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Fund Focus: Reliance Banking Fund - Banking on more gains December 15, 2009
Mr. Sunil Singhania, Senior Fund Manager - Equities at Reliance Mutual Fund shares his outlook on the banking sector in this fund focus interview.
Author : Dhanashri Rane


Untitled Document

2009 has been a year of recovery. The equity markets have rebounded to 17000 points with a spur in Initial Public Offers, private placements and also, there has been a revival of inflows into mutual funds. Since last year, the central bank, Reserve Bank of India (RBI) has adopted a policy of easing interest rates and has infused ample liquidity into the system. Moreover, a healthy and well-regulated banking system has equally contributed to the growth in the economy. Further, in order to avoid the concentration of risk, RBI has recently taken measures such as an increase in provisioning for loans given to the commercial real estate sector and has increased the Non-Performing Loans (NPL) coverage to 70% of gross NPLs by September 2010 from the current 60%.

Despite this, Moody’s, the international rating agency, has expressed concern over rising NPLs and has maintained a negative outlook on the Indian banking system. NPLs have gone up to 22.5% in Financial Year (FY) 2009 over last year’s 11.9%.

Standard and Poor’s, another international rating agency, recently commented that, "Naturally, the banks' reported profitability would be suppressed in FY 2010 (ending March 2010) and FY 2011 as the banks set aside profits to comply with the higher provision levels”. In the second quarter, most of the banks in the mid-cap segment have reported moderate growth earnings owing to limited gains from treasury and poor credit off-take. The demand for credit has been sluggish, especially the growth in credit card and consumer durables has been negative in the first half of 2009 (source: Reserve Bank of India).

We speak to Mr. Sunil Singhania to get his perspective on the banking sector.

Key Points from the interview –

  • Overweight on Public sector Banks
  • Credit growth to be around 14-15% for FY 2009-10
  • Rise in inflation is the biggest threat to banking sector
  • Higher provisioning is public knowledge and may not have much impact
  • Net Interest Margins to improve from the third quarter onwards
  • Reliance Banking Fund – Focus on alpha and consistency in fund management

iFAST: BANKEX, the BSE Index reflecting the banking sector zoomed up by a whopping 197% since March 2009. What is your outlook on the valuation of public and private sector banks? Are banks within the mid-cap space better valued than the large-cap banks and why?

Sunil Singhania (SS): We remain positive on the Indian banking sector and feel it is a good multi-year theme that has the potential to give good double-digit returns and be a market out-performer. The RBI’s able leadership ensured that the Indian banking sector remained almost untouched by the huge financial crisis in 2008 and 2009. In fact, the Indian banking sector has emerged globally as one of the most resilient and well-governed with the best asset quality and return ratios.

Within the banking space, we are presently more positive on the public sector space. The reasons are manifold but simple:

  1. The public sector banks (PSBs) have transformed themselves significantly over the last few years and can now compete with the private sector in terms of product offerings and technology

  2. PSBs have shown that they have better credit risk systems than before; a fact borne out of the very low Gross and Net Non-Performing Assets which are comparable to any private sector bank

  3. The Return on Equity (ROE) for most of the PSBs is comparable or even higher than the most highly valued private sector banks. With ROEs of 18% and above, most PSBs trade at just over 1X price-to-book value, compared to 2-4X for private banks. In fact, the PSBs come across as one of the cheapest sectors in India with a stable profit growth scenario

  4. After losing market share to the private sector banks, the PSBs have over the last two years regained market share both in terms of deposits and advances

iFAST: What are the key drivers and the risks faced by banking stocks? How does your fund management team track them?

SS: The biggest risk to the banking sector in India at present is the possibility of a surge in inflation numbers. We expect this will lead to a rise in the yields of Government securities and interest rates. That could affect the profitability of banks.

In the medium term, the increase in provisioning cover proposed by the RBI may also impact a few banks. However, we feel that most of this is public knowledge and might not impact as much, unless the numbers really come out very negative.

At Reliance Mutual Fund, we have a very large research team. We also have a three-member economic research team that specifically analyses economic data, which is very crucial for the financial sector. We as a fund house are also the largest on fixed income side, managing nearly US$17bn of fixed income assets. On the equity side, we continuously interact with our well-qualified debt team and take their inputs on the emerging interest rate scenario as well.

iFAST: Is there in difference in evaluating the earnings reported by banks/financial companies as compared to non-financial companies?

SS: There is a big difference.

The most important factors for banks or financial companies are:

  • Net Interest Margin (NIMs) [the average difference in the borrowing and lending rates of banks,  a positive and good margin indicates better income for banks]

  • Spread  [ the difference between banks’ cost of raising funds i.e., interest given to depositors and the rate charged to borrowers]

  • Fee-based income

  • Credit growth [demand for loans]

  • Cost income ratio [measures efficiency, lower value is better]

  • ROEs.

Though some of these ratios are also applicable to non-financial companies, the parameters are very different.

iFAST: The credit off-take in the first half of 2009 has shown a poor trend over last year. Will the sluggish credit growth impact the profitability numbers of the banking sector? How?

SS: The credit growth has been lacklustre in the first half of FY 2009-10 as the economy came out of the extreme pessimism led by the global financial crisis. Our view is that the credit should pick up in the second half of the year, but it will be lower than 18% growth as guided by RBI. We expect full-year credit growth to be 14-15%, which should be good in the (given) circumstances. However, the profitability should be better as NIMs should improve from the third quarter onwards as high cost deposits start getting re-priced downwards.

iFAST: Reliance Banking Fund is the best performing Banking and Financial Services fund on our platform from 1 July 2004 to 30 June 2009. What has contributed to the fund’s performance?

SS: We have been focusing on generating alpha (excess returns of fund against the benchmark) right from the inception. Our philosophy of focusing on risk-adjusted returns on a consistent basis has also borne fruit.

Having a consistent portfolio manager (same since last 5 years) and a large and qualified research team has also helped. While keeping an eye on the benchmark constituents, we have consistently taken stock bets where we had fundamental belief rather than just have an allocation view based on the weightage in the index.

Volatility Measure of Reliance Banking Fund

Portfolio Turnover Ratio Sharpe Ratio Standard Deviation Beta

0.45

0.1115

5.3723

0.955

Source: Factsheet, 30 November 2009

iFAST: Moody’s has recently downgraded the supported ratings of 13 commercial banks. Does similar downgrades in the ratings assigned to banks by international agencies impact the way you manage your funds?

SS: The Moody’s downgrade was a result of their small downgrade of the country. Indian banks were amongst the very few banks globally that attracted record deposits at the height of the financial crisis when many global banks were seeing a run on their deposits. We believe that is the best rating a bank could have, which is the trust of its depositors.


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


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