Business Quality of Financial Institutions

[atulgarg]

In an attempt to understand and evaluate the business quality of Financial institutions (long due), I have captured some stats for HDFC and ICICI bank (Thanks to a post from Donald in another thread for trigger)

HDFC BANK

	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Revenue	32,619.76	24,361.72	19,983.52	19,802.89	12,320.38
EBDIT	5,167.09	3,926.40	2,948.70	2,244.94	1,590.18
Depreciation	542.52	497.41	394.39	359.91	271.72
EBIT	4624.57	3428.99	2554.31	1885.03	1318.46
Operating Margin	14.18	14.08	12.78	9.52	10.70
Equity	29,924.68	25,379.27	21,522.49	15,052.73	11,497.23
Borrowings	23,846.51	14,394.06	12,915.69	2,685.84	4,478.86
Deposits	246,706.45	208,586.41	167,404.44	142,811.58	100,768.60
Total Assets	337,909.49	277,352.61	222,458.56	183,270.78	133,176.60
Equity Dilution	0.99	0.98	0.93	0.83	0.00
Asset Turnover	0.10	0.09	0.09	0.11	0.09
Equity / Assets (Capital Adequacy ratio)	8.86	9.15	9.67	8.21	8.63
Deposits / Total Assets	73.01	75.21	75.25	77.92	75.67
Borrowings / Total Assets	7.06	5.19	5.81	1.47	3.36
EBIT/Total Assets	1.37	1.24	1.15	1.03	0.99
RoA (EBIT/Total Assets)(1-tax_rate)	0.96	0.87	0.80	0.72	0.69
Return on Equity	15.45	13.51	11.87	12.52	11.47
ICICI BANK
	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Revenue	41,450.75	33,082.96	32,999.36	39,210.31	39,667.19
EBDIT	6,465.26	5,151.38	4,024.98	3,758.13	4,157.73
Depreciation	524.53	562.44	619.50	678.60	578.35
EBIT	5940.73	4588.94	3405.48	3079.53	3579.38
Operating Margin	14.33	13.87	10.32	7.85	9.02
Equity	60,405.25	55,090.93	51,618.37	49,883.02	46,820.21
Borrowings	140,164.91	109,554.28	94,263.57	67,323.69	65,648.43
Deposits	255,499.96	225,602.11	202,016.60	218,347.82	244,431.05
Total Assets	473,647.09	406,233.67	363,399.71	379,300.96	399,795.07
Equity Dilution	1.00	0.97	1.00	1.00	0.00
Asset Turnover	0.09	0.08	0.09	0.10	0.10
Equity / Assets (Capital Adequacy ratio)	12.75	13.56	14.20	13.15	11.71
Deposits / Total Assets	53.94	55.54	55.59	57.57	61.14
Borrowings / Total Assets	29.59	26.97	25.94	17.75	16.42
EBIT/Total Assets	1.25	1.13	0.94	0.81	0.90
RoA (EBIT/Total Assets)(1-tax_rate)	0.88	0.79	0.66	0.57	0.63
Return on Equity	9.83	8.33	6.60	6.17	7.64

Looking at the number above seems like both HDFC and ICICI are neck to neck in terms of operating margin and asset turnover. ICICI even seems to have better capital adequacy ratios. However what makes HDFC stand apart is their ability to grow their Assets under management (AUM) using mainly Deposits thereby keeping the borrowing levels pretty low as compared to that of ICICI. This in turn has resulted in drastic changes in ROE as seen in the table above.

Please share you views on what do you think makes HDFC a better business than ICICI.

[financemayur]

hi atul

nice work done to understand the comparative positions of fin institutions. will be grateful if you could attach the excel sheet of above calculations.thanks

[financemayur]

if i am not mistaken in above calculation depreciation has been deducted twice from the EBIT.For HDFC bank net profit for FY12 is 5167.09 where depreciation has already been counted for. so the EBDIT should be 5167.09+542.52=5709.61. pls correct me if i am wrong.

