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PSBs shine among banks; insurance cos slip into losses due to Covid claims

PSBs shine among banks led by higher profitability, lower NPA formation: Q1FY22 was marked by tepid growth and slightly worse-than-expected asset quality deterioration in the secured retail/SME segments, which led to elevated provisions and hurt profitability. Most banks preferred to build/carry forward Covid provisions, but for select banks like ICICI Bank. However, PSBs, in general, reported higher profitability, aided by better margins, one-off gains from the UB stake sale, healthy treasury gains, higher PSLC fees and lower opex as the bulk of wage arrears/pension-related provisions are largely behind. Among PSBs, SBI, BOB, Indian and Canara Bank were clear outliers.

Among private banks, ICICI was a clear outlier in terms of growth, asset quality and profitability, and it carries a strong provision cover. Federal and KVB (upgrade to Buy) were outperformers among small- and mid-sized banks. AU SFB too reported strong results, but higher restructuring/ECLGS were minor irritants. Most MFI players reported weak asset quality outcomes, with Ujjivan once again slipping into losses.

Improving collections to ease stress formation, but some spillover into Q2 inevitable:

Most banks indicated improving collection trends from Jul’21 (reflecting in lower bounce rates back at 27% from high of 31% in May) across retail business segments, though some states, like Kerala, Assam and WB saw a late pick-up due to prolonged lockdowns. However, banks expect some NPAs from the inflated SMA pool to spill over into Q2, while the restructuring pool too should inch up. Collection activity may return to the pre-Covid level in Q3, subject to no severe Covid third wave. Within retail, recovery rates should improve in secured mortgages and gold loans as stress formation in those segments was higher than expected due to impaired mobility, which has normalized now.

Credit card performance was better as lenders had already recognized vulnerable customers after the first wave and offered early easy EMI options. However, PL, LAP, CV and TW could see prolonged stress. Though lumpy corporate NPA formation is largely behind, the risk of stress is emerging in select weak corporates (preCovid) like Vodafone and Future Retail. Although these exposures may not turn NPAs soon, banks may shore up provisions at least on Vodafone. That said, PSBs could see optical improvement in NPAs due to the transfer of NPAs to NARCL in Q2.

Tepid growth, poor asset quality hurt NBFCs; insurance cos slip into losses due to Covid claims:

Overall AUM growth for our NBFC coverage remained tepid at 1.5% qoq (~7.6% yoy). The asset quality deteriorated in the absence of a moratorium. In our coverage, HFCs performed better than vehicle financiers in terms of disbursements and asset quality. Among NBFCs/HFCs under our coverage, HDFCL and BAF were relative outperformers. Chola reported a weak quarter, but the outlook is relatively positive.

Overall, premium/APE growth was week for insurance companies due to tepid demand for market-linked ULIPs, but signs of a pick-up are visible. Reasonable momentum is also seen in group protection, annuity and credit life products. All insurance companies saw a surge in Covid-related death claims, leading to huge accounting losses. VNB margins for most players, barring I-Pru Life, too slipped qoq due to a higher share of ULIPs. We upgraded I-Pru Life to Buy from Hold, factoring in superior VNB growth (~29% yoy) and an improving product mix (protection share at ~22%).

As the economy opens up, growth and asset quality should recover and support the rally in BFSI:

We believe that underlying consumption demand remains strong and should bounce back as the economy opens up and as the risk of a third Covid wave moderates. The improvement in collection efficiencies should limit incremental stress formation, while the healthy provision cover should keep provisions in check at least for large private banks. PSBs, in general, should perform well as the transfer of NPAs to NARCL should meaningfully lower NPAs and provision burden, resulting in healthy profitability.

We prefer ICICI, Axis and Federal Bank among PVBs and SBI, BOB and Indian Bank among PSBs. For HDFCB, the RBI lifting the credit card suspension is credit positive, but the continued suspension of digital initiatives remains a sentimental overhang. IIB has improved asset quality and built a strong provision buffer, but its exposure to Vodafone remains a key irritant. IIB plans to adequately provide for Vodafone in FY22 and move on. Among NBFCs, we prefer HDFCL, CIFC and SHTF, while among insurers, we prefer SBIL, ICICI Pru Life and HDFCL.

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