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A new dawn

CY21 marks the culmination of a 10-year asset quality refix, with a stress pool now fairly bounded. The dawn of CY22 marks beginning of a decade characterised by P&L and balance sheet improvements. Starting narrow and percolating down, stronger balance sheets and digital nimbleness will give large private banks an edge.

Fintech risk is for real, squeezing mid-size banks and NBFCs further. The impact will be felt more on valuations than on business. Market underperformance aside, large banks’ dominance will rise and rerating will happen. Challenges in operating landscape will demand more out of NBFCs, thus historical multiples, will only be seen in pockets. Top picks: Banks - ICICI, Axis, HDFCB, SBI; NBFCs: HDFC.

Banks: Structurally better, cyclically positive

Proactive recognition, bounded stress pool, reasonable buffers and strong capital position puts banks in a structurally better space. While subsequent COVID waves portends uncertainty, the crisis is now better defined with bounded outcomes. The dual edge of cost advantage and equity confidence will be hard to match for smaller, less differentiated players. Thus, we expect growth to be oriented towards large private banks. Also, balance sheet heft and digital nimbleness give large banks an edge over mid-sized banks. Our strategy remains bipolar, with a preference for large private banks - order being ICICI, Axis and HDFC Bank.

NBFCs: Opportunities but in pockets

Battling on multiple fronts over years –IL&FS crisis (liability constraints), Covid-19 and regulatory challenges – NBFCs have morphed into a resilient self, evident in higher liquidity, capital and provision buffers. Recent NPL norms will have an impact, but, would mark an end to bigger changes. We see NBFCs’ operating niche being challenged and squeezed further between banks & Fintechs. Longevity of pandemic percolates into vulnerability of customers (MFI/CVs etc), making recovery far ended. Rising rates will entail operating pressure points. Better growth and consolidated space makes HFCs preferred segment – HDFC top pick.

Outlook: Residual uncertainties have reduced, reversal to play out

Financials have underperformed with most lenders (ex-ICICI), now trading below the 3-year average; mainly due to i) Global factors ii) pockets of uncertainties & iii) portfolio re-orientation on Fintechs. The moot question hence is, whether a derating is structural or will it reverse? We believe a re-rating will play out with large private banks increasing dominance. Mid-size banks would face more challenges, eventually affecting their valuations. For PSUs, structural challenges persist – we like only SBI. NBFCs particularly will see their niche being incrementally challenged via i) a lower cost of delivery from banks with digital initiatives, ii) better data availability iii) movement away from cash etc. These would weigh on structural valuations for NBFCs, unless they differentiate their operating style to maintain growth. Key risk to our positioning remains any Covid-19 related surprise leading to a negative paradigm-shift.

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