[subashnayak_19_]

Hi all,

Not sure, if this is the right thread to ask this question. But I know I have zero knowledge on valuing banks/NBFC. The max I could get till my limited effort is one should invest in companies with good and conservative management, and low NPA.

Can someone help me (with links, sites) from where I can learn about how financial companies are valued and why they are done in the same way. I have heard there is a good thread at TED on the same, my 30 mins effort to unearth the same didn’t help me. Things seems to start at a higher level from post #1 in most of the cases; couldn’t get any fundamental lesson from them.

[Donald]

Atul, Subash and others,

Since you guys are interested in learning how to analyse different businesses including Banks/Financials, you are all advised to take the PAT Dorsey Book seriously.

If I remember correctly PAT Dorsey has given us a guided tour of how to analyse different sector businesses including Banks, AMC and Insurance, Consumer Services, some 13 or 14 of them. Using his template, without knowing too much we could identify Yes Bank and SBI quoting at 0.5x BV but comparable RoEs as the best bets in 2008-09 meltdown. (See TED threads).

This is infact a good reminder to myself, to go and re-read PAT Dorsey a second time (I did spend a good lot of time first time round, but I was totally green then; a 2nd round now should do me a whole lot of good).

Those interested can put their hand up for creating Sector Primers/And how to Analyse for Banks, for Pharma, and other sectors - using Live examples from ValuePickr - that will be a cool value-addition for ValuePickrs in 2013.

[atulgarg]

Thanks for pointing that out Mayur, You are right.

The updated stats are below.

HDFC BANK:

	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Revenue	32,619.76	24,361.72	19,983.52	19,802.89	12,320.38
EBIT	5,167.09	3,926.40	2,948.70	2,244.94	1,590.18
Operating Margin	15.84	16.12	14.76	11.34	12.91
Equity	29,924.68	25,379.27	21,522.49	15,052.73	11,497.23
Borrowings	23,846.51	14,394.06	12,915.69	2,685.84	4,478.86
Deposits	246,706.45	208,586.41	167,404.44	142,811.58	100,768.60
Total Assets	337,909.49	277,352.61	222,458.56	183,270.78	133,176.60
Equity Dilution	0.99	0.98	0.93	0.83	0.00
Asset Turnover	0.10	0.09	0.09	0.11	0.09
Equity / Assets (Capital Adequcy ratio)	8.86	9.15	9.67	8.21	8.63
Deposits / Total Assets	73.01	75.21	75.25	77.92	75.67
Borrowings / Total Assets	7.06	5.19	5.81	1.47	3.36
EBIT/Total Assets	1.53	1.42	1.33	1.22	1.19
RoA (EBIT/Total Assets)(1-tax_rate)	1.07	0.99	0.93	0.86	0.84
Return on Equity	17.27	15.47	13.70	14.91	13.83

ICICI BANK:

	Mar '12	Mar '11	Mar '10	Mar '09	Mar '08
Revenue	41,450.75	33,082.96	32,999.36	39,210.31	39,667.19
EBIT	6,465.26	5,151.38	4,024.98	3,758.13	4,157.73
Operating Margin	15.60	15.57	12.20	9.58	10.48
Equity	60,405.25	55,090.93	51,618.37	49,883.02	46,820.21
Borrowings	140,164.91	109,554.28	94,263.57	67,323.69	65,648.43
Deposits	255,499.96	225,602.11	202,016.60	218,347.82	244,431.05
Total Assets	473,647.09	406,233.67	363,399.71	379,300.96	399,795.07
Equity Dilution	1.00	0.97	1.00	1.00	0.00
Asset Turnover	0.09	0.08	0.09	0.10	0.10
Equity / Assets (Capital Adequcy ratio)	12.75	13.56	14.20	13.15	11.71
Deposits / Total Assets	53.94	55.54	55.59	57.57	61.14
Borrowings / Total Assets	29.59	26.97	25.94	17.75	16.42
EBIT/Total Assets	1.36	1.27	1.11	0.99	1.04
RoA (EBIT/Total Assets)(1-tax_rate)	0.96	0.89	0.78	0.69	0.73
Return on Equity	10.70	9.35	7.80	7.53	8.88

