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Higher credit costs drive sharp earnings cuts across mid-size private banks

* Credit growth moderates; estimate FY25 credit growth at ~11%: Systemic credit growth has declined to ~11.5% from the recent high of ~16% amid a slowdown in unsecured retail and demand moderation in certain other secured segments. A few banks have already lowered their growth guidance (IIB, RBK), while select large banks are also likely to report tepid full-year growth guidance owing to a high CD ratio and rising asset quality concerns. Slower economic activity as reflected in a slower GDP growth print is closely watched and may drive growth moderation in Corporate/SME segments. While the incremental LDR has moderated to below 80% (~100% in Jul’24), the outstanding LDR remains elevated at ~80%. We thus estimate credit growth to be at ~11% for FY25, while expect FY26 growth to be broadly maintained at 12.5%.

* Deposit growth stood at 11.5% in Dec’24; CASA accretion remains a challenge: Deposit growth has broadly followed a narrow range of 10-13% over the past 18 months and is up 7.8% YTD vs. the YTD credit growth of 7%. Further, deposit competition remains aggressive as many banks are focusing on improving their CD ratios, while competition from PSU banks is also picking up. CASA accretion remains a challenge as depositors are locking in money at higher term deposit rates ahead of a potential reversal in the rate cycle. Consequently, we estimate the funding cost to stay elevated, thus maintaining pressure on margins. With rate cuts projected in early CY25, the banking system’s yield will likely witness further pressure over the coming quarters.

* Asset quality stress remains elevated in MFI, unsecured retail; PSU banks are well placed: 1HFY25 saw a deterioration in asset quality for select lenders, and we believe that the asset quality stress will continue for lenders (mainly mid-size private banks), especially those with exposure to the unsecured retail and MFI segments. We factor in a rise in provisioning expenses for select players like IIB, RBK, Equitas, Bandhan and IDFCFB, while large private/PSU banks are relatively better positioned to navigate through the current cycle.

Private Banks: PAT to grow ~2.3% YoY in 3QFY25 (5.8% YoY in 2QFY25 and 7% YoY in FY25E)

* For the private banks under our coverage, we estimate PPoP growth of 10.4% YoY/ 0.6% QoQ and PAT growth of 2.3% YoY/decline of 2.2% QoQ in 3QFY25. We also estimate a 15% CAGR in earnings over FY25-27.

* We estimate NII to grow 9.3% YoY in 3QFY25. Among large private banks under our coverage, HDFCB’s growth is estimated to be at 6.5% YoY, ICICI at 10.9% YoY, Axis at 9% YoY, KMB at 8.9% YoY, and Federal at 15% YoY. For IIB, NII is expected to decline by 0.3% YoY.

* Opex is likely to follow a normalized trend, as banks continue to invest in branches and digital capabilities. Other income is anticipated to be modest as bonds yields have seen a slight uptick, while markets have been volatile.

* Overall slippages are expected to remain under control, though unsecured retail (especially MFI segment) is likely to witness high delinquencies. We remain cautious about the credit quality outlook and factor in higher credit costs across most mid-size banks with exposure to unsecured retail/MFI segments.

PSU Banks: PAT to grow 36% YoY (vs. 33.5% YoY in 2QFY25 and 19.7% YoY in FY25E)

* We estimate PSBs to report earnings growth of 36.3% YoY (12.2% QoQ decline) amid lower other income and tepid margins. NII is likely to see a modest 5.4% YoY growth as the margin bias remains negative. Accordingly, we estimate PSU banks to report a 10% CAGR in aggregate earnings over FY25-27.

* Opex is likely to be under control, as most of the wage-related provisions and other opex were accounted for in FY24. Thus, we expect opex to follow a normalized trajectory. Treasury performance is likely to remain muted as bond yields have seen an uptick in 3Q, while equity markets have been volatile.

* Asset quality is likely to remain robust: Though 2Q saw a slight increase in SMA pool, it should not translate into slippages. Moreover, healthy recoveries will keep the credit cost under control. The asset quality developments in MSME segment, along with ECL provisioning requirements, will be monitored closely to better assess the credit cost outlook.

Small Finance Banks: Asset quality pressures to continue

* AUBANK’s 3QFY25 PAT is likely to grow 30.2% YoY to INR5b (aided by merger with Fincare SFB, 14.5% QoQ decline). NII is expected to grow 53% YoY (2.6% QoQ), while NIMs may decline marginally. Asset quality may witness a slight deterioration with high delinquencies in MFI/Card segments.

* EQUITASB is estimated to report a modest quarter, with PAT expected to dip by 60% YoY as provisioning expenses remain elevated on both fresh slippages and MFI slippages in the erstwhile quarters as per the provisioning policy. We estimate advances growth at 20% YoY/3.6% QoQ, while NIMs may moderate by 18bp QoQ.

Payments/Fintech: Credit cost to stay elevated; Paytm on track to report adj. EBITDA breakeven in 4QFY25

* SBICARDS: Retail spend growth is likely to remain healthy, while NIMs may see a slightly positive bias. However, asset quality stress is likely to continue, leading to high credit costs. We thus estimate PAT to decline 21.5% YoY.

* PAYTM: We estimate 10% QoQ growth in GMV in 3QFY25 to INR4.9t. Revenue from operations is projected to increase 8% QoQ to INR18b, while contribution profit is estimated to rise 14% QoQ to INR10.12b in 3QFY25. Contribution margin is thus likely to improve to ~56.6%.

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