Dalal Street Investments

Morgan Upgrades Financial Services

May 18, 2009

With strong election results for UPA, in our opinion, reduces the tail risk of sharply higher NPLs. Morgan’s economist has upgraded his GDP forecast for India. In an improving economy, banks are less likely to underperform. Morgan has raised its industry view to In-Line.

The negative view on Indian banks has been premised on a weak outlook for revenues and a likely increase in non-performing loans (NPLs). This view still holds. However, with the general elections sending the strongest government since the early 1990s, the outlook for reform has increased – implying potential pickup in capital flows. In such a scenario, we believe that the tail risk of sharply higher NPLs due to lack of capital has subsided.

The bank stocks that will be most positively affected are IDFC, HDFC and State owned banks (PSU Banks). For IDFC, loan growth should improve if the government focuses
on infrastructure spending.

M&A of PSU Banks ?
Clearly among the most inefficient in the region, for a variety of reasons – e.g.,
a huge employee base and overlap in operations. Since it now does not depend on the Left parties, the government may allow banks to right-size the employee base.

Indian bank’s underlying earnings were much lower than reported as revenues were under pressure and underlying asset quality was weakening. Now capital flows may improve in India, thereby reducing some pressure on asset quality. Nonetheless, not everything is back to F2007-F2008 levels. The global economy still faces problems, which will put some pressure on Indian bank earnings.


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