As interest rates rise, firms salt away NCD plans

The net interest margin (NIM) of banks is set to fall on a sequential basis in the third quarter of FY11.

NIM is a measure of the difference between the interest income generated by banks and the amount of interest paid out to their lenders, relative to the amount of their assets.

According to analysts, the banking sector will now have concerns on sustaining NIMs.

The signs are already evident before the Q3FY11 result announcements.

The Bombay Stock Exchange (BSE) banking index Bankex plunged 12% in the last three months and during the same period banking funds emerging as the worst performers among all funds categories with negative returns.

In the three months ending January 7, 2011, the category average showed a negative return of 13.59%, according to Delhi-based mutual funds tracker Value Research Online.

“We believe the NIM expansion theme that played out through the first half of FY11 is no longer true, as deposits are getting repriced at much higher levels. While the tight liquidity position for most of Q3FY11 warranted some hike in deposit rates, the asymmetry in rate hike between deposits and loans is a likely indicator that loan growth is shallow and yet to be sufficiently broad-based,” said Nilanjan Karfa, Murali Gopal, Ratna Sinroja and Divya Choudhary of BRICS Securities in a report released Friday.

The report also points out that over the last quarter, banks had raised their deposit rates by 100 to 125 basis points (bps) on average, while corresponding base rate/prime lending rate has gone up by only 50 bps.

Cumulatively, FY11 saw on average deposit rates moving up by 200 bps as compared to hikes in PLR and base rate of 100 to 125 bps and 75 to 100 bps respectively.

The outlook for NIMs is gloomy. According to Vaibhav Agrawal, vice president (research), Angel Broking, over the next six quarters, NIMs will compress by 40 to 60 bps for smaller banks with current account and saving account (CASA) ratio less than 30% and for bigger banks the compression will be in the range of 10 to 20 bps.

Chaitra Bhat, banking analyst with LKP Securities feels that Q4FY11 will not be all that rosy for bank stocks as the sector is exposed to various challenges. While others feel the challenges to this sector would continue in the entire first half of 2011.

“We believe operating environment is likely to be challenging for banks, at least through first half of 2011, resulting in little earnings visibility. Banking environment has become incrementally tougher with asymmetric rise in interest rates, liquidity scarcity, high inflation, micro-finance institutions exposure, non-performing assets, among other things,” said analysts from BRICS Securities in their report.

“We expect moderation in FII flows in 2011, which along with sector rotation out of bank stocks may lead to banking sector under-performing broader market in general, at least through first half of 2011,” they said.

It is advised by Karfa, Gopal, Sinroja and Choudhary that investors should stick to banks with strong retail liability franchise, greater comfort in terms of NPAs, higher NPA coverage, and relatively better earnings stability and visibility.