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August 26, 1997


Newer banks have a better chance of surviving

Some months ago, I picked the banking industry as one that would gradually outperform the broad market. It is five months since that column, and I am now beginning to be proven right. The Bank of India stock has appreciated from its initial public offering level of Rs 45 to Rs 62 recently, the Bank of Baroda counter has surprised many an analyst by moving from Rs 85 to Rs 170, while HDFC Bank has simply taken one's breath away: the company posted an earning per share of Rs 2.0 for 1996-97 and the stock touched a 52-week high of Rs 76, resulting in a p/e of 38. Encouraged by this success on the secondary market, ICICI Bank dared to issue stock to investors at a retrospective p/e of above 30 which would have been unthinkable for a number of merchant bankers midwifing the issue a few months ago.

My faith in the banking industry comes from some plain conclusions. One, the government has turned on a few selective knobs within the economy which should turn the broad industrial indices around a few months from now. Once this happens, the growth in banking will happen automatically. Two, the credit reserve ratio cuts over the last year-and-a-half have been perhaps the biggest in the modern history of Indian banking, leaving a much bigger float with banks with which to expand their business. Three, with interest rates coming down, there is an appreciation in the value of the bonds held in the statutory liquidity ratio portfolios of some of these banks.

Besides, the losses of the past -- in a rising interest rate scenario -- which necessitated higher provisions to be made, will now be replaced by gains from bonds when these are sold in the market. As a result, the depressed bottomlines of the past could rebound strongly over the coming years.

Four, historically bank deposits as a percentage of the GDP was 73 per cent in Thailand and 78 per cent in Malaysia in the early nineties; in 1996, my estimate is that the figure in India was around 43 per cent only. Even at today's levels, there is a lot of catching up to do. Five, if the Indian GDP grows at 6.5 per cent over the next five years and attracts foreign direct investment of around $ 50 billion, the growth in the banking sector could be to the extent of Rs 5,000 billion -- more than what the power or telecom industries are going to see. My argument is that the stock markets in the country have not discounted this into the current pricing of the industry. When it wakes up to the dynamite of potential within, the discounting graph will strengthen in a hurry.

The rise in the level of the water will, however, not raise all ships. The archaic banks functioning just the way they did in the sixties will stay put; the quicker ones will grow at their expense. The quicker ones are going to be those with a low salaries bill, those with a strong computerised network, those who are going to be quick in their response time to customers, those who are going to provide increasing value to their clients, those who are going to provide services and solutions that banks did not offer before, those who go to where the customers are instead of the other way around and those who treat their walk-in clients like their benefactors instead of treating them like insects standing in a queue.

The newer banks in the private sector stand a better chance in adapting to the increased demands. This is becoming increasingly evident in the way the banking industry is growing: There are 65,000 public sector branches in the country compared with 160 new private sector branches. The latter holds a three per cent market share. That is not the important number. The compelling statistic is that of the incremental market, the new private sector branches have a market share of 14 per cent.

Anyone intending to take a position on India's banking industry needs to look only this far. With the private sector banks, one has few options. IndusInd and UTI Bank are unlisted. HDFC Bank is one which is quoted at a p/e which is in line with the p/e enjoyed by respectable banks the world over, reflecting solidity, credibility and growth. You can look at ICICI Bank if you are sure that it will not be merged into ICICI and if there substantial growth coming up in the next two years which can justify this fancy discounting.

That, after a process of elimination, leaves us with Global Trust Bank. There are a number of things that I like about GTB:
* It quotes at a low p/e ratio. In a regulated banking industry, I see no reason why one bank should quote at a p/e in excess of 30 and the other around six, even as they belong to the same segment.
* The bank has been promoted by the man who has, in a sense, 'created' the aura and image of banks on the capital market -- Ramesh Gelli. After turning the sleepy Vysya Bank into a rage on the stock market, Gelli left to start his own bank. The image rubbed off at the time of the IPO and the issue was subscribed more than 100 times. But thereafter the fizz escaped. Despite reporting improved results for 1996-97, the stock stayed put.
* The balance sheet is conservative. The company has made provisions to the extent of Rs 460 million 1996-97. Half the provisions have been made to the extent of 100 per cent of the NPAs. Had this been done only to the mandatory extent, GTB would have reported a pre-tax profit of nearly Rs 800 million. I like GTB's guts; it made provisions and declared a lower net profit.
* Treasury operations are likely to emerge as a critical area in the banking industry especially in a falling interest rate. The basic business of banks is to buy and sell money: in the emerging scenario, banks will be able to borrow from the call money market and invest in government bonds -- for periods as low as even a day. This treasury operation is already one in which GTB has built up an expertise: the bank earned Rs 170 million in profit from this segment in 1996-97. Once the convertibility of the currency becomes a reality, this edge will reflect its fullest potential.
* It is a bank high on its service credo. The internal rule at the bank is that a draft has to be made within three minutes and delivered to the customer; a customer can have a draft made at any desk within the bank, the cheque can be deposited at any desk as well. The bank also works up to 4.30 pm each day compared with the normal 2.30 pm closing time at most banks in the country.
* The flexible service and the extended hours are possible due to one factor: computerisation. GTB account holders are realising that by becoming an account holder one is no longer tied in to a specific GTB branch. If you have an account in the Opera House branch in south Bombay, you can coolly walk into the Chowringhee branch in Calcutta and withdraw money. You can deposit money in a Delhi branch and have it credited within minutes to your Bombay account. The operative words are 'within minutes'.
* This computer-friendliness has resulted in a redefinition of service at GTB. If you are an account holder who has access to a computer-modem, you are welcome to send a message to any friend or associate anywhere in the country where GTB has a branch. All you have to do is to send the message to the GTB website from where the webmaster redirects the message to destination within a day. In most cases, the bank also follows this up with a fax to the recipient. This service comes for free. And there is no limit to the number of messages than can be sent.
* GTB is perhaps the most information-transparent bank. For proof look at its annual report for the last two years. The shareholder-friendliness also reflects in the fact that dividend warrants are ready a day after the AGM to be distributed to shareholders. Besides, the bank has enlisted for dematerialisation of its shares which means that buyers of stocks can engage themselves in paperless trading.

Two reasons make GTB interesting from a stockpicker's point of view. The bank has earned around Rs 1.11 billion of profits in two-and-a-half years' working -- on an equity of Rs 1.04 billion. Not many banks -- or companies -- are capable of this at the start of their business existence. As a result, the return on average net worth has increased from 28 per cent to 32 per cent to 35.5 per cent. Dividend received for the original allottee has been Rs 3.70 per share over the period.

Deposits at GTB are expected to increase from Rs 23 billion (as on 31 March, 1997) to Rs 32 billion towards the end of the current year. I expect that the bottomline, post provisions, is likely to increase from Rs 570 million to around Rs 770 million in the current year. Earnings per share is expected to be around Rs 7.50. In 1998-99, the profits are expected to rise to Rs 1.1 million (EPS Rs 10-plus).

The play is likely to be in the discounting. HDFC Bank is priced in excess of a p/e of 30; with higher profits and a lower equity, if GTB can get a discounting of even 15, you should see the stock double from the current levels in anticipation of the bottomline for 1997-98. Thereafter, even higher.

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