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Growth visibility strong; treasury near term catalyst

After a correction in Q1FY23 amid global uncertainty, domestic markets witnessed an outperformance compared to global peers on the back of sustained and strong economic parameters. The banking sector has outperformed (the Bank Nifty gained ~22% whereas the Nifty was up 12% from June 2022) as the earnings outlook has improved due to anticipation of improvement in business growth, lower credit cost and bottoming of NPA. PSU banks, which remained laggards in the last several fiscals, have seen a relatively higher revival (PSU Nifty gained ~32% from June 2022) on the back of a better show on growth as well as asset quality; reversal of treasury losses reported in Q1FY23 remains a near term catalyst.

Taking over the baton from previous quarter, bank credit growth has picked up pace, up 15.4% YoY, 2.2% QoQ at | 114.9 lakh crore, led by retail & MSME segments. The corporate segment is showing green shoots of revival as working capital limits are getting utilised. Bank credit growth is expected to pick up further as demand improves. We believe NPAs have largely bottomed out with lower credit cost expected to aid earnings trajectory.

Banking sector outlook:

* Treasury losses amid run up in yields impacted improvement in operational performance in Q1FY23. However, recent decline in yields is expected to reverse these losses in Q2FY23, which remains a near term catalyst, especially for PSU banks. Thus, we expect strong earning trajectory for banking sector and, particularly PSU peers in Q2FY23

*For Q1FY23, business momentum was healthy, attributable to robust demand in retail & MSME segment. Loan growth for the quarter came in at 15.4% YoY. Sectoral data shows retail segment was up 18.1% YoY and agri credit jumped 13% YoY. Large corporate credit, which had been a drag on overall banking credit growth has started to enter the positive territory and was up 3.3% YoY. Management commentaries and data indicate revival in utilisation in WC limits ahead. Thus, we believe bank credit growth should continue to remain in double digits in FY23E

*The asset quality trend continued to improve led by healthy recoveries and steady incremental slippages. GNPA ratio for banks in our coverage declined ~6-35 bps with average drop (all banks) at ~10 bps. On an absolute basis, GNPA declined ~1% QoQ, 12.1% YoY for banking sector. Restructured book declined by an average of 20 bps QoQ, thus indicating overall reduction in stress. Management comments, revival in economy suggests improvement in asset quality and lower credit cost ahead

*NII grew at a healthy pace of 13.5% YoY, 2.5% QoQ. C/I ratio inched up 177 bps QoQ from 49.0% to 50.8%, mainly due to enhancement of distribution and tech capabilities. Credit cost (provisions) declined both QoQ and YoY due to lower slippages. However, earnings growth pace moderated QoQ due to treasury losses. Net profit grew 32.4% YoY but de grew 10% QoQ at | 41242 crore

The momentum in credit growth and operational performance are expected to continue ahead in FY23E. Firing up the unsecured book is expected to aid in initial quarters of FY23E; recovery in corporate credit offtake is expected to revive credit growth from H2FY23. Gradual transmission of rate hike would offset rising competitive intensity on deposits. Overall, we expect continued traction in valuation with preference for lenders possessing a healthy CASA base, higher floating rate asset, adequate PCR and capital. Top picks: State Bank of India, Axis Bank and City Union Bank

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