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We expect our banking coverage universe to report profit growth of +17% YoY/ -6.5% QoQ (incl. impact of HDFC Ltd merger) in 2QFY24E. The moderation in earnings growth estimates is largely on account of NIMs compression of 10-15bps across banks as the impact of deposit rate hikes starts to reflect in the top-line for the banks. We expect the NIMs to bottom out in 2HFY24 provided there are no further changes in RBI policy repo rates. In line with our expectations, sector loan growth (ex-HDFC Ltd) was steady at 15.1% YoY (and 3.0% QoQ) for 2QFY24 (as of 8Sep’23) led by retail (esp. auto and unsecured products) while loans to industry still lags. We expect a moderation in credit growth from current levels and expect FY24E credit growth to be 13-14% YoY. Deposit growth continues to pick pace in 2QFY24 (+12.8% YoY as of 8Sep’23) and we expect deposit growth to gradually improve in medium term as the impact of lagged deposit rate hikes plays out. Opex growth for our coverage banks should remain near elevated levels as incremental loan growth is retail-led and also as banks continue to invest in technology, distribution and people infrastructure. Asset quality will remain in fine fettle and provision costs will stay moderate (stable avg. credit cost of 90bps in 2QFY24E). In our view, larger banks offer attractive risk reward at current valuations given their ability to navigate the clouded macro environment. Our preferred plays are ICICIBC, AXSB. We believe KMB and Bandhan offer attractive risk reward at current valuations. Within smaller banks, Equitas SFB is our preferred pick.

* Loan growth momentum steady; deposits picking pace: In line with our expectations, sector loan growth (ex-HDFC Ltd) was steady at 15.1% YoY (and 3.0% QoQ) for 2QFY24 (as of 8Sep’23) with expectations of moderation going ahead as lagged effects of rate hikes play through. Loans growth continues to be led by retail (esp. auto and unsecured products) while loans to industry still lags. Further, provisional loan growth numbers reported by few large banks have been strong and we expect the growth trend to hold up for other larger players too. We expect our banking coverage universe to report a loan growth of +13.6% YoY/+2.1% QoQ for 2QFY24E. We expect incremental credit growth to be retail-led while share of wholesale loan demand is expected to stay modest. Overall, we expect a moderation in credit growth from current levels in FY24E. Deposit growth continues to pick pace in 2QFY24 (+12.8% YoY as of 8Sep’23) resulting in improved LDRs (incremental 12M rolling LDR at 87% as of 8Sep’23). We expect deposit growth to gradually improve in medium term as the impact of lagged deposit rate hikes plays out.

* Margins to see some compression: We expect our coverage banks to see a 10-15bps QoQ compression in NIMs in 2QFY24E as the impact of deposit rate hikes starts to reflect in the top-line for the banks. Scheduled commercial banks have seen an increase of 215bps in Weighted Average Domestic Term Deposit Rates (fresh) over May’22 to Aug’23 vs an increase of 161bps Weighted Average Lending Rates (fresh) which in turn is expected to impact NIMs. We expect the NIMs to bottom out in 2HFY24 provided there are no further changes in RBI policy repo rates

*Opex to stay near elevated levels; healthy asset quality to sustain: We expect opex our coverage banks to remain near elevated levels as incremental loan growth is retail-led and also as banks continue to invest in technology, distribution and people infrastructure. However, on the other hand, credit costs for banks are expected to remain at low to moderate levels given no medium term headwinds seen on the asset quality front (stable avg. credit cost of 90bps in 2QFY24E). Thus, we expect banks in our coverage universe to report PAT growth of +17% YoY/ -6.5% QoQ (incl. impact of HDFC Ltd merger) led by impact of NIMs compression.