Banking with the best

It has not been the best of times for the Indian banking sector. News on the international front, led by the subprime crisis as well as the recent revelations of losses in the derivatives market, have frightened investors. As a result, banking stocks have been badly hit over the last three months. While the BSE Bankex outperformed the Sensex last year with returns of 31.8 per cent compared to 25 per cent returned by the bellwether index, it has underperformed the frontline index since January 1, 2008, dipping 20.6 per cent against the Sensex’s 13.3 per cent slide to date. The big question now is: can investors bank on banking stocks?

A problem too many

There is more than one issue that is rattling investors, and forex derivatives are their latest concern. For banks, derivatives have been a growing source of income. The problem occurs when some derivative calls taken on behalf of corporate clients go wrong. Some companies default on their positions and maintain that banks did not keep them apprised of the downside. But, who bears the losses? Some companies have taken the legal route and have filed lawsuits against their bankers.

Last month, State Bank of India (SBI), the country’s largest bank, announced that its clients were expected to incur losses of nearly Rs 700 crore on account of foreign derivatives contracts. ICICI Bank and Axis Bank are also affected.

However, since income from exchange transactions form a small part of the income of most banks, the losses are likely to be moderate. Punit Srivastava, Banking Analyst, Enam Securities, feels the losses incurred from forex derivatives are not such a big issue.

The subprime crisis in the US, too, has taken its toll on Indian banks. On January 31, 2008, ICICI Bank said its mark-to-market losses from exposures to the subprime crisis were $264 million (Rs 1,056 crore). Then, the news of the Rs 60,000 crore farm loan waiver announced by the Finance Minister came as a huge blow for PSU banks.

Surely, these are bad times for banking stocks, but market analysts think investors can still find some interesting opportunities.

All’s not lost

But the scenario for the banking sector is not entirely gloomy. A report by Karvy Stock Broking has noted a growth in deposits during 2007-08. “This has been mainly due to strong growth in time deposits. Total accretion in time deposits during 2007-08 was Rs 4,92,300 crore compared to Rs 4,37,800 crore in 2006-07,” it says.

The market has been extremely uncertain for a while and a lot of investors have incurred serious losses. As a result of this, as well as negative news flows from other economies, the banking index and individual stocks have plunged by over 40 per cent from their highs. “We believe that at the current levels, banking stocks are broadly underpriced,” it adds. Analysts tracking the sector say that investors have to pick their stocks. “Prices in the sector have corrected by 25-30 per cent,” says Srivastava.

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Arun Kejriwal, Director of the Mumbai-based Kris Securities, is upbeat about the sector. “If the economy has to grow, the banking sector has to take off,” he says. SBI and Bank of Maharashtra are his favourites. “SBI is owned by the government and the merger of its subsidiaries is good news. Bank of Maharashtra’s net non-performing assets are under control,” adds Kejriwal. Still, investors would be better off being a little cautious. The market has yet to react to RBI’s decision to hike the cash reserve ratio (CRR) by 0.25 per cent to 8.25 per cent. So, what should investors do?

The importance of looking for the best stocks at reasonable prices for the long term can hardly be overstated. The top picks in the Karvy report are Axis Bank, Oriental Bank of Commerce, Bank of India, Union Bank, Punjab National Bank and SBI. Banking stocks that have lost a lot of ground can also be good picks. “The current and future uncertainties of the market notwithstanding, the banking sector has to grow and, therefore, it is as good a time as any for investors to pick and choose their stocks,” says Kejriwal.

Overall, investors can look for opportunities in the banking sector. Keep an eye out for key developments, as the markets may not yet have heard the last of the derivatives losses or the impact of the subprime crisis. Investors will do well to keep this in mind before going ahead. But, by all means, do bank on them selectively.