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Earnings outlook steady; will optimism turn into reality in FY22E?

Asset quality under watch, resumption of AQ classification to aid clarity

* The improvement in earnings outlook is led by a continued uptick in economic recovery and abating concerns around asset quality. Systemic loan growth is showing signs of a revival, with disbursement across various retail products – such as 2W, Home, Auto, LAP, and Gold loans – surpassing pre-COVID levels, while Banks remain cautious on the unsecured book. Even growth in the corporate segment is showing revival signs, with a focus on lending to highly rated corporates mainly for working capital needs. We expect growth to pick up and estimate systemic loan growth at 6.8%/11% for FY21E/FY22E. Private Banks under our coverage are likely to grow relatively higher by ~11%/17% YoY.

* AQ classification to resume, expect a slight uptick in GNPL ratios (over pro forma levels): The focus is likely to shift towards actively pursuing recovery efforts as the SC stay on NPA recognition stands withdrawn. Thus, lenders would recognize actual NPAs, which would keep slippages/asset quality elevated, though the pace of formation is likely to moderate. Although overall trends in asset quality have fared better than expectations, led by a sharp improvement in collection efficiency and a lower restructuring book, the recent surge in COVID-19 cases and the fear of a lockdown in key districts keep us watchful on asset quality. While many Banks have already provided for this likely increase and carry additional provision buffers, which should limit the impact on profitability, we expect them to continue to strengthen their balance sheets and credit cost to remain elevated. We estimate our Banking coverage universe to deliver ~17%/108% PPOP/PAT growth in 4QFY21E (on a low base).

* Private Banks: Operating profitability to improve while provisions would remain elevated. We estimate Private Banks to report PPOP growth of ~19% YoY (+2.7% QoQ) and PAT growth of ~108% YoY (+2.2% QoQ) due to a low base in 4QFY20. Although credit cost is likely to remain higher, a pick-up in loan growth along with healthy traction in fee income and modest opex would support earnings.

   * Loan growth is likely to pick up, led by rising consumer demand, particularly in the Retail segment. Even growth in the Corporate segment is recovering, with the focus on lending to highly-rated corporates. Banks, however, remain cautious about growing their unsecured portfolio. We expect loans of Private Banks to grow by 11%/17% over FY21E/FY22E, and estimate AXSB/ICICIBC to deliver 7.1%/13.5% YoY loan growth over 4QFY21E. HDFCB reported a growth of 14% YoY (+4.6% QoQ) while FB/IIB reported sequential growth of ~5%/3%. KMB is likely to report strong sequential growth (~5%) while RBK is likely to report flattish growth.

   * Margin to exhibit stable/improving trends - While continued monetary easing has resulted in low lending rates, cost of funds is likely to remain low, given the excess liquidity in the system. Although negative carry on slippages could impact margins, gradual deployment of excess liquidity and repricing of deposit base would support margins. Large Banks, with a strong liability franchise, are better placed to tackle margin pressure. We expect NII growth of 15% YoY, with BANDHAN ~27% and ICICIBC/KMB at 18% each.

   * Deposit traction would remain strong, reflecting 12% YoY growth for the system, while many Banks have increased focus on ramping up retail deposits. Most Banks indicated that the deposit rates have bottomed out and cost of funds is likely to remain low.

   * Asset quality would remain under watch as lenders would recognize actual NPAs as the stay on NPA recognition has ended. Though slippages would remain higher, it is likely to moderate on a sequential basis. We remain watchful of commentary given the rising COVID-19 cases and fear of a lockdown in key districts. Within MFIs, elections, and rising COVID-19 cases in key states could impact recovery trends. We remain watchful on BANDHAN, IIB, and RBK.

* PSBs earnings to show a healthy pick up. We estimate operating metric for PSBs to improve led by an improving overall environment. Within PSBs, we expect SBIN to report healthy performance supported by the resolution of Bhushan Power & Steel, which would result in healthy recoveries and a seasonally strong quarter on fee income. PSBs are expected to deliver NII/PPOP growth of 27%/16% YoY and PAT growth of ~110% YoY (on a low base).

