5 % of PBT FY11 FY12E 7.7 5.3 2.4 1.9 14.8 5.2 -0.9 -6.0 7.8 3.5 -3.5 1.7 2.4 0.8 1.4 8.3 1.5 -0.6 0.0 5.3 4.2 -1.1 FY13E 3.0 4.2 2.2 2.8 6.3 5.0 1.2 1.4 3.0 2.1 0.6
Exhibit 33: In our view, SBI and BOI will likely be impacted the most if rates rise
Sensitivity of profits to higher yields assuming current yields of 8.3%
Adjusted PBT estimates (Rs mn) (In Rs mn, unless specified) BOB BOI PNB SBI Union Bank FY2012E AFS Profit Portfolio AFS Portfolio as Before Tax as of FY11 % of Investments 64,316 159,045 22.3% 42,991 309,145 36.6% 78,620 205,574 21.5% 206,403 715,127 27.0% 35,893 102,640 17.1% Duration (Years) 2.81 1.22 2.71 3.30 1.59 % impact to our PBT estimates
8.25% 8.50% 8.75% 9.00% 63,869 62,752 61,635 60,518 42,614 41,671 40,728 39,785 78,063 76,670 75,277 73,884 204,043 198,143 192,243 186,343 35,730 35,322 34,914 34,506
8.25% 8.50% 8.75% 9.00% -0.7% -2.4% -4.2% -5.9% -0.9% -3.1% -5.3% -7.5% -0.7% -2.5% -4.3% -6.0% -1.1% -4.0% -6.9% -9.7% -0.5% -1.6% -2.7% -3.9%
Note: BOI, UNBK data as of 1QFY12. Source: Company data, Goldman Sachs Research estimates.
15
July 27, 2011
Asset quality deterioration likely to reflect in FY2013

Slower corporate sales growth, and EBITDA margin pressure will likely translate into an increase in NPLs for banks and finance companies, in our view, and we believe the NPL ratio for the industry could move up to around 3% from 2.5%. However, we expect to see increase in NPLs only in FY2013E, as banks will initially restructure/evergreen loans. Exhibit 34: We expect NPLs to increase in FY13E
Gross and net NPL ratios in FY10-FY13E
Gross NPL (% of total advances) FY10 FY11 FY12E FY13E Public banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank New private banks Axis Bank HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Bank Yes Bank NBFC HDFC LIC HF 1.4 2.9 1.7 3.1 2.2 1.3 1.4 5.1 1.2 3.6 0.3 0.8 0.7 1.4 2.2 1.8 3.3 2.4 1.1 1.0 4.7 1.0 2.0 0.2 0.8 0.6 1.4 2.1 1.7 3.2 2.4 1.2 1.0 4.2 0.9 1.7 0.2 0.8 0.6 2.0 2.5 2.1 3.8 2.8 1.5 1.3 4.4 1.2 1.9 0.4 0.8 0.7 0.3 1.3 0.5 1.7 0.8 0.4 0.3 2.1 0.5 1.7 0.1 0.5 0.1 0.3 0.9 0.8 1.6 1.0 0.3 0.2 1.1 0.3 0.7 0.0 0.5 0.4 0.7 0.7 1.3 1.0 0.4 0.2 0.8 0.2 0.7 0.0 0.6 1.0 1.0 1.8 1.4 0.7 0.4 1.3 0.4 0.8 0.1 0.0 Net NPL (% of total advances) FY10 FY11 FY12E FY13E
Exhibit 35: implying provisions to start rising as well during the same period
Loan loss provisions as % of advances: FY10-FY13E
Loan loss provisions as % of Advances FY10 FY11 FY12E FY13E Public banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private Banks Axis Bank HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC HF Shriram Transport Finance 0.61 1.06 0.56 0.83 0.60 1.37 1.56 2.42 0.83 2.26 0.57 0.06 0.43 (0.07) 2.29 0.56 0.49 0.97 1.29 0.85 0.77 0.90 1.06 0.70 0.34 0.27 0.03 0.38 0.49 1.51 0.51 0.51 0.89 0.86 0.65 0.45 1.00 0.67 0.64 0.41 0.17 0.05 0.44 0.13 2.06 0.55 0.67 1.00 0.90 0.77 0.78 1.10 0.60 0.90 0.70 0.36 0.06 0.42 0.10 2.50
16
July 27, 2011
Valuations not too high, not too low, do not expect a significant decline/appreciation
While macro issues still remain a concern and are yet to be reflected in the performance of banks, we believe valuations are not too high, hovering above historical averages. Given that we expect weaker earnings performance, we believe the stocks are unlikely to rerate significantly, but they may not decline significantly either, given that they are below peak levels. In such a scenario, we expect stock prices to move in a narrow range till we see rates stabilize and fall. We prefer being selective and prefer stocks that carry higher probability of meeting our earnings estimates i.e., have lower risk to earnings, and whose valuations are reasonable vs. growth and ROE. We revise our 12-m TPs by 2%-5% as we roll forward our target BVPS to June-2012 for the stocks under our coverage that are yet to report 1QFY12 results (BOB/PNB/SBI/ICICIB/IDFC/ Power Finance/Shriram Transport).
Exhibit 36: PSU banks have corrected sharply but still trade just below 1SD
PSU Banks 12-m fwd P/B (X)
1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 0.90 PSU Average +1 SD -1 SD +2 SD
Exhibit 37: while correction in private banks has been less steep and they are currently trading at 1SD
Private Banks 12-m fwd P/B (X)
4.5 4.0 3.8 3.5
1.13
Private
Average
+1SD
-1SD
+2 SD
Average P/B (Jan-03 to Mar-07) 0.7X Average P/B (Apr-07 to Current) 1.1X
3.0 2.5 2.0 1.5 1.0 0.5 0.0
2.9 2.5
Source: Company data, Bloomberg, Goldman Sachs Research estimates.
17
July 27, 2011
Exhibit 38: MSCI India valuation including financials is above average

