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Suresh Krishnamurthy

SHAREHOLDERS of State Bank of India can hold on to the stock. The improving financial ratios of the bank vis-a-vis its levels of non-performing assets and operational costs indicate the scope for further improvement in profitability. This could turn out to be advantageous if the outlook for the economy improves.

However, fresh investments in the SBI stock need not be considered at current levels. The relatively low dividend yield offered by the stock compared to those of other banks means low levels of downside protection for an investor.

The dividend yield of around 2.5 per cent compares poorly with the higher yields offered by other public sector banks, even when adjusted for the far superior position that SBI is placed in terms of the ability to grow compared to other banks. Importantly, it is not easy for banks to raise the level of dividend payout even in the backdrop of sustained improvement in profit growth because of regulatory constraints.

The level of downside protection is important considering that the growth rate of the economy continues to remain uncertain. Any prolonged period of low growth with attendant implications such as an increase in NPAs can put pressure on profitability in the backdrop of declining spreads.

In this backdrop, fresh investments can be considered when the level of downside protection available is more robust. A dividend yield of between 3.5-4 per cent can be considered an attractive entry point for the stock.

Suitability: Banking sector stocks have generally exhibited significantly low levels of volatility compared to the market indices. Among bank stocks, SBI is one of the least volatile. In this backdrop, the SBI stock is suitable for inclusion even in a conservative investor's portfolio.

The personal loans segment is the thrust area for SBI.

Positive signs

SBI's earnings performance in recent quarters should stand out compared to other banks for one reason: The contribution of profit from sale of investments. In the year ended March 2002, profit from sale of investments rose by 3 per cent. In other words, the growth in profits has been powered by operational performance and not by the windfall profits generated by fall in interest rates.

SBI's profit for the year-ended March 2002 rose 32 per cent over year ended March 2001 on a comparable basis. This is lower than what was reported by other banks. However, the quality of growth was superior. In the half-year ended September 2002 too, growth in `other income' was modest; it rose 16 per cent. This is again lower than that recorded by most other banks. There were, however, signs of higher contribution from profit from the sale of investments in the quarter ended September 2002. Still, its contribution has been substantially lower vis-à-vis other banks.

This ensures that the provision for bad loans made by the bank in recent quarters is sustainable. These provisions will not seem inadequate even if there is a rise in interest rates. Net non-performing assets ratio declined from around 6.03 per cent at end-March 2001 to 5.19 per cent at end-September 2002. The ratio does not look attractive even now. But it is not scary either.

Another encouraging aspect of SBI's performance was the fall in the incidence of operating expenses. In the half-year ended September 2002, net interest income rose 8.6 per cent. In contrast, operating expenses rose only by 3.4 per cent. Given that spreads are under pressure and will be under more pressure going forward, reducing the incidence of costs is essential to enable growth in profits. The lower growth in operating expenses is therefore encouraging.

In addition, the strategy of not booking profits on government securities and holding them till maturity will help in future periods. Since yield on investments will not decline, it will help SBI deal with pressure on spreads in a much better manner compared to other banks.

Mixed outlook

These factors should normally lead to a bullish outlook for the stock. In fact, over a fairly longer term, it does appear to be so for the banking sector behemoth — SBI. However, the roadblocks in the economy could still create problems for the bank in the near-to-medium term.

A downturn in the economy could scuttle any gains from the improvement in profitability in recent quarters. Importantly, emergence of fresh non-performing assets has continued in this fiscal too. If spreads continue to decline further because of easy liquidity situation and fresh non-performing assets rise, it could undo most of the gains in the last few quarters.

Incidentally, SBI has been fairly aggressive in its lending operations this fiscal. The market share in advances for SBI only increased this fiscal especially because of the surge in personal loans segment. This can turn out to be negative if the overall economic environment takes a turn for the worse. As of now, the signals on the economic front have been mixed giving no room for optimism.

The signals can be considered as having turned positive only when the gross non-performing assets of SBI are contained in absolute terms and do not grow. This may happen in the next six months. Till such time, however, investors need to exercise caution.

The stock now trades at a premium to the book value adjusted for net non-performing assets. There are a few banks such as Corporation Bank that are trading at a discount to their book value adjusted for net non-performing assets.

The premium may be justified, considering the premier position of SBI. In addition, the book value does not include the value of its subsidiaries.

If the value of its investments in subsidiaries and other ventures is considered, the premium will vanish. These, however, could be reasons to bid up the stock when the NPAs of SBI stop rising, for which improvement in the economy appears a must.

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