* Asset quality challenges in mid-sized Private Banks remain a monitorable: We expect the performances of mid-sized Private Banks to remain mixed as they face challenges on asset quality, given their high restructuring book and low collection efficiency as compared to larger peers. We estimate DCB to report a decline of ~11% YoY in net earnings, while RBK would report an increase of ~40% YoY (on a low base), despite higher credit cost. FB is best placed in terms of liability franchise and would reflect a stable margin trajectory, led by an improving CASA mix. It is likely to report earnings growth of ~49% YoY (+11% QoQ) aided by healthy asset quality trends.

* Small Finance Banks: We expect AUBANK to report strong PPOP/PAT growth led by an uptick in loan growth, while provisions are likely to moderate on a sequential basis. EQUITAS is expected to report PPOP growth of 22% and PAT growth of 36% YoY (-8% QoQ).

* Life Insurers – premium growth to pick up while operating metrics remain resilient. Most Life Insurers are witnessing a gradual recovery in their new business premium (NBP), with SBILIFE/HDFCLIFE/MAXF to reflect APE growth of 38%/31%/27% YoY. IPRU would continue to reflect tepid trends as FY21E is likely to be a base reset period, reflecting a slowdown in ULIPs. We expect VNB growth of 45%/42%/36% for MAXF/SBILIFE/HDFCLIFE, while IPRU would report VNB growth of 17% YoY over 4QFY21E.

* Other monitorables:

   * Asset quality outlook and restructuring trends – The management commentary on slippage/restructuring trends and provisioning would be an important metric given the rising COVID-19 cases and fear of lockdown in key districts. More clarity would emerge in the restructuring pool.

   * Outlook on loan growth and margins – The management commentary on the growth outlook would be key to assess a recovery in the overall environment. Outlook on margins, given a pick-up in loan growth (as excess liquidity gets deployed), lower lending rates, and lower cost of funds.

   * Treasury performance – Bonds yield have increased during 4QFY21 which could impact the treasury book and the gains which Banks were sitting on. We expect the quantum of treasury gains to decline on a sequential basis.

Top Picks – ICICIBC, HDFCB, SBIN, FB, and MAXF

ICICIBC (Buy)

* ICICIBC has substantially increased its PCR to ~86% (pro forma PCR ~78% – highest in the industry) and carries unutilized COVID-related provisions of INR64.7b (~1% of loans). Slippages have been controlled, while restructuring book stood lower ~0.4% of loans. It is well-cushioned with higher provisions on its Balance Sheet and has guided for normalization of credit cost from FY22.

* The bank continues to see strong growth in Retail deposits and has succeeded in building a robust liability franchise over the past few years. It has one of the lowest funding costs (with cost of deposits declining to 4%) among Private Banks, enabling it to underwrite a profitable business without taking undue Balance Sheet risks, thus supporting margin further.

* The retail mix remains healthy with: a) CASA ratio of 45.2%, b) retail contribution-to-fees ~78%, and c) increase in loan mix to ~66%.

* ICICIBC appears firmly positioned to deliver healthy sustainable growth, led by focus on core operating performance. We estimate RoA/RoE of 1.8%/15.5% for FY23E. Adjusted for subsidiaries, the standalone bank trades at 1.7x FY22E ABV.

HDFCB (Buy)

* HDFCB has shown robust traction in its Corporate portfolio, which is compensating for the softness in Retail lending. Loan growth over FY21 YTD has been largely led by the Corporate segment (53% of total loans). The management continues to focus on lending to highly rated corporates, which has enabled a sharp decline in RWA-to-total assets ratio to ~66% (v/s 75% in FY19). Even the retail book witnessed revival trends, with disbursements crossing pre-COVID levels.

