Higher margins, lower credit costs to propel SBI's return on assets by FY21

While the bank believes higher margins and lower credit costs will propel its return on assets by FY21, some analysts expect NPAs may remain elevated

After giving the market a pleasant surprise with its July-September 2019 quarter (second quarter) results, announced last Friday, State Bank of India’s (SBI’s) management’s efforts to retain investor confidence led to an 11 per cent rise in the stock in the last two days.

The country’s largest bank, on its investor day on Wednesday, presented a strengthening picture of its balance sheet along with growth opportunities for its subsidiaries, which, in turn, would increase shareholders’ returns.

To begin with, SBI foresees its return on assets (RoA), an important profitability measure tracked by market, to reach to 0.9-1 per cent levels by 2020-21. Notably, even in a stressed scenario, it expects RoA to be between 0.75 per cent and 0.85 per cent, higher than estimates of most analysts.

The expected rise in net interest margin (NIM), lower slippages (loan accounts turning bad), and improvement in credit cost (bad loan provisioning as a percentage of average loan book) are factors that would propel SBI’s shareholders’ returns.

While faster growth of high-yielding personal loans, a strong low-cost liability franchise, and overall loan growth are expected to boost NIM, robust provision coverage ratio (PCR), likely lower slippages from small and medium enterprises, and agri portfolios and expectations of loan recoveries from large accounts should help lower credit costs.

SBI has been employing a conservative approach, mainly towards corporate loan provisioning. At present, SBI’s PCR stands at 74 per cent for its corporate book, higher than the expected loss from default ratio of 62-63 per cent. The bank believes that this excess provision would also take care of any potential stress in sectors, such as telecom and non-banking financial companies. However, analysts believe the credit cost targets may take longer to materialise.

“Non-performing loan formation will remain high unless the economy rebounds sharply. Coupled with the continued struggle for banks to recover old bad loans, this implies that credit costs stay high,” said Morgan Stanley’s analysts in a note.

Thus, how the bank achieves its credit cost and the overall asset quality guidance would be closely watched by the Street, given its strong influence on profitability and earnings. Nevertheless, growth in subsidiaries such as SBI Life Insurance, SBI Funds Management, SBI Cards, and SBI General Insurance, among others, should boost value for SBI’s shareholders. In light of this, analysts at Motilal Oswal have raised their target price for SBI from ~350 on October 25 to ~370, implying an 18.5 per cent upside from the current level. While much of it has been taken well by analysts and the Street, it does point to better days ahead.