PSU banks are amongst the major gainers in the markets today. Union Bank, Dena Bank, Bank of India among the major gainers. Dena Bank and Bank of Baorda have hit their respective 52-week highs.

Analsyts say that the banking stocks are very hot right now and as you saw yesterday even as the market could not hold on to its gains, PSU banks did very well. SBI has been leading this bull charge. Soem sentiment has also been boosted by the ECB curb announced by RBI to stem dollar inflows.

"The current move, though only pre-emptive in nature, follows a number of other steps that RBI has been taking to contain system liquidity. The move will also be supportive for loan growth and lending yields for domestic banks, since the alternative of ECB funding may, in some cases, be restricted or uncompetitive (where imports are costlier), "says a CLSA report.

Also PSU Banks may soon have access to greater foreign capital and more liquidity if their proposals to the ministry of finance are approved. The ministry is currently examining a proposal by PSU banks to permit splitting of stock and to raise the cap of FDI and FII holding in such banks to beyond 20%. The banks also want the finance ministry to relax the norms for payment of minimum dividend

Apart from the minimum dividend issue, chiefs of public sector banks have made a whole host of important suggestions to the finance minister in order to shore up their capital base and meet Basel II norms as well as the demands for more credit capital.

One suggestion that may be approved without much political controversy is the proposal to allow stock split so that banks can improve their liquidity and their market capitalization but what may not pass political muster is the proposal that banks be allowed to divest government stake in them to below 51% so that they have more headroom to raise capital, something that has raised a political storm in the past. Yashwant Sinha as finance minister had proposed that that minimum government holding be reduced to 33 % with the public sector character of banks being maintained, but there was opposition from the congress at that time. Most banks are also in favour of increasing the FDI/FII ceiling in PSU banks from the current 20%, a proposal that is still pending with the MOF

PSU banks seek capital but experts say PSU banks should raise tier ii capital, which is a politically safe way to raise funds. "If the govt loses control over the public sector banks because of dilution of govt stake, then it cannot meet social objectives & this is likely to face political opposition. So a better that action would be taken for these banks to raise tier ii capital from entities like GIC & LIC" says Sunil Sinha, Principal Economist at Crisil

Some banks have also suggested that PSU banks be allowed to raise capital by issuing non voting shares or shares with differential voting rights the banks have also requested the RBI to review the draft guidelines on meeting Basel II norms as that is putting pressure on the banks to raise more capital

On his part, the finance minister has already promised that the requirement of making a minimum payment of dividend shall be relaxed for PSU banks on a case-to-case basis. The ministry of finance in consultation with the RBI is now considering the rest of the suggestions.

Kolkata-based Allahabad Bank (AllBank) is making a pitch for a controlling stake in at least one South-based private bank. AllBank, which has a capital of Rs 447 crore, has started the process and has short listed South Indian Bank and Lakshmi Vilas Bank as possible targets, ET report says. It has mandated Ernst & Young to identify block holders of equity in both these banks, so that the acquisition process can be streamlined.

AllBank Chairman and Managing Director AC Mahajan was not available for comments and Executive Director SK Goel also refused comments. However, AllBank is on the prowl to strengthen its presence in the South and an acquisition would help it expand its footprint there.

Both South Indian Bank (SIB) and Lakshmi Vilas Bank (LVB) seem to be a good fit in AllBank’s scheme of things. AllBank has less than 100 branches in the four southern states while SIB has nearly 500 and LVB some 230-odd branches across the country, of which the majority are located in the South.

The managements of both SIB and LVB have denied any knowledge of the move. SIB Chairman VA Joseph said: “The bank is growing and has an all-India presence. We don’t want to lose our identity. In any case, no one has approached us.” LVB General Manager R Sridharan said: “No bank is talking to us. It will not be easy for banks to take over a bank like us, where the shareholding in widely distributed and no promoter has any significant holding.”