MSCI India: 12-m forward PE(x), average and 1SD
(X) 25
MSCI India
Forward P/E Average +1 SD -1 SD
Exhibit 39: whereas below average excluding financials

MSCI India excl financials: 12-m forward PE(x), average and 1SD
P/E (x)
22
MSCI Excl financials
Average
+1 SD
-1 SD
20
20
18
15 14.34 10
16
14
14.1
12
10
May-10
Nov-10
May-04
May-05
May-06
May-07
May-08
May-09
Jul-00
Jul-01
Jul-10
Jul-98
Jul-99
Jul-02
Jul-03
Jul-04
Jul-05
Jul-06
Jul-07
Jul-08
Source: FactSet, I/B/E/S, MSCI, Goldman Sachs Global ECS Research.
Jul-09
Jul-11
Source: FactSet, I/B/E/S, MSCI, Goldman Sachs Global ECS Research.
Exhibit 40: Current valuations are below the historical peak valuations of January 2008
Summary of valuations: Current vs. market peak (January 2008) and subsequent low (March 2009)
Current valuation on GSe 12m fw PE 12m fw PB (x) (x) 7.45 7.13 6.79 10.95 6.23 12.88 22.80 17.61 16.50 33.47 11.17 23.83 12.69 8.66 8.24 10.88 14.34 1.43 1.13 1.44 1.95 1.15 2.34 3.84 1.97 2.71 4.32 2.28 5.04 1.60 1.91 1.22 2.40 2.46 Market peak Valuation on 8-Jan-2008 12m fw PE 12m fw PB (x) (x) 9.83 7.86 8.64 17.43 7.03 27.03 35.08 35.21 41.02 63.21 31.85 36.67 38.18 6.90 19.33 16.52 23.33 1.48 1.89 1.70 2.80 1.82 4.10 5.07 3.11 2.87 9.11 5.34 7.01 5.27 1.54 2.87 3.91 4.91 Market low Valuation on 9-Mar-2009 12m fw PE 12m fw PB (x) (x) 2.24 5.16 2.50 6.21 2.87 4.36 11.93 7.29 3.49 14.42 2.72 12.95 5.92 2.59 6.33 4.54 10.63 0.49 0.75 0.60 0.87 0.68 0.73 1.75 0.57 0.55 0.90 0.42 2.40 0.89 0.51 1.13 1.04 1.83 Current vs Peak 12m fw PE -24% -9% -21% -37% -11% -52% -35% -50% -60% -47% -65% -35% -67% 26% -57% -34% -39% 12m fw PB -3% -40% -16% -30% -37% -43% -24% -37% -5% -53% -57% -28% -70% 24% -57% -39% -50% Current vs Low 12m fw PE 233% 38% 172% 76% 117% 195% 91% 141% 372% 132% 311% 84% 114% 234% 30% 140% 35% 12m fw PB 190% 51% 140% 124% 69% 223% 119% 246% 397% 381% 438% 110% 79% 272% 8% 131% 34%
Price (Rs.) Public Banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private Banks Axis Bank HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC Housing Finance Power Finance Shriram Transport Finance Sensex 900 389 1,165 2,442 304 1,320 498 1,041 269 466 319 694 135 215 202 678
18
May-11
Nov-03
Nov-04
Nov-05
Nov-06
Nov-07
Nov-08
Nov-09
July 27, 2011
Exhibit 41: HDFC Bank and Kotak Mahindra Bank are currently trading at a premium to average valuations and we have a Sell rating on both
Current valuations vs. historical ranges
Current valuation on GSe 12m fw PE 12m fw PB (x) (x) 7.45 7.13 6.79 10.95 6.23 12.88 22.80 17.61 16.50 33.47 11.17 23.83 12.69 8.66 8.24 10.88 1.43 1.13 1.44 1.95 1.15 2.34 3.84 1.97 2.71 4.32 2.28 5.04 1.60 1.91 1.22 2.40 Valuations (median) FY03-07, FY10-June11 12m fw PE 12m fw PB (x) (x) 6.72 6.49 6.98 9.68 5.70 13.07 20.28 15.76 16.42 13.78 17.67 19.87 16.09 7.89 10.66 7.67 1.17 1.10 1.40 1.55 1.20 2.26 3.24 1.78 1.82 2.18 2.58 4.47 2.32 1.55 1.59 1.70 Current vs Median 12m fw PE 11% 10% -3% 13% 9% -1% 12% 12% 0% 143% -37% 20% -21% 10% -23% 42% 12m fw PB 22% 3% 3% 26% -5% 4% 19% 11% 49% 98% -12% 13% -31% 23% -23% 41%
Price (Rs.) Public Banks Bank of Baroda Bank of India Punjab National Bank State Bank of India Union Bank Private Banks Axis Bank HDFC Bank ICICI Bank IndusInd Bank Kotak Mahindra Bank Yes Bank NBFCs HDFC IDFC LIC Housing Finance Power Finance Shriram Transport Finance 900 389 1,165 2,442 304 1,320 498 1,041 269 466 319 694 135 215 202 678
Exhibit 42: Target price changes