* Stress in the MSME segment declined to 2.3% v/s 9% as anticipated earlier, while the impact on total asset quality due to COVID-19 remains under control, with total restructuring at 0.5% of loans and pro forma slippages at INR49b. The bank holds sufficient additional contingency provisions to manage residual stress as business trends normalize fully. We estimate credit cost to sustain at 1.5% for FY21E and moderate to 1.3% by FY23E.

* A strong liability franchise would support margin. The bank is, thus, well-placed to gain incremental market share on both the asset and liability fronts. We expect RoA/RoE of 2.1%/18.5% for FY23E. The bank trades at 3.1x FY22E ABV.

SBIN (Buy)

* SBIN appears well-positioned to report a strong uptick in earnings as the uncertainty ushered by the COVID-19 pandemic has receded significantly. Over the years, SBIN has strengthened its Balance Sheet and increased its PCR (including TWO) to 86%. It further holds a PCR of ~89% on Corporate NPAs.

* It expects total COVID-19 impact on asset quality to be limited, with total slippages + restructuring expected to remain ~2.5% for FY21E. It reported a moderation in its pro forma GNPA/NNPA ratio, while the restructuring book was controlled at 0.8% of loans. Domestic collection efficiency is in line with other large Banks ~97%.

* SBIN has one of the best liability franchises (CASA mix: ~45%). This puts it in a better position to manage yield pressure, while a reduction in the interest rate on deposits would continue to support margin to a large extent.

* Subsidiaries – SBI MF, SBILIFE, and SBICARD – exhibited robust performances over the last few years, which could result in value unlocking.

* We estimate FY23E RoA/RoE of 0.8%/14.6%. Subsidiaries account for ~34% of total valuation. Adjusted for subsidiaries, the standalone bank trades at 0.7x FY22E ABV.

FB (Buy)

* On the asset quality front, the impact from COVID-19 remains under control as FB has no big ticket (>INR1b) accounts in its watch list. The management has guided at a restructuring book of INR15-16b (1.3% of loans), while CE stood ~95%. We expect slippages to increase and credit cost to stay elevated for FY21E as the focus remains on strengthening PCR. We expect the same to moderate from FY22E.

* CASA + retail TD constitutes ~90% of total deposits. FB saw a reduction in its cost of deposits and has a lower cost of funds advantage as compared to other mid-size Banks. This, along with a focus on cross-selling liability products to corporate clients to garner salary accounts, would support margin.

* FB has been taking a cautious approach in lending to high-rated corporates. The mix of retail loans has improved to ~33% in 3QFY21 from 28.4% in FY19. Though business growth remains subdued, we expect a gradual pick up in loan growth, resulting in an improvement in overall operating performance.

* We expect RoA/RoE of 1.2%/15% by FY23E. The stock currently trades at 0.9x FY22E ABV.

MAXF (Buy)

* MAXLIFE delivered a resilient performance amid a difficult macro environment, reporting ~14% growth in individual APE in FY21 YTD v/s a decline of ~2% for private players. Also, the market share in individual APE improved to ~6.4% in FY21 YTD (~90bp increase over FY21 YTD).

* The management increased its focus on the Protection and Non-PAR segments, with their share increasing to ~31% in FY20 from ~16% in FY17. In the current low business volumes, the share of Non-PAR and Protection increased sharply to ~49% as on 9MFY21. We believe MAXLIFE will continue to deliver better than industry trends in both these segments.

* The management has been making significant investments in growing its proprietary channels – branch/employee count has increased by ~190/~5,600 over FY17-20 – which enabled it to steadily gain market share. Overall, these contribute ~30% of total APE. The partnership with AXSB increases the longterm growth visibility/cross-sell opportunity for MAXLIFE.

* Distribution mix has started reflecting productivity gains, and increased focus towards high margin products has enabled healthy expansion in VNB margin. We expect margin to remain steady between 24% and 25%. This would enable 25% VNB CAGR over FY20-23E, while operating RoEV sustains ~21%. The stock currently trades at 2.8x FY23E EV after considering 80% MFS stake and 20% holding company discount.

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