Challenging Quarter in the Offing
The performance of Banking, Financial Service & Industry (BFSI) is likely to remain under pressure owing to slower momentum in NII growth and higher credit cost. We expect the banks having significant exposure to corporate term loan to report sequential rise in slippages and higher provisioning expenses. The Reserve Bank of India (RBI) has identified 12 large stressed corporate accounts and asked the banks to refer them to newly enacted Insolvency & Bankruptcy Code (IBC). Further, the RBI has also asked the banks to provide >50% on exposure to these accounts, which will negatively impact their profitability. Besides, the RBI has given a timeframe of 6 months (till December 31, 2017) to resolve several other large stressed accounts. In case the banks fail to resolve these accounts by the given timeframe, they might have to refer them to IBC. Hence, we expect earnings of the corporate focused banks to remain subdued in 1QFY18. Further, ageing of the existing NPAs would keep credit cost of the banks having higher stressed loan portfolio at elevated level. However, the banks with higher retail/consumer portfolio will continue to show stable trend in their assets quality. Hence, the banks with more focus towards retail lending will continue to deliver a better performance both on earnings and assets quality front.
Banking system credit growth still remains at multi-year low of 6% in the fortnight ending June 23, 2017. YTD growth in loan book stood at negative 0.3%, which clearly indicates muted growth in loan book in 1QFY18, especially of the corporate focused PSU banks. Further, deposit growth also remains higher due to massive deposit inflow during the demonetization drive. Owing to liquidity overhang in the sector, lending rate also fell sharply, which resulted in moderation in Net Interest Margins (NIMs). This along with pressure on NIMs will curb NII growth for these banks in 1QFY18 and in full FY18 as well.
However, the sector has got positively impacted by the shift in RBI Monetary Policy stance from neutral to accommodative due to sharp fall in inflation. G-Sec yield declined sharply post May 2, 2017, which resulted in mark-to-market (MTM) gain on non-HTM investment portfolio of the banks. As the banks have deployed major chunk of excess liquidity from the demonetization drive in these government bonds, they have option to book profit from this portfolio. Further, the treasury gain is expected to remain sequentially higher, which would support their profitability.
We expect our banking sector coverage universe to report a subdued growth in NII (16.6% YoY and 0.2% QoQ) led by private banks with 16.6% YoY and 1.7% QoQ growth vs. 16.3% YoY and 1% QoQ decline by their PSU counterparts. We expect core fee income to remain subdued due to lower credit off-take and relatively lower third party distribution income. As a result, other income of our banking sector coverage universe is expected to decline by 6.1% QoQ. Thus on pre-provisioning profit front, we expect 17.1% YoY growth and 7.9% QoQ decline, led by PSU banks with 21.1% YoY growth and 14% QoQ decline vs. 12.9% YoY and 0.2% QoQ growth by the private banks. We expect our banking sector coverage universe to report 5.2% YoY growth and 0.3% QoQ decline in PAT, led by PSU banks with 7.3% YoY and 9.5% QoQ growth vs. 4.3% YoY growth and 4.1% decline QoQ by the private banks, as we expect the credit cost of the PSU banks would moderate from high base of the year-ago quarter.
Outlook & Valuation
Lower operating profit, subdued core fee income and higher credit cost on ageing of NPAs will negatively impact sequential performance of the banks in 1QFY18. As the recent steps by the RBI and the Government of India clearly indicate that the banks will have to accelerate the resolution of their assets quality, we expect further surge in provisioning expenses in FY18E. We expect overall return will continue to remain depressed over FY118E for the sector in general and the PSU banks in particular. Though the incremental deterioration in asset quality has been aptly addressed in last few quarters, speedy resolution will continue to impact banks’ profitability. We expect this trend to continue along with further improvement in core operating performance. 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 would decline along with relatively moderation in credit cost from FY19E.
Our Top Picks: IndusInd Bank, DCB Bank, HDFC Bank and Federal Bank among private banks, while among the PSBs, State Bank of India (SBI), Bank of Baroda (BoB) and Indian Bank are expected to outperform their PSB peers.
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