HDFC Bank, Axis top global charts

Thanks to high return ratios, they are the most expensive globally on a price-to-book value basis

Indian private banks HDFC Bank, Axis Bank and ICICI Bank along with their Chinese peers China Construction Bank Corp (CCB), Industrial and Commercial Bank of China (ICBC) and Agricultural Bank of China (ABC) occupy the top six slots among global banks on key return ratios, namely return on equity (or shareholders’ funds) (RoE) and return on assets (RoA). A comparison of the top 10 Indian banks and top 10 global banks (by total assets) reveals that banks in these two countries enjoy the best in class return ratios among global peers (see table).

For FY16, HDFC Bank and Axis Bank earned the highest return on assets of 1.91 per cent and 1.67 per cent, respectively, followed by CCB, which clocked return on assets of 1.3 per cent. ICBC and ICICI Bank completed the top five list with RoAs of 1.29 per cent and 1.17 per cent, respectively. The Chinese banks follow December year-end and, hence, the data for them is at the end of calendar year 2015. HDFC Bank tops its global peers on RoE as well, which stood at 18.63 per cent in FY16. Axis Bank stood fifth in this table with an RoE of 16.95 per cent, after CCB, ICBC and ABC that reported RoEs of 17.18 per cent, 17.1 per cent and 17.03 per cent, respectively.

However, despite having equally good return ratios, the Chinese banks lag their Indian peers on valuations. HDFC Bank, Axis Bank, ICICI Bank and State Bank of India (SBI) are the top four highly valued banks currently based on FY17 estimated price-to-book value basis. JP Morgan is the fifth bank based on valuations. So, what explains this divergence in valuations?

Lack of transparency on bad loans is among the key reasons, estimate analysts. “China is the least advanced in both non-performing assets resolution and provisioning while India is mid-way in booking the losses thanks to recent AQR (asset quality review) by the Reserve Bank of India (RBI),” says analysts at Credit Suisse in a report dated 8th August 2016.

In fact, asset quality is a key determining factor in valuations of banks in recent times. That, along with weak return ratios, is the key reason why Indian public sector banks namely Bank of India, Union Bank of India and Canara Bank are among the five most inexpensive banks globally.

With respect to Indian private banks, their out-performance on return ratios front is largely fuelled by healthy pre-provisioning profits generated not just in FY16, but over the past many years. On the other hand, most public sector banks have struggled on this front in recent years with the exception of SBI and Union Bank that have started seeing some increase in this metric in both FY15 and FY16.

Given that the strong performance of these banks appears to be well baked in their current valuations, are investors waiting for some correction to enter these stocks? Not quite.

Santosh Singh, Financials analyst at Haitong Securities, says, “Operating profits of banks in the western worlds have been declining and the cost of doing business has also increased there. In the western world, the return ratios are under stress. So, (Indian) private banks have always been the favourites of FIIs (foreign institutional investors) and that trend is likely to continue.”

Analysts at Credit Suisse, too, remain positive on Indian private banks despite acknowledging the fact that they are the most expensive banks in the Asia-Pacific region.