12-m Target price Price Up/downside Rating (July 26) Old New Chg (%) potential (%) Buy Buy Neutral Buy 900 1165 2442 1041 135 202 678 1070 1350 2650 1235 145 210 680 1110 1410 2760 1255 150 220 710 3.7 4.4 4.2 1.6 3.4 4.8 4.4 23% 21% 13% 21% 11% 9% 5%
Rs. Public Banks BOB PNB SBI Private Banks ICICI Bank NBFCs IDFC PFC Shriram
Ticker BOB.BO PNBK.BO SBI.BO ICBK.BO
IDFC.BO Neutral PWFC.BO Neutral SRTR.BO Neutral
For important disclosures, please go to http://www.gs.com/research/hedge.html. Source: Datastream, Goldman Sachs Research estimates.
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July 27, 2011
NBFCs vs. banks: Which will see a turnaround first?

In a rising rate environment situation, we expect bulk borrowers to get impacted the most in terms of spreads/margins and performance, and also likely to turn around before retail borrowers as rates stabilize and fall. However, we believe bulk and retail borrowers are unlikely to turn around in the next two to three quarters till the full impact of cost increase is reflected. Given the current high valuations of HDFC (considered as a defensive stock), and sector-specific issues hurting IDFC (power exposure) and Shriram (RBI tightening norm, structural increase in cost), we prefer Yes Bank, IndusInd Bank among banks that have higher wholesale funding.
Exhibit 43: Wholesale borrowers are more impacted as rates rise

Change in 6M CP/CD rates, change in company spreads
Cumulative change (%) Q3FY08Q3FY09Q3FY10Q2FY09 Q2FY10 Q1FY12E 3.75 -8.05 5.53 4.46 -7.41 4.29 Q4FY09Q1FY11Q3FY08Q3FY09 Q4FY10 Q1FY12E (1.37) (0.43) (0.54) (0.57) 0.52 (0.22) (0.72) (1.84) (0.06) 0.15 (0.44) 0.03 (0.20) 0.33 (0.39)
Exhibit 44: which is reflected in their stock prices

