STATE Bank of India (SBI)

STATE Bank of India (SBI) managed to beat analyst’s estimates by a huge margin during the fourth quarter, despite unfavourable economic environment prevailing during the period. However, India’s largest bank is grappling with several issues. SBI’s strategies in last six months provide some insights into the future of the company.
PERFORMANCE:

SBI reported a 46% year-on-year growth in net profit for the March’09 quarter. But, the growth was not triggered by a growth in net interest income (NII), as in the case of the first three quarters of the fiscal. Till December’08 quarter, the growth in NII closely tracked the growth in net profit. However, the same wasn’t the case in March’09 quarter. While, the net profit grew by a handsome 46%, the NII remained flat. NII is the difference between the interest earned and interest paid, and forms the core of a bank’s operations. In the absence of a growth in NII, other income helped the bank boost its bottom line.

The bank’s other income grew by 68% during the period and its core fee income grew by 34%. Higher profits from sale of investments was the reason behind the record growth in other income. Profit from investments amounted to Rs 1,519 crore in the March’09 quarter, compared with just Rs 296 crore a year ago. The bank’s treasury also put up a stellar show, still income from this route depends on the vagaries of asset markets. The treasury income do not follow any trend other than that of the market. As a result, the income from this route is not sustainable. The point here is that the growth in profits is more on account on non-recurring income than from core banking operations.

This is not the only reason for concern. The bank offered attractive rates on deposits in the December’08 quarter, resulting in a 36% growth in deposits during the period. The trend continued into the March’09 quarter, with deposits growing at 38%. Simultaneously, the bank also stepped up lending. Its loan book grew by 30% in March’09. Though the bank managed to beat industry growth in credit offtake, its deposit mobilization was so high that its credit deposit ratio (advances divided by deposits) fell to 66.6% in March’09 from 72.6% a year ago. The challenge for the bank is to maintain high growth in advances and moderate the deposits growth.

Meanwhile, the bank tried to raise its market share in home loans and auto loans by offering attractive rates. This brought some success as its portfolio of auto loans and home loans increased by 36% and 21% in the fourth quarter. However, auto loans and home loans combined formed just over 10% of its loan book at March’09-end. Corporate and international trade loans continued to be the key growth drivers. The bank performed really well as its international loan book grew by a stupendous 54% and its corporate book jumped by 31% in March 2009. The bank is taking steps to reduce cost of funds. Last Wednesday, the bank cut deposit rates by 50 basis points for various maturities. The bank stepped up deposit mobilization by current account and savings account (CASA) route in March and put a brake on term deposits. The CASA deposits attract much lower interest rates, as they offer high liquidity than term deposits. While, term deposits grew by a mere 2.8%, the CASA deposits swelled by 15.2% in the March’09 quarter, compared with the previous one.

Though, the earnings growth was higher in the March’09 quarter, there were many issues pending. The bank did not want to sacrifice on loan growth, which made it attract deposit at higher rates than other banks. It realized that the net result of high lending and borrowing might not be favorable in short-term. At the same time, it made its treasury function more efficiently and core fee income also grew. As soon as Reserve Bank of India took steps to ease rates, the bank mobilized more deposits through CASA route and later cut deposit rates to control rising cost of funds. SBI being the largest bank in India has surely shown the way to other state-run banks to grow even in turbulent times.

VALUATION:

The bank is trading at a price to earnings multiple of 9 times. Clearly, the valuation doesn’t match the bank’s earnings growth of 35.5% in FY09. Typically, banking stocks trade at a discount to their earnings growth, but in case of SBI, the gap is too wide. So, we advise investors to invest in the stock for long-term gains.