Banking industry sources, however, said negotiations are on for over six months. According to senior Reserve Bank of India (RBI) officials, the central bank primarily examines the intention of the predatory bank before allowing it to acquire any other. It also determines whether depositors’ interest would be safeguarded in the context of such a takeover. A predatory bank also needs to take prior clearance from the RBI for acquiring more than 10% stake in a private bank.

At the other end of the spectrum, Securities & Exchange Board of India (SEBI) rules demand that the predatory entity should come out with an open offer or announce a swap ratio of shares or offer both options to existing shareholders of the targeted entity after acquiring a majority stake.

The National Stock Exchange (NSE) data on the Thrissur-based SIB’s holding structure as on March, 2007 show that foreign institutional investors hold 41.84%, domestic banks and financial institutions collectively hold 4.84%, insurance companies 0.88%, mutual funds 0.99%, bodies corporate 5.02%, individuals 46.39% and other trusts hold 0.04%.

Within the bank and FI category, Kochi-based Federal Bank holds 4.59%. The bank has a paid-up equity capital of Rs 70 crore and reserves of Rs 635 crore. In fact, SIB is planning to issue two crore fresh shares shortly by way of qualified institutional placement.

The shareholding pattern of Karur-based LVB shows that promoters hold 0.79%, banks and FIs 9.02%, insurers 0.45%, FIIs 1.67%, corporate bodies 20.49%, individuals 67% and others hold 0.58%. Within the bank and FI holdings, Federal Bank holds 4.76% while Indian Bank holds 3.43%.

IDBI Capital - Karnataka Bank (Buzzing Stock)

Updates:

Business Update – Karnataka Bank has achieved a business level of Rs.235bn in FY07 against the targeted Rs.250bn. However, the bank has expressed confidence that it will achieve an incremental business of Rs.50bn in FY08 taking the total business level to Rs.285bn in FY08. Karnataka Bank had earlier in FY07 set itself a business level of Rs.500bn by FY10.

The bank has started offering interest at the rate of 10% for senior citizens on it’s term deposit products of 18 months while it is 9.25% for others for the same maturity. The bank’s PLR is presently at 14%.

Similarly, the interest rates on other products too have been revised from February. While the rates on NRE deposits have been revised downwards, those on loans have been marginally revised upwards.

Network Expansion – The bank is also expanding it’s network fast to gain exposure and presence across the country. Karnataka Bank recently opened it’s 407th branch in Siliguri in West Bengal. It is fully geared up technologically and about 97% of the bank’s business currently is covered under the CBS.

Results and expectations:

Karnataka Bank has posted a YoY increase of 20% in bottomline for the 9MFY07 period. The last quarter may be difficult as the bank’s in general are facing the pressures on their NIM owing to hardening interest rates.

The bank has had a skewed pattern of non-tax provisioning. While it was quite higher at Rs.331m in Q1FY07, there was a write back in Q2FY07 to the tune of Rs.163m and a lower provisioning of just Rs.62m in Q3FY07. Higher provisioning again in the last quarter may affect bank’s profitability. Earnings may also be affected because of higher interest expenses. The Q3FY07 results are reflective of a possible trend. While the NII growth was higher at 12% YoY and 19% YoY in 1Q and Q2FY07, it was down to just 9% YoY in Q3FY07. Considering the fact that the bank has raised rates though only on select products, we would be cautious on the severity of it’s impact and feel it may have a negative bias.

Valuations:

Karnataka Bank has reported an EPS of Rs.12.4 in 9MFY07. Expecting about Rs.3.3 EPS in the last quarter, Karnataka Bank may post an EPS of Rs.15.7 for FY07. This would be a change of 8.1% YoY. Karnataka Bank had posted an EPS of Rs.14.52 in FY06.

Assuming marginally higher change (~10% YoY, inspite of the incremental business growth target of 21% being a bit conservative and discounting for a tougher operating environment), we can expect Karnataka Bank to post an EPS of Rs.17.3 in FY08. The current share price of the bank is 10x the FY08 EPS we have calculated.

ENAM's Coverage on Banking Sector (APril 07)

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