Change in 6M CP/CD rates, change in stock prices
Change (%) 6 month CD rate 6 month CP rate Change in spreads (%)
Change (%) 6 month CD rate 6 month CP rate Stock price performance (%)
Cumulative change (%) Q3FY08Q3FY09Q3FY10Q2FY09 Q2FY10 Q1FY12 3.75 -8.05 5.53 4.46 -7.41 4.29 Q3FY09Q3FY10Q3FY08Q2FY09 Q2FY10 Q1FY12 (3.6) (35.3) (15.8) (11.3) (20.3) 2.7 (15.8) 0.9 (0.1) (19.8) 0.9 (1.6) (15.7) (25.6) (24.6)
Wholesale borrowers HDFC (0.65) 1.33 IDFC 0.53 (0.05) LIC Housing Finance (0.15) 0.37 Yes Bank (0.12) 0.95 Wholesale borrowers offset by pricing power/ higher CASA Shriram Transport Finance (0.61) 3.79 IndusInd Bank 0.16 1.66 Axis Bank (0.09) 0.73 Kotak Mahindra Bank 0.50 0.17 Retail borrowers Bank of Baroda 0.35 (0.31) Bank of India 0.67 (0.86) HDFC Bank 0.28 0.08 ICICI Bank 0.32 0.27 Punjab National Bank 0.37 (0.03) State Bank of India 0.51 (0.73) Union Bank 0.62 (0.11)
Wholesale borrowers HDFC 9.9 31.4 IDFC 3.5 38.6 LIC Housing Finance 222.1 86.2 Yes Bank (0.9) 71.5 Wholesale borrowers offset by pricing power/ higher CASA Shriram Transport Finance 94.8 102.8 IndusInd Bank 54.2 130.0 Axis Bank 28.4 56.0 Kotak Mahindra Bank (15.8) 22.6 Retail borrowers Bank of Baroda 47.7 80.9 Bank of India 48.8 25.4 HDFC Bank 14.1 51.1 ICICI Bank (14.9) 22.7 Punjab National Bank 46.6 62.4 State Bank of India 19.3 47.3 Union Bank 46.9 61.9
Source: Datastream.
20
July 27, 2011
High ownership has not reduced through the cycle

Despite high inflation and interest rates, ownership in the banks and financials sector has remained high as can be seen from FII holdings, share of banking stocks in top 200 companies, and banks holding as per MSCI. This poses two types of risks, (1) Incremental buying in the sector may be limited given likely earnings pressures, and (2) possibility that investors sell in case operating performance of companies is worst than expected.
Exhibit 45: FII ownership in NBFCs, and smaller private banks is higher than in the past
FII share holding during market peak (Jan 08), Low (Mar 09) and Current (Mar-11/June-11)
80%
PSU Banks Private Banks NBFCs
Exhibit 46: DII have increased stake in ICICI Bank, INBK but reduced in IDFC, and LICHF
DII share holding during market peak (Jan 08), Low (Mar 09) and Current (Mar-11/June-11)
60%
Private Banks NBFCs
70 70% 65 62 60% 49 49 48 58 40% 47 38 30 26 26 20 16 16 15 20 19 20 14 20 14 13 10% 5 0%

BOB BOI PNB SBI Union Bank Axis HDFC Bank ICICI Bank IndusInd Kotak Yes HDFC IDFC LIC HF Shriram BOB
PSU Banks
51 50%
50%
47 37
47
37
40%
40 30
41 30% 25 28 25
29
30%
27 20% 18 16 12 17 17 12 17 12 13 8 5 2 7 11 8 5 5 17 12
19
20%
8 5 3
10%
0%
BOI
PNB
SBI
Union Bank
Axis
HDFC Bank
ICICI Bank
IndusInd Kotak
Yes
HDFC
IDFC
LIC HF Shriram
Market Peak (Jan '08)
Market Low (Mar '09)
Current
Market Peak (Jan '08)
Market Low (Mar '09)
Current
Source: Capitaline, BSE.
Source: Capitaline, BSE.
Exhibit 47: While inflation and interest rates have been moving higher, financial stocks weightage has remained high and close to peak levels
Share of banking and financial stocks in top 200 stocks
14% 12.7 12% 12.5
Exhibit 48: as confirmed by the weightage of financial stocks in MSCI India, which is currently at a peak
Weightage of banks, and NBFCs in MSCI India
25.0% 23.30
20.0%
10% 10.5
8%
15.0%
6% 4.41 4%
10.0%
2%
5.0%
3.41
0%
0.0%
Jul-97
Jul-99
Jul-03
Jul-05
Jul-07
Mar-96
Mar-98
Mar-02
Mar-04
Mar-06
Mar-08
Jul-09
Nov-96
Nov-98
Nov-00
Nov-02
Nov-04
Nov-06
Nov-08
Mar-00
Banks
Finance
Banks
NBFCs
Source: Capitaline.
Source: Factset,MSCI, GS Global ECS Research.
Nov-10
Jul-01
Mar-10
21
July 27, 2011
Exhibit 49: Mutual funds have increased their stake in financial stocks
Sectoral deployment of funds by mutual funds
18% 17.31% 4.5% 17% 3.99% 16% 3.5% 4.0% 5.0%
15%
3.0%
2.5% 14% 2.0% 13% 1.5%
12% Sep-09 Dec-09 Mar-10 Jun-10 Banks

Source: SEBI.
1.0% Sep-10 Finance (RHS) Dec-10 Mar-11 Jun-11
22
July 27, 2011
Reg AC
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23
July 27, 2011
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