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We expect Q1FY26 to be another soft quarter for PVBs, mainly owing to slower credit growth and sharp margin correction due to the swift rate cuts recently. However, HDFCB and ICICIB are expected to report relatively better performances. PSBs, in general, are likely to report relatively better earnings resiliency vs PVBs, aided by lower margin contraction and higher treasury gains. Similarly, we expect SBI Cards to report a better margin, benefiting from the recent uptick in APR on revolver portfolio and reducing borrowing cost, though partly offset by higher LLP. Our medium-to-long-term preferred picks based on better margin/earning resiliency are HDFCB, ICICIB, SBI, RBL, KVB, Ujjivan, Indian Bank, and SBI Cards.

Slower growth, swift lending rate cuts to hurt margins

Credit growth for the system as well as our coverage stocks remains subdued at ~10% YoY/1% QoQ, while deposit growth on a weak base is at ~11% YoY/0.5% QoQ, leading to a slight uptick in LDR. Among banks that have provided business updates, HDFCB, KMB, BOB, KVB, and AU SFB surprised positively on credit growth. Amid weak credit demand and persistent stress in unsecured loans, we believe any pick-up in credit growth will be backended and primarily driven by secured loans (mainly mortgages). Thus, we believe that slower credit growth and lending rate cuts (driven by repo rate cuts) should lead to sharp margin contraction in Q1FY26E and Q2FY26E, partly offset by the recent SA rate cuts. For our coverage universe, we expect margin contraction of ~5-20bps QoQ, with large PVBs at the higher-end of the bracket and PSBs at the lower-end. We expect IDFCB, CUBK, SBI, and MFI-heavy banks to report relatively lower margin compression, while SBI Cards is likely to report margin expansion.

Fresh stress flow easing in Cards, but remains elevated for MFI

MFI stress flow is likely to remain elevated due to seasonal weakness in Q1FY26 and the impact of ordinances in Karnataka and TN, leading to elevated LLP for NBFC-MFIs and MFIheavy banks. The PL stress flow has peaked out but is likely to remain elevated in the near term. Credit card stress flow too is easing, but card players would prefer to accelerate charge-offs leading to higher LLP. Overall, corporate asset quality is holding up well and thus, we do not expect any meaningful NPA formation for PSBs. However, agri/KCC slippages could remain elevated for select large PVBs and PSBs due to seasonal factors, thereby calling for higher LLP. On an overall basis, we expect LLP to moderate but remain elevated in Q1FY26E due to higher charge-offs in unsecured and KCC loans

Subdued profitability for PVBs in Q1; PSBs to relatively outperform

We expect overall profitability growth for PVBs to remain subdued at 4% YoY; however, PSBs’ profitability growth is likely to be relatively better at 10% YoY, aided by better treasury gains, recovery from the write-off pool, and lower LLP. Among PVBs, we expect ICICIB, Indian Bank, SBI, and KVB to be outliers, while Axis would report relatively soft results due to weak margins and elevated credit cost. IndusInd Bank may turn profitable in the absence of any lumpy stress recognition. MFI-exposed banks/SFBs are likely to report slightly better profitability QoQ due to some moderation in LLP.

Prefer banks/NBFCs with earning resiliency amid growth/margin pangs in H1FY26

Bank Nifty has largely tracked the overall market performance over the past 3M (refer to Exhibit 7) amid hopes of a pick-up in credit growth following monetary policy/regulatory easing, peaking of stress in unsecured loans, and relative valuation comfort. We believe that credit growth is likely to remain soft in H1FY26E due to weak demand and banks’ focus on protecting margins, but should recover in H2FY26E mainly led by secured loans. Though peak stress in unsecured loans is behind, we believe NPA formation as well as LLP would remain elevated in H1FY26E and then gradually ease. Thus, we recommend banks/NBFCs that exhibit better growth/margins and asset quality resiliency while being ready to participate in the growth phase. Our preferred picks remain HDFCB, ICICIB, SBI, RBL, KVB, Ujjivan, Indian Bank, and SBI Cards. We believe Ujjivan and RBL offer a good play on the asset quality recovery story in H2FY26, while Ujjivan also runs a good chance to secure the Universal Banking license, along with AU SFB. Thus, we increased our TP for Ujjivan, RBL, and AU SFB by 18-20%. Further, factoring in the recent capital infusion in IDFCB, lower opex, reduced credit cost owing to a better MFI outlook, and RoA of ~0.8–1.2% in FY26– 28E, we raise our TP by ~14% to Rs80

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