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Business and asset-quality normalization gains pace with risk of a third wave waning

* Retail credit growth is showing early signs of a pick-up, but corporate credit growth still lags behind: We estimate ~8% credit growth yoy in Q2 for our coverage universe, which is slightly better than systemic credit growth of ~6.7% as per last available data from the RBI (Sept 10, 2021). Private Banks are expected to retain the leading position in credit growth. The provisional credit growth numbers for Q2 disclosed by some banks are better than expected, with HDFCB/IIB being the outliers.

Our discussions with bankers indicated early signs of disbursement pick-up in mortgages, car and card segments. However, PL, MFI and new CV still remain laggards. That said, repayments have also improved after unlocking, and thus it will take some time for better disbursement trends to fully manifest in underlying credit growth. Improving freight rates and utilization levels could reignite demand for CVs in H2FY22. We estimate overall credit growth of ~9% for FY22, with a reasonable pick-up in retail credit in H2 and back-end working capital demand from corporates.

* Risk of higher fresh NPA formation subsides as the probability of a severe 3rd Covid wave decreases: Fresh retail NPA formation is likely to be lower qoq as 1) banks have done lumpy recognition in Q1 itself (including in mortgages), 2) the economy is opening up fast, and 3) the risk of a severe Covid 3rd wave has subsided.

There is an improvement in cheque bounce rates - to 27% from 31% in May 21. However, they still remain higher than pre-Covid levels (20-25%). That said, fresh stress formation will remain elevated in CV, PL, LAP, TW and MFI. The stress in SME is also moderating and should largely manifest through restructuring. Among corporates, Srei Group could be a large default with the NCLT vacating the stay on NPA recognition. UCO, Axis, Indian Bank and KVB have sizeable exposures to Srei. Indian Bank, however, carries reasonable provisions for the same.

* Retail collections, corporate resolutions accelerate: Our discussions with private bankers and on ground checks suggest that overdue collection efficiency at the pan-India level is improving across retail products, except for states such as Kerala, WB and Assam, mainly in the MFI segment. Among large corporates, DHFL was marked as one of the largest resolutions after Essar and Bhushan Steel, with a decent recovery rate of 37%. This should reflect in Q2 and should mainly benefit Canara and Union, among large PSBs. Some more resolutions are in the pipeline from infra/diversified conglomerates in FY22. In addition to these resolutions, the transfer of the first tranches of NPAs to NARCL should moderate PSBs’ GNPA ratios meaningfully in Q3.

* PVBs to report better profitability in Q2 and PSBs too: We expect private banks to post strong profits on better NIMs (on better growth/lower interest reversals) and lower NPA formation. PSBs should also benefit from the one-off cash recovery from DHFL and lower tax incidence, offset in part by higher staff cost due to the change in NPS/pension scale. Among large PVBs, ICICI could be a clear outlier in terms of growth/asset quality and profitability. HDFCB has reported better-than-expected credit growth, which, coupled with some margin normalization and a moderation in LLP, should lead to better profitability. IIB could see moderate profitability due to its conservative provisioning stance on VIL. Federal Bank might report better profitability, benefiting from a moderation in credit costs and recovery from DHFL. Among PSBs, SBI and Canara will be the outliers.

* Stay put with banks benefiting from faster business and asset-quality normalization: In our view, business and asset-quality normalization should accelerate in the absence of a severe 3rd Covid wave, but large banks should be the early beneficiaries. Among the large banks, ICICI remains our top pick, followed by HDFCB, Axis and SBI. We like IIB (Buy) as well, given its conservative provisioning stance on VIL, which could be reversed once better visibility is attained. It should also benefit from an expected pick-up in VF in H2. Among small-mid size banks, we prefer Federal Bank, Canara, Indian Bank and Equitas SFB.

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