Top Fund Manager Adds Banks After Stress Tests: Corporate India

Indian banks, which posted their biggest rally in four years yesterday, will defy predictions of worsening bad loans with the economy poised for a rebound, according to the nation’s biggest money manager.

HDFC Asset Management Co.’s Mid-Cap Opportunities Fund is raising stakes in non-state lenders after the fund’s stress tests showed they were “attractive,” said Chirag Setalvad, who manages the portfolio. A Bloomberg gauge of 11 banks surged 9.9 percent yesterday after new central bank Governor Raghuram Rajan flagged measures to free up the industry. The index has declined 47 percent from a May high as the monetary authority raised interest rates to stem the rupee’s unprecedented drop.

Setalvad, 39, forecasts banks’ profitability, already at the lowest since 2009, will recover in two years as Rajan unwinds measures to support the currency that increased costs for banks, and as Asia’s third-largest economy recovers. Overseas and local investors have been selling lenders since June as bad loans rose to the highest level in five years.

“The banking sector has got issues and when that happens it presents an opportunity,” Setalvad, whose company manages $15.9 billion of assets, said in an interview, without identifying companies. “Even the ugly is getting priced in adequately. The general expectation is that the economy will recover therefore asset quality will improve.”

‘Underweight Banks’

Yes Bank Ltd. yesterday surged 22 percent to 287.5 rupees, paring this year’s loss to 37 percent. The shares increased 2 percent to 292.95 at the close. HDFC Bank Ltd., India’s biggest lender by market value, added 1.1 percent after rallying the most since May 2009 yesterday.

The BI Indian Banks index’s 50 percent decline this year made it the worst performing among 222 Asian indexes tracked by Bloomberg as of yesterday.

The “jump in bank stocks has to be short-covering; no long-only fund comes and buys in the manner that we saw” yesterday, Prateek Agrawal, chief investment officer at ASK Investment Managers Pvt., said in an interview on Bloomberg TV India. “We are seriously underweight banks. The stress on their balance sheets in terms of bad loans will only increase.”

Foreigners sold $1.4 billion of shares in lenders in the two months to July after buying $3 billion in the January to May period, latest data from the market regulator show. Indian fund managers cut their holdings in bank shares to 17 percent in July from 21 percent in January, data show.

Bad Loans

Bad loans in the banking system rose to 3.92 percent of total lending as of June 30, the highest in at least five years, from 3.4 percent at the end of March, according to central bank data. Stress tests by the monetary authority show delinquent loans may jump to 4.4 percent by March, the Reserve Bank said in its annual report on Aug. 22.

The stressed-asset ratio, which measures bad loans and restructured assets as a percentage of loans, was at 10.02 percent at the end of June, central bank data show. The measure is approaching 10.4 percent, a level last seen in 2002, according to rating company ICRA Ltd.

Rajan’s move this week to flag the need to cut the requirement for banks to invest in government securities and ensure lending to productive sectors of the economy, as well as allow some lenders to open branches without seeking RBI approval, will help improve the delinquent loan situation, said Manish Sonthalia, a Mumbai-based money manager at Motilal Oswal Asset Management Co.

The central bank will also look at ways to improve the recovery mechanism for bad loans and propose a database for large loans across lenders, Rajan, the ex-International Monetary Fund chief economist, said.

Wrong Call

“The steps may not alleviate immediate stress,” Seshadri Sen, a Mumbai-based analyst with JPMorgan Chase & Co. wrote in a report dated Sept. 4. “But some will have a major long-term impact on bank profitability and growth.”

HDFC Mid-Cap Opportunities Fund added 100,000 shares of Yes Bank in July boosting its holding to 1.4 million shares and bought 30,000 shares of Axis Bank Ltd. to increase ownership to 500,000 shares, according to data compiled by Bloomberg. Holdings in state-owned Punjab National Bank and Indian Bank were unchanged in the period.

The cost to insure debt of State Bank of India surged 165 basis points in three months, according to data provider CMA. Setalvad is switching into non-state banks after his “call on public sector undertaking banks went wrong,” he said. “I didn’t anticipate the economic environment to get so adverse and as a result the asset quality to remain under pressure for as long as it has.”

Rating Cut

India’s $1.8 trillion economy expanded 4.4 percent in the three months through June from a year earlier, the slowest pace since 2009 amid weakening industrial output. The government’s failure to cut its fiscal and current account deficits prompted Standard & Poor’s this week to reiterate it may cut India’s credit rating to junk.

The Reserve Bank raised two interest rates in July to support the currency, further imperiling economic expansion. The rate at which Indian banks lend to each other for three months surged to a five-year high of 11.59 percent on Sept. 4, compared with 8.52 percent at the end of June.

Easing of restrictions on banks and the government’s move to attract overseas investments may help revive growth. The IMF forecasts India’s economy will expand 6.3 percent in 2014. The RBI predicts a 5.5 percent growth in the year ending March 31.

India’s lower house of parliament passed a bill allowing foreign investment in the pension funds for the first time. The government, which eased norms for retailers and airlines, is also negotiating with opposition parties to raise the FDI cap in insurance to 49 percent from the current 26 percent.

“Expectations of earnings growth are low as investors are extrapolating low economic growth and low profit margins,” Setalvad said. “There is a chance that we will be positively surprised because margins should revert and medium-term growth may be better than what is currently expected.”

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