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Accelerating growth, improving asset quality bode well for banks

Better growth and asset quality lead to healthy profitability, partly offset by higher opex/MTM hit on investments:

Most banks under our coverage reported higher-thanexpected earnings, mainly led by strong credit growth, better margins (lower CoF, interest reversal on NPAs, better LDR) and lower loan loss provisions as asset quality improved meaningfully. However, lower treasury gains/MTM on bonds and higher opex (mainly for large private banks) to support the surge in business volumes, including cards/retail credit, partly moderated the earnings beat. Among PSBs, SBI, BOB and Canara were clear outliers, while Indian Bank disappointed a bit in terms of growth/earnings. Among private banks (PVBs), ICICI was a clear outlier, while Axis sprung a surprise on growth, margins and asset quality. Kotak too reported strong consistent growth/margins, but HDFCB disappointed on margins/fees. IIB continued to struggle with growth/asset quality. Among small/mid-size banks, Federal was a clear outlier, followed by KVB/CUBK. Bandhan returned to profitability, but asset quality remains a concern in the near term. We expect Q4 to be strong for banks in general on the back of better growth/NIMs and asset quality. ICICI, Axis, SBI and BOB will be the key stocks to watch out for.

Overall credit growth accelerates led by continued strong consumer credit growth and corporate revival:

Overall systemic credit in Q3 stood high at 9%, mainly led by a surge in corporate credit (for large PSBs/PVBs) and accelerated growth in the consumer retail segment (including mortgages, cards). PL is also showing signs of pick-up, but with some setbacks possibly in Jan’22. Car finance growth was sub-par due to underlying weak volumes (impact of chip shortage), while new CV too remained a laggard. Business Banking/SBL segments witnessed acceleration as asset quality risks receded, while MFIs resumed aggressive growth despite continued sub-par collection trends. Credit growth in early Jan’22 moderated a bit to 8% due to run-off of short-term corporate loans and banks turning risk-averse due to a surge in Covid cases. With the pandemic’s impact ebbing, we expect credit growth to reaccelerate, led by strong consistent growth impulses in consumer retail, some pick-up in commercial retail and seasonal pick-up in corporate credit, along with disintermediation from bond markets as rates rise.

Improving recovery trends to reduce NPAs further:

Moderate slippages, better recovery and higher w-offs led to a further reduction in the GNPA ratio across banks in Q3 (barring DCB). However, stress still remains elevated in select retail segments, such as CV/CE, TW, MFI and SBL/SME, reflecting in sub-par asset quality, as accelerated provisions on Srei Infra were made in Q3 and some contingent provisions were made for Future Retail and Spice Airways, which could slip in Q4. PSBs expect the NARCL transfer in the 1 st phase to further reduce the corporate NPA pool and cash recovery to flow through P&L, partly offsetting a weak treasury performance. Overall, we expect NPA ratios to moderate due to lower slippages and higher recovery/w-offs as most banks, barring a few small private banks, sit on a comfortable provision cover.

Sustained growth momentum to drive up valuations:

We believe that as the asset quality pain is largely behind, barring select segments, accelerating credit growth should drive up valuations for banks. Deposit/money market rates have inched up, casting some pressure on NIMs, but better LDR and lower interest reversals should protect NIMs in the near term. Rising bond yields may hurt PSBs in terms of MTM provisions, but better investment yields, lower retirement liability and disintermediation from the bond market supporting credit growth could largely offset the negative factors. Among large banks, ICICI remains our top pick, while Axis has moved up the order, followed by SBI. Retain Buy on HDFCB, but its relatively sub-par margin/fee performance and continued embargo on digital initiatives remain irritants for the near term. IIB will remain side-ways until growth accelerates, while the asset quality risk on CV/MFI is behind. Among small/mid-size banks, we like Federal, Indian Bank and Equitas SFB.

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