Banking Sector Update : Working through a period of uncertainty and high volatility by Kotak Institutional Equities
Working through a period of uncertainty and high volatility
Given the uncertainties that we are currently surrounded with, it is likely that we may have to rely on two probable paths: (1) valuation and (2) charting the probable course of action but having a flexible view on the possible range of outcomes. In this report, we shall give a perspective on how we are looking at the issues at hand.
Valuation, if inexpensive, can obliterate near-term business performance
In an uncertain world, an inexpensive valuation can always provide comfort, especially in a cyclical business. Exhibits 1-10 show the valuation of private and public banks. We are not at cyclical lows that we had tested during Covid or during the corporate NPL cycle. PSU banks have underperformed large private banks in recent times despite no concerns about asset quality. SBI’s outperformance with its public bank peers suggests a general preference to stay with better quality names—a thesis that is worth assessing.
Have a flexible outlook on growth and asset quality in a period of slowdown
As growth and NPLs have some degree of correlation, it would be a reasonable assumption to make that managements are probably undecided on the pace of growth and places to grow that can offer relatively safer outcomes. We could potentially see scenarios where (1) PSU banks gain market share as they could potentially be a lot more confident than private banks, (2) the government could look to give confidence and comfort to lenders to build growth in certain areas through credit guarantee mechanisms such as what we witnessed during Covid through schemes such as ECLGS, (3) cash flow mismatches create growth opportunities, especially in the corporate sector where credit consumption has been weak, as the ability to raise equity or manage cash flow through internal accruals has been strong. The issue with these types of growth, especially those funding cash flow mismatches during the current period, is likely to be scrutinized intensely even when the risk-reward is favorable to lenders and (4) loan growth slows but deposit growth accelerates, which implies that the opportunity to improve NIM comes through liability mix rather than assets. Notwithstanding newer ideas to boost growth, it is fairly certain that the wide range of outcomes creates its own set of payoffs on growth, NIM, credit cost and profitability. Having a strong view on one particular path could result in missing the theme that might eventually dominate the next few years.
Axis and SBI well-positioned; microfinance plays possible around the corner
We don’t see any reason to change our view currently. We would want to believe that system credit could potentially grow slower than system deposits. We also believe that asset quality deterioration, despite fears, is unlikely to materialize immediately. This would imply that Axis Bank would be positioned best among the large private banks. SBI is likely to be well-positioned in this leg of the cycle, where concerns are primarily on NIM.
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