Linking loans to external benchmark may delay SBI's profit revival

Profitability may take further hit on policy rate cut of 25-40 bps

The State Bank of India stock slumped over 7 per cent on concerns over asset quality and the impact on profitability after its move to link all new floating rate loans to the external benchmark, which, in its case, is the repo rate. 

After the tax cut last week, the Street had brushed aside the impact of SBI’s move to link its retail loans to repo rate.

However as the dust settles and investors assess the actual gains from last Friday’s measures, the old problem once again surfaces for banks, explaining why the SBI stock fell so sharply and most of the banking stocks were in the red.

While other banks are yet to make a similar move, analysts expect them to follow the leader to defend market share. 

Home loans account for 18 per cent of the public sector bank’s loan book. Banks usually prefer a floating rate to fixed rate on this product. 

The impact of linking home loans to repo rates could be exacting on SBI’s profitability, which was on the road to recovery from the March 2019 quarter. 

Based on the current repo rate of 5.4 per cent, the impact on SBI’s profitability is compressed to 10 basis points (bps). Home loans offered by the bank now start at 8.1 per cent. However, we are in a declining repo trajectory. 

Therefore, if the central bank announces another rate cut anywhere between 25 and 40 bps — in October or later — profitability or net interest margin (NIM) may take a huge knock. At 3 per cent in the June quarter, numbers have just about started firming up and looking better.  For analysts at Morgan Stanley who have turned ‘equal-weight’ from ‘overweight’ on the SBI stock, asset quality concerns are equally worrisome. 

While they expect credit costs (or cost of loans turning bad) to moderate by nearly 90 percentage points to 180 bps in FY20, they say they aren’t very confident of these estimates. 

“Given SBI’s size, it is among the largest lenders to many of these stressed borrowers,” Morgan Stanley points out, with respect to fresh bad loan accretion. 

The brokerage is also concerned that if SBI were asked to help any of the challenged lenders when they face distress, it could compound the asset quality pressure further.

“We view a re-rating as unlikely, unless the macro situation were to stabilise or improve,” they noted. 

Further, the lender has Rs 16,000 crore stuck in the recovery process, the receipt of which is extremely important to strengthen its books. 

With these concerns taking centre-stage, analysts feel that even if the SBI stock trades at its FY20 book value, investors should wait for all the uncertainties to settle before taking fresh exposure to the stock.