SBI's core earnings at risk

Bank needs fund infusion of $9-11 bn by FY18; NPAs as a percentage of net worth stands at 34%

Over the past few years, investors have chosen to ‘rent’ shares of the country's largest lender State Bank of India (SBI) rather than own it, as its profitability has fallen sharply. So each time the price falls below Rs 1,500 a share, buying interest buoys the stock.

However, after its third quarter numbers, the stock may trend lower as its core earnings are at risk and the bank continues to under-provide for its impaired assets. The stock has been downgraded after its net profit in the December quarter fell 34 per cent.

The fall in net profit would have been 94 per cent, says Credit Suisse, had the bank maintained its provision coverage at second quarter levels. In Q3, the bank reduced provision coverage for bad loans by five per cent sequentially, to 45 per cent. The return on assets, too, stayed flat despite the increase in base rate. Prior to provisioning, the bank’s profit remained flat compared to the corresponding quarter last year, even as the base rate was increased.

The bank continues to witness a sharp run-up in bad loans, both sequentially and annually. Net non-performing assets as a percentage of net worth is now 34 per cent, which analysts say is the highest among large public sector banks. The pipeline of restructured assets in the coming quarters is also substantial at Rs 9,500 crore.

The run-up of bad loans and fall in profit is even higher for SBI's subsidiaries. During the third quarter, subsidiaries reported a 55 per cent fall in net profit compared to last year. In less than three years, the share of subsidiaries to SBI's profit has fallen from 30 per cent share to 15 per cent. While impaired loan ratio of subsidiaries increased to 11.5 in the third quarter from 10.9 per cent in the second quarter, provision has dropped to 40 per cent from 43 per cent in the second quarter. The bank will need to infuse capital given that impaired assets are eroding its capital.

According to analysts, the bank's Tier-I capital stands at 10.2 per cent, if one includes the retained earnings. This would be below 10 per cent, if one factors in higher provisions. The sharp rise in bad loans, low provisions and double digit loan growth will force SBI to raise capital within the next 12 months. Credit Suisse expects SBI's total capital need to be in the range of $9-11 billion by FY18. This would be equivalent to dilution of 55 per cent at current market prices. Going by the deteriorating financials, the brokerage has cut its earnings per share estimate by 5-7 per cent and cut its target price to Rs 1,374 from its earlier target of Rs 1,417. Morgan Stanley has cut its target price to Rs 1,150.