[atulgarg]

Donald,

Thatâs right, the need for re-reading the PAT-Dorsey Book(PDB) can not be stressed enough. Infact while looking at the HDFC/ICICI balance sheet, there were lots of new/different terms. So I went back to PDB and come up with these stats. Was wondering if my interpretations so far are in line with those of seniors and if we can collectively refine it. Will go back to drawing board (PDB) again…

Thanks,

Atul

[Donald]

Hi Atul,

This is a good start.

A quick look tells me a few things are missed; when collated/computed (across the industry, not just 2 banks) this will make for a much better perspective.

1). Gross NPAs, Net NPAs and Provisioning Coverage. Becomes very important to check - and on a consolidated basis (better to use Consoilidated data for all comparisons) as the subsidiary assets may be huge but adequate provisioning may not be there for non-performing assets. If I remember correctly ICICI Banks provisioning was jut 0.5 compared to industry average of 2 in 2008,2009.

2). Cost Efficiency - Operating costs/ Net Revenues - that tells us a few more things, where things are headed in tough years

3). NIMs (Net Interest Margin) spread over a number of years over different economic cycles tells us how well the Institution manages profitability even in adverse rising interest rate scenarios

4). Sources of Revenue growth. Its useful to track Fee Income/net Revenues and Fee Income growth. How much of revenues is from treasury operations and how much from other services is another important indicator of a Banks diversification across Asset classes

5). Sources of Funds - How much is Current Account & Savings Account -CASA (low cost funds); and the trend over years tells us a few more things

Some of these figures are quoted only in the ARs and not in the Quarterly statements and hence not reflected in data providers data. Also a proper perspective will set in only when you have data collated for say some 10 banks - leading private and PSU Banks - because you will get a sense of industry averages and the range typically Banks operate in.

If you can divide the work about some 3 of you (in the interest of time/drudgery; I had compiled myself for all the banks with some help from Ayush in 2009), this will be a very rewarding exercise I can assure you - first for yourself - and then for other ValuePickrs:)

)- Donald

PS:Then there are other very important aspects like the Quality of the Asset Book ( and its distribution) e.g. I suspect PSU Banks are loaded with infrastructure and Power sector Loans, etc. Also Size & Quality of the Contingent Items (off balance-sheet items) are also very important to dig into for a comprehensive look - but requires much more effort:)

[Prdnt_investor]

In terms of banks, following the quarterly results is very important and equally important is the conference calls that follow.

A lot of details pointed out of context makes very little sense, but when observed over a period gives a greater sense.

The YES Bank thread on TED is a classic learning point for learning about bank analysis. Some senior boarders have great discussions on bank valuations.

The chart of YES from one of the senior boarder at TED, look at the list of parameters.

