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PPoP miss, but lower provisions drive earnings beat in Q2 for banks:

Banks under our coverage (cumulatively) reported an 8% miss on PPoP due to lower treasury gains and higher opex, but lower provisions led to a marginal (2%) earnings beat in Q2. Overall, PAT growth for our coverage universe was largely in-line at 23% YoY/down 4% QoQ, with PSBs reporting nearly 30% YoY/down 4% QoQ profit growth (partly dragged by SBI), while that for PVBs was relatively moderate at 19% YoY/down 4% QoQ, partly due to HDFC’s merger. Within large PVBs, ICICIB and IndusInd were outliers in terms of overall performance while maintaining heathy contingent buffer amid rising risk on unsecured loans. HDFCB surprised positively on business/earnings growth, but sharp margin correction was an irritant. Axis reported in-line earnings but continued to struggle on opex, while Kotak witnessed a sharp margin correction. Within small/midsize PVBs, KVB was an outlier delivering 1.5% RoA. CUBK continued to struggle on growth but delivered earnings beat due to lower provisions. IDFC First Bank reported an earnings miss due to higher LLP. Within SFBs, Ujjivan SFB reported in-line numbers, while AUSFB reported a sharp margin correction/rise in stress. Bandhan continued to disappoint on growth/asset-quality front. Within PSBs, BOB disappointed on margins/asset-quality front, while Indian Bank and Canara Bank reported decent performance. SBI surprised positively with stable margins, but higher opex led to earnings miss. Within NBFC MFIs, CREDAG reported strong results, while stress from floods persisted in Fusion Microfinance.

Growth remains healthy, but rising funding cost weighs on margins

Overall credit growth for our coverage universe was 15.5% YoY/4.4% QoQ mainly driven by retail, while deposit growth also accelerated. CASA cannibalization continued in Q2 as well, but a few banks witnessed a sequential dip in absolute SA deposits during Q2, which is otherwise typically seen in Q1 and possibly could be due to mini DeMo of Rs2K notes. This coupled with rising CoF and impact of ICRR weighed on margins – down 10-40bps QoQ with HDFCB/Ujjivan and Equitas reporting the highest margin contraction. However, banks like Axis, IIB, SBI and Canara reported stable margins, while RBL was an outlier reporting margin expansion. Going forward, most banks expect the growth momentum to remain healthy, with the festive season bunching up in Q3, while the pace of margin contraction is expected to moderate a bit in Q3 as the impact of ICRR is largely behind.

Stress in unsecured loans on rise; RBI could act post the festive season

Headline GNPA ratio declined further to 3.2%, down 20bps QoQ due to moderate slippages, healthy recoveries and higher w-offs. However, select banks like Bandhan, AUSFB and SBI Cards among NBFCs reported a sequential uptick in NPAs, while Fusion reported higher slippages due to the impact of floods in northern India. BOB also reported higher slippages due to the recognition of GoAir and one corporate based out of UAE. Separately, a few banks confirmed our view on rising stress in unsecured PL/BL (refer our recent note on October 15 – RBI’s intervention in unsecured loans could hurt growth/profitability BFSI Sector Update_151023_Others) and potential RBI action post the festive season. Our discussion with the banks suggests that stress in the low-ticket PL is mainly due to overleveraging/income dislocation for customers, while banks in general (ex-SFB) have negligible exposure to these loans. That said, we believe any RBI action could moderate growth in the unsecured PL/BL segment, as players turn cautious. Cards are also witnessing stress, as is visible in the case of RBL/SBIC and, thus, RBL initiated making a contingent provision buffer (1% on cards + MFI). Among other banks, ICICI, Axis, HDFC, IIB and Ujjivan already carry healthy contingent buffers (>0.7% of loans).

Prefer banks with a healthy capital/provision buffer amid rising signs of stress

We expect credit growth to remain healthy in the near term due to the festive season bunching up in Q3, while the pace of margin contraction is likely to ease a bit vs. Q2 with ICRR impact largely behind. Opex should continue to remain elevated with private banks expanding their liability/customer franchisee, while PSBs accelerating provisions on retirement liabilities amid nearing conclusion of new-wage negotiation. This should weigh on PPoP growth. However, LLP should remain soft, leading to continued healthy profitability with most PSBs reporting ~1% RoA and PVBs reporting 1.0-2.3% RoA. That said, amid rising signs of stress in unsecured loans in select pockets, we prefer banks with relatively healthy capital/provision buffer. Among large-cap banks, we prefer IndusInd and ICICI Bank, while we believe that management’s transition should weigh on Kotak’s performance. Within small-mid cap banks, we prefer Karur Vysya Bank (KVB) followed by Federal Bank. A higher share of unsecured loans poses a risk for RBL, but the bank has proactively begun building contingent provision buffers, which we believe is a step in the right direction. Within PSBs, we prefer Indian and Canara Bank, given their healthy RoA trajectory and reasonable valuations. Among SFBs/NBFCs, we retain our BUY rating on Ujjivan and CREDAG, while we believe the merger will be a drag for AUSFB and rising stress on SBI Cards. Stocks to watch-out for in Q3: For HDFCB – Healthy deposit growth and margin recovery, while CGFMU/Assam loan recovery for Bandhan Bank could trigger an upmove in the stock price.

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