Multiple Headwinds to Impact Performance
Performance of Banking & Financial Service (BFS) sector is likely to remain under stress in 3QFY18 led by: (a) sharp decline in profitability from treasury operations; (b) higher MTM provisioning on non-HTM portfolio of the bank (benchmark 10 year Gsec yield increased by 65bps QoQ in 3QFY18); (c) higher provisioning on existing NPAs as well as additional provisioning on loans referred to NCLT/IBC; and (d) weaker business growth. However, the banks/NBFCs with relatively higher exposure to Retail and MSME segments will continue to deliver strong numbers.
Earnings profile of the corporate focused banks to remain subdued: We expect the banks with significant exposure to corporate term loans to report elevated level of provisioning. Further, ageing of existing NPAs and write-down of security receipts from sale to the ARC will keep their credit cost elevated in 3QFY18. However, fresh slippages are expected to decline, as recognition of stressed assets is peaking out across the banks. Continuing to remain firm on NPA recognition, the Reserve Bank of India (RBI) has asked the banks to refer 25 out of total 28 cases from the second set of larger stressed corporate accounts to NCLT/ IBC proceedings post the expiry of Dec’17 deadline. Further, the RBI has also asked the banks to provide more than 50% on all these accounts, which will negatively impact their profitability. Several cases referred to NCLT/IBC in first list indicated relatively higher haircut (in range of 60-80%) by the banks and hence, we expect provision expenses to remain elevated. Further, few banks to report higher asset quality divergence in Annual Supervision Audit conducted by the RBI for FY17, which will be keenly watched by the market participants. Within that, we expect accelerated haircut/write-off by the Public Sector Banks as the Government of India has given final nod for much-needed capital infusion to the tune of Rs880bn in 4QFY18. However, the banks with higher retail/consumer portfolio will continue to show stable trend in their asset quality.
Credit growth revived marginally: After touching multi-year low in 1HFY18, credit growth revived marginally to 10.7% in fortnight ended 22nd Dec’17. We expect major part of incremental credit growth may flow into private banks helping them to improve their operating performance further. Further, deposit growth remained higher led by massive inflow of deposit during the demonetisation drive. Lending rate fell sharply owing to liquidity overhang, which resulted in moderation in Net Interest Margins (NIMs). This along with pressure on NIMs will curb NII growth for these banks in 3QFY17E as well as in FY18E.
Rising Gsec yield play spoilsport: Further, the sector has got negatively impacted by sharp rise in bond yield due to deteriorating conditions on fiscal deficit front. Fiscal deficit of the Central Govt. touched112% of Budget Estimate for FY18 as of Nov’17-end, as the Govt. continued spending spree to support the economy. Resultantly, the benchmark G-Sec bond yield jumped to 7.33% as of 3QFY18-end from 6.66% as of 2QFY18-end.
Increase in G-Sec yield will result in MTM loss on non-HTM investment portfolio of the banks as well as result in sharp decline in treasury income. As the banks have deployed major chunk of excess liquidity from the demonetisation drive in government bonds, they have to report MTM loss from this portfolio. We expect our banking sector coverage universe to report a NII growth of 22% YoY and 4.6% QoQ led by PSBs (24.8% YoY and 3.7% QoQ) and private sector banks (18.9% YoY and 5.7% QoQ). However, other income of our banking universe is expected to decline by 13.3% YoY and 29.5% QoQ due to sharp decline in treasury income. Thus, on pre-provisioning profit front, we expect 15% QoQ decline. Overall, we expect our banking sector coverage universe to report 19.7% YoY and 5.8% QoQ decline in PAT led by PSBs with 68.5% YoY and 27.3% QoQ decline vs. 0.2% YoY and 2.1% QOQ decline for private banks.
Outlook & Valuation
Lower operating profit, subdued treasury income and higher credit cost on ageing of stressed assets will negatively impact the sequential performance of the banks in 3QFY18. As the recent steps by the RBI and the GoI clearly indicate that the banks will have to accelerate their efforts to resolve issues on asset quality front, we expect further surge in provisioning expenses in FY18E. We expect overall return to remain depressed over FY18E for the banking sector in general and corporate term loan focused banks in particular. Further, we believe that incremental deterioration in asset quality has been aptly addressed in last few quarters, however speedy resolution will continue to impact banks’ profitability. We expect improvement in banks’ core operating performance in coming quarters due to peaking out of NPA recognition cycle and improvement in non-corporate credit demand. As we expect the demand for retail loan to pick-up before any rise in demand for infrastructure/corporate loans, we prefer the banks having higher exposure to consumer and business banking portfolio. We expect asset quality stress to decline along with relatively moderation credit cost from FY19E onwards.
Our Top Picks: IndusInd Bank, DCB Bank, HDFC Bank and Federal Bank among private sector banks and SBI and Indian Bank among the PSBs.
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