	Q2 FY11	Q4 FY11	Q1 FY12	Q2 FY12	Q3 FY12	Q4 FY12
Interest Income	953.79	1,222.61	1,399.54	1,438.65	1,684.06	1,785.10
Interest Expense	640.63	874.11	1,045.35	1,053.02	1,256.48	1,336.87
Other Income	131.00	186.76	165.29	214.05	211.43	266.35
NII	313.16	348.50	354.19	385.63	427.58	448.23
Net Income	444.16	535.26	519.48	599.68	639.01	714.58
Operating Expenses	162.75	186.49	194.38	213.76	240.17	284.22
Employee Costs	87.76	103.02	109.81	109.95	121.70	133.69
Operating Profit	281.41	348.77	325.10	385.92	398.84	430.36
Provisions & Contigencies	17.44	43.26	1.51	37.87	22.35	28.48
Net Profit	176.26	203.38	216.08	235.02	254.09	271.80
Basic EPS	5.13	5.86	6.21	6.73	7.23	7.71
Non Int Income to Total Inc	29.49%	34.90%	31.80%	35.69%	33.09%	37.27%
Cost to Income %	36.64%	34.80%	37.40%	35.65%	37.58%	39.77%
NIM	3.10%	2.80%	2.80%	2.90%	2.80%	2.80%
CAR	19.43%	16.50%	16.20%	15.98%	16.13%	17.94%
Tier I CAR	11.00%	9.70%	9.60%	9.40%	9.20%	9.90%
ROA	1.50%	1.50%	1.50%	1.60%	1.50%	1.50%
ROE	20.90%	21.70%	22.10%	22.60%	23.00%	23.60%
Advances	30,348	34,360	33,100	34,194	35,868	37,988
Deposits	40,014	45,940	43,580	44,075	46,929	49,151
CASA	10.10%	10.30%	10.90%	11.00%	12.60%	15.00%
Cost of Funds	6.70%	7.80%	8.50%	8.60%	8.90%	9.00%
Gross Yield on Advances	9.50%	10.70%	11.60%	12.20%	12.40%	12.50%
Spread	2.80%	2.90%	3.10%	3.60%	3.50%	3.50%
Gross NPA	0.22%	0.23%	0.17%	0.20%	0.20%	0.22%
Net NPA	0.06%	0.03%	0.01%	0.04%	0.04%	0.05%
Loan Loss Coverage	74.70%	88.60%	95.20%	80.20%	80.00%	79.20%
Branches		214		305	331	356
ATM		247				606
Employees					5013	5642

[atulgarg]

@Donald,

Thanks for your valuable and elaborate inputs. That has provided the muchneededdirection for me to take my exercise further.

@Rudra,

Thanks for your inputs and that table. That gives good flavor of data to capture for financial institutions.

Also, looks like it is high time to have a look at some TED threads, which have some good information.

[kkamit37]

Hey guys !

What an amazing thread this is, and even more an amazing community. Hope to participate a lot more in coming days.

@Rudra

Can you please pose the link of the thread. And please let me know which is this TED community where these discussions are going on. I am not able to find it.

[Donald]

In the days of googling, finding what you want should be fairly easy:).

In 2008 & 9, I remember some good discussions on Yes Bank and ICICI vs HDFC bank threads on TED - The Equity Desk.

Search for “theequitydesk+Yes Bank” and “theequitydesk+ICICI Bank+HDFC Bank” and you will get these exhaustive threads.

[ayushmit]

Hi Friends,

Recently somebody brought to my notice a very concerning data for the health of PSU Banks:

Bank’s 90% exposure to corporate sector (don’t remember right…may be overall exposure too) is to just 13 cos in India. And the interest coverage ratio for these 13 cos is just about 1-1.5 (for some cos it was less than 1)

Similarly we also discussed how banks re-structure bad loans, just to avoid booking them as NPAs and getting into troubles. And this is becoming a very common practice. This has also been confirmed by several CA friends I have.

Ayush

[soumyapanigrahi]

I second that Ayush. It might be infinitely difficult for individuals to get loans fom PSU banks. However for people with money and power all guidelines and rules are bent. I know for sure some cases where a loan amount sanctioned was 4 times the actual value of the land. And there are such innumerable cases. If a local goon can get this done I can only think of what all rules are being bent for big co-operates. As a rule I have decided to not have a single PSU banking stock in my Portfolio.

[kkamit37]

Just wanted to know what TED stands for.

Thanks a lot !

[atulgarg]

@Donald & Ayush,

Thanks for you continued inputs.

@Ayush,

how can we figure out if some bank has re-structured their loans to avoid book them as NPA. is there a way to do that from the Financial statements.

@Amit,

TED stands for http://www.theequitydesk.com".

[Vedant]

Hi,

Here is a compilation of relevant ratios and their calculation for BFSI sector. Source: RBI website. Hope this helps.

Items like capital, reserves, deposits, borrowings, advances, investments and assets, liabilities used to compute various financial earnings / expenses ratios are averages for the two relevant years.

