Salient to Investors:

Prashant Jain at at HDFC Asset Mgmt sees value in India’s biggest lenders on prospects of fewer bad loans that have made them Asia’s worst-performing bank stocks in the past year. Banks account for 29 percent of his HDFC Top 200 Fund. Jain said the worst of the fiscal crisis appears over, and inflationary pressures are waning, so the RBI will lower interest rates, growth will improve and P/E multiples will rise.

Diwakar Gupta at State Bank of India said a drop in delinquent debt from a 5-yr high will lure investors to the nation’s lenders, while the government’s commitment to capitalize public sector banks is comforting: funds that will help fill the gap between retained earnings and Basel III requirements.

Vishal Narnolia at SMC Global Securities is bullish on Indian banks, says they have been punished enough for asset quality issues, and have the lowest price to book values among Asian banks.

Saswata Guha at Fitch Ratings expects a turnaround at Indian banks by September, while bad loans will increase to 4.2 percent by March 31.

S&P and Fitch cut their credit outlooks and ratings to BBB- for India in 2012 on government failure to reduce the budget and current-account deficits.

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Prashant Jain, chief investment officer at India’s biggest money manager, said he sees value in some of the nation’s biggest lenders amid prospects of a reduction in bad loans that have made them Asia’s worst- performing banking stocks in the past year.

Jain, who manages $18.6 billion at HDFC Asset Management Co., also runs HDFC Top 200 (ITCT200), India’s largest equity fund. Banks account for about 29 percent of HDFC Top 200’s assets, according to data compiled by Bloomberg. The fund owns state-run Canara Bank, Bank of Baroda and Bank of India (BOI), the three worst performers on the 88-company MSCI AC Asia Banks Index (MXAS0BK) in the past 12 months.

Finance Minister Palaniappan Chidambaram’s budget pledge to add 140 billion rupees ($2.6 billion) to boost capital at banks will help state-run lenders increase credit and revive Asia’s third-largest economy forecast to expand at the slowest pace in a decade in the year ending March 31. A drop in delinquent debt from a five-year high will lure investors to the nation’s lenders, according to Diwakar Gupta, chief financial officer atState Bank of India (SBIN), the country’s biggest financial services company.

“At some point non-performing assets have to moderate,” Jain, 45, said in an interview to Bloomberg TV India. “Last quarter was better than the previous quarter and there is expectation this quarter will again be better than the last.”

HDFC Top 200 is India’s best performing large-cap fund in the past decade. It has returned 28 percent annually compared with the 21 percent gain at the S&P BSE Sensex index in the same period.

‘Punished Enough’

Canara Bank’s bad debt widened to 2.77 percent of total loans at the end of December from 2.58 percent in the preceding quarter, while Bank of Baroda’s delinquent debt widened to 2.41 percent from 1.98 percent.

Canara Bank (CBK)’s shares fell 0.6 percent to 417.15 rupees in Mumbai, extending the past year’s decline to 18 percent. Bank of Baroda rose 0.1 percent to 709.2 rupees. The S&P BSE Bankex (BANKEX) index of 14 lenders gained 0.3 percent, the only gauge among the 14 industry measures compiled by the BSE Ltd. to increase today. The index trades at 10.9 times its future earnings, down from 18.7 times in 2010.

“Indian banks have been punished enough for asset quality issues,” said Vishal Narnolia, Mumbai-based analyst at SMC Global Securities Ltd. “They are the cheapest among Asian banks as far as price to book value is concerned. We expect that the shares will rise from now onwards.”

Bank of Baroda (BOB), India’s second-largest state-run bank by market value, has a price-to-book value of 1, compared with 5.32 times at PT Bank Central Asia (BBCA)Indonesia’s biggest lender by market value. The measure for Canara Bank was at 0.8 times.

Soured Debt

Soured debt as a proportion of banks’ total credit jumped to 3.6 percent in September, the highest in at least five years, Reserve Bank of Indiasaid in a Dec. 28 report. Lending grew 16.4 percent in the twelve months through Feb. 8 after slowing to 15.12 percent in December, the weakest pace in two years.

“We are expecting a turn around at banks by September,” Saswata Guha, Mumbai-based director at Fitch Ratings said in an interview. Bad loans at Indian banks will increase to 4.2 percent by March 31, he said.

Chidambaram in his budget presented in Parliament on Feb. 28 announced measures to accelerate infrastructure projects which will help in recovering bad loans in road and power sectors, said SMC’s Narnolia. Chidambaram allocated 330 billion rupees ($6 billion) for the ruling coalition’s flagship rural jobs program and 100 billion rupees for a plan to give the poor cheap food grains, ahead of a general election due by 2014.

Chidambaram’s Pledge

The finance minister, who raised taxes on people earning more than 10 million rupees a year and on luxury vehicles, also pledged to narrow the government’s budget shortfall to 4.8 percent of gross domestic product in the 12 months starting April 1 from 5.2 percent.

Standard & Poor’s and Fitch Ratings cut their credit outlooks for India last year, citing the government’s failure to reduce the budget and current-account deficits. Both companies rank the country at BBB-, the lowest investment grade.

“The worst of fiscal appears to be clearly behind us,” said HDFC Mutual’s Jain. “Since inflationary pressures are waning, the RBI would now certainly do more because that’s the need of the hour. You need lower interest rates.”

The central bank cut its policy rate to 7.75 percent from 8 percent on Jan. 29, the first reduction since April. Six of 15 economists in a Bloomberg survey forecast the Reserve Bank of India will cut the benchmark rate by three-fourths of a percent by December.

Largest Holding

While falling borrowing costs will help lenders including State Bank of India, HDFC Top 200’s largest holding, boost lending and reduce bad debt, higher capital will improve its risk buffers. India’s banks will need to raise as much as 1.75 trillion rupees from equity sales to meet the Basel III capital rules, according to estimates from the central bank.

The Basel Committee on Banking Supervision, whose first two versions of global financial standards failed to avert crises, established a new set of rules in 2010 dubbed Basel III. At least 7 percent of banks’ risk-weighted balance sheets must be backed by common equity that can absorb losses, up from 2 percent before the 2008 crisis, the committee determined.

“The government’s commitment to capitalize public sector banks is comforting,” State Bank’s Gupta said in an interview. “These funds will help to fill the gap between retained earnings and Basel III requirements.”

Asset Quality

Total bad loan ratio at State Bank of India widened to 5.3 percent as of Dec 31 from 5.15 percent in September. Pace of bad loan increases is slowing and the lender is trying to recover bad loans to improve asset quality, Chairman, Pratip Chaudhuri, said on Feb. 14.

State Bank’s shares, which have dropped 7 percent in the past year, advanced 0.6 percent to 2,099.5 rupees and were among the 10 biggestgainers on the benchmark S&P BSE Sensex index, which fell 0.2 percent.

The company’s return on assets, a measure of how well shareholder money is reinvested, was 18.1 percent in the three months ended Sept. 30, compared with 25.7 percent at Indonesia’s Bank Central. The measure reached a record 32 percent at State Bank at the end of March 2006.

“Ultimately, interest rates will move down, growth will improve and price to earnings multiples also will start moving up,” said Jain.