10 Emerging Market Banking Stocks Analysts Favor

NEW YORK (TheStreet) -- The "softer" monetary policy adopted by Western economies has created a liquidity deluge in emerging markets like Brazil and China. The central banks in these countries have moved in to purge excess liquidity, in a bid to prevent currency appreciation and formation of asset bubbles.

People's Bank of China has hiked reserve requirement rates for the third time in the last two months, and policy makers in Brazil have increased the reserve and capital requirements to flush out excess liquidity. The government of India has increased policy rates to hedge inflation fears, although the measures seem a little sanguine in recent weeks.

The Reserve Bank of India announced liquidity enhancing measures like open market operations and reducing statutory lending rate from 25% to 24% to address the persistent shortfall in domestic liquidity. Going ahead, the pattern in deposit growth, currency expansion, and government spending would be crucial in shaping liquidity conditions in the country. Another concern is the pricing pressure related to domestic demand and global commodity prices, experts suggest that broader inflation could be around 6-6.5% by March 2011.

Although Citigroup ( C), JPMorgan Chase ( JPM), Bank of America ( BAC), and Wells Fargo ( WFC) are trading at a discount in comparison to their emerging markets peers, our stock picks have higher growth potential.

These 10 banks offer investment opportunities, going ahead. In our selection, Chinese and Brazilian banks are trading at roughly similar valuations of 2 to 2.7 times book and 1.8 to 3.1 times, while Indian banks look expensive at 2.1 to 4.6 times.

These stocks are ordered by upside potential.

10. Industrial & Commercial Bank (ICBC) (Hongkong: 1398) is a China-based commercial bank providing personal and corporate banking services.

Net profit grew at a robust 27% during the third quarter on account of widening spread, better cost-control measures, and prudent provisioning. Stable profit growth increased investment return for shareholders. The annual return on average assets and the weighted average return on equity reached 1.4% and 23.7% by end of September quarter, or up 15 basis points and 350 basis points, respectively, from the end of 2009.

During the first three quarters, the bank witnessed substantial growth -- loans grew 15% on a year-over-year basis, while deposits rose 16%. Growth across all business segments remained balanced.

Net interest margin rebounded to 2.4%, which was 14 basis points higher than that at the end of 2009 on account of efficiency in asset allocation and profitability.

At the end of September 2010, ICBC's non-performing loans (NPL) decreased to 1.15%, down 39 basis points from the end of 2009. At the same time, provision coverage ratio rose to 210%, which further enhanced the bank's capacity to withstand risk.

The stock is trading at 1.9 times its 2010 book.

9. China Merchants Bank (PINK: CIHHF) is a China-based commercial bank operating through personal and corporate banking businesses, as well as online and electronic banking services.

During the period from January to September 2010, net profit surged 57.4% year-on-year. Net interest income scaled up 41% year-on-year, while net interest margin stood at 2.58% for the first nine months of 2010. Further, development of the SME business would improve the bank's loan pricing power and strengthen its presence in corporate banking.

However, during the first three quarters, the bank's deposits and loans grew 18.4% each year-on-year, weaker than the industry average of 20% for deposits and 18.5% for loans. In the scenario of a gradual tightening in credit supply, banks with prudent lending policies such as China Merchants Bank could outperform the sector, say analysts.

Net profit growth is pegged at 52% and 29% for 2010 and 2011, respectively. The stock is trading at 1.89 times of 2011 book.

8. Agricultural Bank of China (ABC) (Shanghai: 601288) is one of the China's "big four" state-owned commercial lenders.

The continual decline in non-performing loans is improving the bank's asset quality. NPL ratio was 2.08%, narrowing 83 bps from the end of 2009.

Overall profitability has improved with cost efficiencies. The cost-to-income ratio fell from 49.3% seen in 2009 third quarter to 40.5% for 2010 third quarter, an indication that operating income growth was swifter than operating costs. Consequently, net profit for the third quarter grew 37% year-over-year. ABC attributes profit growth to the expansion of its business scale, a strong net interest margin, as well as growing commission revenue.

The bank is witnessing improved business volumes with higher net interest margins and fee income. ABC has benefited from interest rate hikes this year, due to the largest proportion of demand deposit among banks. Analysts expect ABC's rural loan portfolio to grow faster than overall loans and foresee a robust loan growth of 21% next year. At the end of September, the bank's capital adequacy ratio stood at 11.4%, up 3.07% from June this year.

7. Itau Unibanco Holding ( ITUB) has an 11% share of the Brazilian retail banking market.

Loan growth came in higher at 18% year-on-year, compared to private peers. Admittedly, lower margin corporate lending contributed to slower growth, while lending to small and medium enterprises (SMEs) and retail lending grew at a faster pace.

During the September quarter, corporate loans were up 7.8% year-on-year, while SME lending increased by 30% year-on-year, and retail loans moved up 21% during the same period. Asset quality trends have been favorable as well.

Another feature of the earnings season is the pressure on net interest margins (NIM), clearly evident in net interest income (NII). NII only rose 3% quarter-on-quarter as net interest margins got compressed on account of higher funding costs and competition.

The bank maintains a mid-20% return on equity and a healthy mid-teen growth outlook. The stock is trading at 3.4 times its estimated 2011 book.

6. Banco Bradesco ( BBD) is one of the four big banks in Brazil.

The third quarter saw loans growing slower than forecast, total loans increased 20% year-on-year. The best performing segments were small and medium enterprise (SME) loans and personal loans. SME loans rose 27.5% year-on-year, while payroll loans and personal loans grew at 71% and 50%, respectively, during the same period. The laggards were corporate and auto loans, accounting for 40% of total loans.