Operating profit is defined as total earnings less total expenses, excluding provisions and contingencies;

Burden is defined as the total noninterest expenses less total non-interest income.

Cash-deposit ratio = (Cash in hand + Balances with RBI) / Deposits.

Ratio of secured advances to total advances = (Advances secured by tangible assets + Advances covered by bank or Govt. guarantees) /Advances.

Ratio of interest income to total assets = Interest earned / Total assets.

Ratio of net interest margin to total assets = (Interest earned â Interest paid) / Total assets.

Ratio of non-interest income to total assets = Other income / Total assets.

Ratio of intermediation cost to total assets = Operating expenses / Total assets.

Ratio of wage bill to intermediation costs (Operating Expenses) = Wage bills/ Operating Expenses.

Ratio of wage bill to total expenses = Wage bills / Total expenses.

Ratio of wage bill to total income = Wage bills/ Total income.

Ratio of burden to total assets = (Operating expenses - Other income) / Total assets.

Ratio of burden to interest income = (Operating expenses - Other income) / Interest income.

Ratio of operating profits to total assets = Operating profit / Total assets.

Return on assets = Net Profit / (Average Assets)

Return on Equity = Net Profit / (Capital + Reserves and Surplus).

Cost of Deposits = Interest Paid on Deposits / Deposits.

Cost of Borrowings = Interest Paid on borrowing from RBI and others / Borrowings.

Cost of Funds = Total Interest Paid on deposits and borrowings/ (Deposits + Borrowings).

Return on Advances = Interest Earned on Advances / Advances.

Return on Investments = Interest Earned on Investments / Investments.

Return on Advances adjusted to cost of funds = Return on advances â Cost of funds.

Return on Investment adjusted to Cost of Funds = Return on investments â Cost of funds.

Cost / Income ratio = Operating expenses * (Total income â Interest expenses) 100

[atulgarg]

Thanks for getting the detailed Ratios Vinod.

[atulgarg]

Banking Ratios Simplified:

For Banks and any NBFCs, RoA (RoE = RoA * leverage) gives a pretty good idea about the returns a Financial Institutions (FI)is generating and about its performance.

Now what are the components of RoA for Banks.

Return on Assets is defined as follows.

RoA = Net Profit/Total Assets

Net Profit for a Bank can be further broken down as follows

ROA = (Net interest income + other income - Expenses)/Assets

ROA = (Net interest income /Assets + other income /Assets)

: Expenses, we âll talk about in a while.

Where Net interest income /Assets is nothing but Net Interest Margin (NIM)

So RoA is a function of NIM and Other income (Fee based income)

Further Simplifying NIM, it is nothing but the interest Differential a bank earns, so

NIM = (Interest Earned â Interest paid)/Assets

Interest Earned in turn depends on the Quality of Loans, which in turn means lesser Non performing Loans (NPAs), better it is. An NPA is lost interest and lost Asset too…!!

Interest Paid in turn depends on Borrowed Amount and Cost of borrowing that amount. Amount borrowed is a direct function of CASA Deposits. More the CASA deposits lesser is the money, banks need to borrow to maintain healthy balance sheet.

Also Other income is a function of CASA as well (More the deposits more the fees charged plus other services these depositors will avail from the bank.)

For Expenses, lesser the expenses better it is. To track the expenses in Banking, we use what is called cost to income, how much money is spent to earn per unit of money. Cost to Income can simply be defined as

cost to income = Expenses (Assuming operating only) / (Interest income + fee income)

So all in all RoA depends on following

ROA = Increasing CASA ratio, Decreasing NPAs, less Cost of borrowing and decreasing Cost to income

Remember, CASA will not be valid for NBFCs.

Alsohow much a bank can try, there will be defaults in loans and hence NPAs. So how much provisioning a bank does for loan loss is another important thing to look for.

Hope to put a comparative study in due course of time.

Atul

[ameydesai]

http://www.cobrapost.com/index.php/topics?cid=25

please examine the above link albeit with a pinch of salt, this could be true, could not be true, the truth needs to be found out