Indian Banks' Outlook Is Bright As Borrowing Binge Continues
Wall Street Journal, April 27, 2006

By ERIC BELLMAN

MUMBAI, India -- Indian bank shares could climb higher as demand for new loans continues to grow on the back of a robust economy, despite rising interest rates.

HDFC Bank Ltd. and UTI Bank Ltd. last week announced strong earnings for the January-March quarter, indicating demand for consumer and corporate loans remains strong even as the Reserve Bank of India has raised lending rates and tightened policies on property sector credits.

"The credit growth of banks was still above 30% [in the fiscal year ended March 31] and we expect the credit growth to be 25% to 28%," in the current year, says Kanan Shah, a senior analyst at Networth Stock Broking in Mumbai. "If this growth continues, then the [bank] stocks would outperform" the overall market.

With India's economy expanding 8% in the year ended March 31 and economists expecting 8% growth again this fiscal year, consumers are taking out a record number of mortgages and personal loans while companies are borrowing more to expand capacity. Meanwhile, local governments are borrowing to build roads, power plants and ports.

The borrowing binge illustrates the high level of business confidence in India, which boasts one of the world's highest growth rates as well as one of the best performing stock markets. The benchmark 30-share Bombay Stock Exchange Sensitive Index, or Sensex, has surged more than 75% in the past 12 months.

India's central bank has raised its key short-term interest rate several times in the past year, which has forced banks to lift their deposit and lending rates. Mortgage rates, for example, have risen to more than 10% from about 8% a year ago.

At its quarterly meeting last week, the central bank didn't lift rates, but it increased the amount of money banks have to put aside for potential defaults on mortgages and other property loans. This is intended to trim banks' exposure to the volatile property market. Analysts and investors expect the tighter restrictions to spawn higher lending rates.

But while higher rates may eventually slow consumer borrowing, any decrease in loan growth will be offset by fresh demand for corporate and infrastructure loans, some banking analysts predict.

Some of India's lumbering state-run banks, which still dominate the industry, may see their margins and loan portfolios squeezed by higher rates and business shifts. But nimble nongovernment banks are expected to continue to rack up annual profit growth above 20% over the next three years, the analysts forecast.

HDFC Bank, which is listed on the New York Stock Exchange and is India's third-largest bank in terms of market capitalization, last week said its net profit rose 30% to 2.63 billion rupees ($58.6 million) in the quarter ended March 31. Mumbai-listed UTI Bank also announced a 30% rise in quarterly net profit, to 1.52 billion rupees. New York-listed Icici Bank, India's second-largest bank in terms of market capitalization, is expected Saturday to announce double-digit growth for the quarter. State Bank of India, the largest bank, is expected to report that profit was little changed during the quarter.

Yesterday, shares of HDFC Bank rose 1.3% to 836.35 rupees ($18.63), or 18% above where they ended 2005. UTI stock is up 25% so far in 2006. Yesterday, it jumped 3.1% to close at 357.45 rupees. Shares of Icici Bank closed at 567.15 yesterday, down 3% this year.

Banking shares have underperformed the market in the past 12 months, with State Bank of India, HDFC Bank, Icici Bank and UTI Bank all rising between 40% and 50%, well below the Sensex's rally.

The share prices for all three of these banks could climb more than 20% over the next 12 months, some analysts say. "The sector will outperform in the long term," predicts Ms. Shah, whose favorite bank shares include Punjab National Bank, UTI Bank and Federal Bank.

Ms. Shah says UTI's stock price could rise more than 30% in the next 12 months to 466 rupees, while Punjab National Bank could climb more than 40% to 638 rupees. Federal Bank's stock price could rise 15% to 240 rupees, she says.

To be sure, a jump in inflation at home or a higher-than-expected rise in U.S. rates could prompt a sharper rise in interest rates in India, which would likely blunt a rally in Indian bank shares.

Analysts also warn that some of the strongest Indian banks -- such as Icici Bank and HDFC Bank -- are already looking expensive, with their shares trading at more than three times the book value of their assets.

The average price-to-book ratio in Asia is closer to 2.5 times, says Hugh Young, managing director of Aberdeen Asset Management Asia in Singapore. "We are impressed with the professionalism in the [Indian banking] sector but we are worried things are getting a little overheated," he says.

While Aberdeen hasn't been aggressively selling Indian stocks, it has allowed India holdings to slip to 13% of its total portfolio from 15% last year when it invested fresh capital for its Asia funds.

Still, many analysts say investing in strong Indian banks is a good way to seeks gains from India's growth.

"You get a good taste of the whole economy" by investing in banks, says Andrew Holland, head of the strategic risk group of DSP Merrill Lynch in Mumbai. "You are capturing all the growth areas whether it is investment in real estate or [capital expenditures] or credit-card growth."