Asset quality metrics continued to improve in the September quarter. Provision coverage enhanced from 121.7% in the second quarter to 122.6% in the current quarter.

Moreover, fee income grew 20% year-on-year, and net income from insurance and private pensions grew 19% during the same period. However, net interest margins narrowed 30 basis points quarter-on-quarter to 7.5% due to tighter spreads. Analysts are positive on the stock in view of its medium-term growth prospects. The stock is trading at 3 times its 2011 book.

5. Banco do Brasil (PINK: BDORY) is a major Brazilian and Latin American bank.

Headquartered in Brasilia, the bank reported lower-than-estimated provisions for loan losses, a lower effective tax rate, and better-than-forecast net interest income, which led to earnings upside during the quarter. Consequently, analysts upgraded the stock and revised earnings, accounting for lower credit losses.

Continued improvement in asset quality metrics is expected to have a beneficial impact on credit losses. In the current quarter, analysts revised earnings for 2010, 2011, and 2012 upwards by 4%, 6%, and 3%, respectively.

Net interest income is expected at 12% in 2011 and 10% in 2012, while fee income is expected to grow at 11% and 10%, respectively, during the same period.

A consistent profitability return of 20% on equity and improvement in earnings quality would help narrow the valuation discount of the bank, in comparison to its private-sector peers. The stock is trading twice its estimated 2012 book.

4. Sberbank Rossai (Moscow: SBER03) is a Russia-based commercial bank.

Sberbank continues to increase its loan portfolio by over 1% month-over-month, and expects 2011 loan growth of 12-14% year-on-year. Corporate loans are likely to expand at 9-10% year-on-year in 2011, while retail is seen growing at 15%.

Given the positive effect from accelerating inflation and expected Central Bank of Russia rate hikes, analysts expect net interest margin for 2011 at 6.1%. The positive effect of re-pricing deposits is going to sustain until the first quarter of 2011, after which deposit costs would stabilize. In retail, loan sales have shifted towards higher-yielding products..

Overall, analysts have upgraded earnings forecast, net profit is expected to grow at 21% in 2012. On the asset quality front, higher revenues will offset higher provisions. The stock is trading at 7.5 times its estimated 2011 earnings.

3. State Bank of India (Mumbai: SBIN) is India's largest bank and operates in business segments like corporate banking, treasury, and retail banking, among others.

During the September quarter, net advances increased by 19% year-on-year, underpinned by strong growth in retail and mid-corporate loans. Deposits grew 10.7%, benefiting from a robust 27.7% growth in low-cost deposits during the same period. Market share in advances stood at 17%, up 46 bps year-on-year. Credit-deposit ratio rose to 74.7% at the end of September from 67.5% in the same period last year, up 716 bps.

Due to the strong low-cost deposit base and high fee income, SBI's return ratios have improved over the past few years. SBI reported a 113 basis points upgrade in net interest margin to 3.43%, compared to the same period last year, due to growth in low-cost deposits, a substantial decline in bulk deposits, and higher yield on advances.

On the asset quality front, the bank faced large slippages, with the non-performing asset provision coverage ratio including technical write-offs improving to 62.8% from 60.7%. Factoring in the bank's fundamentals and robust operating performance during the past several quarters, analysts have re-rated the stock. The stock is trading at 2.1 times its estimated FY2012 adjusted book.

2. ICICI Bank ( IBN) is India's largest private sector bank with consolidated total assets of over $115 billion.

During the September quarter, loan book expanded 5% sequentially. The expansion came after nearly six quarters of stagnation as growth has come from corporate, and agricultural loans. The management expects loan book to grow at 20% for the full year.

Another positive, is the improvement of low-cost deposits ratio. A Current and Saving Accounts (CASA) improvement and expansion of branch network to 2500 outlets; should help the bank to maintain the present CASA levels of around 42% in the next couple of years. Subsequently, net interest margins improved 10 bps to 2.6% sequentially in the September quarter due to enhancement in low-cost deposits. Analysts expect ICICI to maintain margins of 2.5%-2.6% for 2011 fiscal. Overall, net profit grew 20% year-on-year in the September quarter.

Positively, net non-performing loans narrowed 15 bps to 1.6% and provision coverage improved to 69% for the quarter. With asset quality concerns fading, analysts expect earnings to grow at 20%-25% during 2010 and 2012. ICICI is trading at 2.1 times its 2012 estimated book.

1. HDFC Bank ( HDB) is an India-based banking company operating in business segments like retail and wholesale banking, and treasury operations.

Retail loans grew 31% year-over-year, as of September 2010, while overall advances grew 37% during the same period. The bank has increased the proportion of corporate segment as well as the share of non-secured retail, which could be margin dilutive, thereby improving the quality of its books. Besides, high capitalization and prudent lending practices have curtailed bad loans. Going forward, as a percentage of loans, bad loans would stand at 1.3%-1.4% for fiscal 2011, say analysts. However, the bank's strong focus on the rural segment may lead to higher non-performing assets, but could churn higher return ratios in the long term.

HDFC Bank had maintained an earnings growth of around 30% over the last three years. The bank's balance sheet grew around 30% during the last five years. However, asset growth could narrow to about 25% on a higher base over the next couple of years. Improved return ratios could sustain net profit growth at 28%-30%, according to analysts. The stock is trading at 3.7 times its 2011-12 estimated book.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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