Performance of the banking & financial service (BFS) sector is likely to remain under stress in 2QFY18, led by: (a) higher provisioning for ageing of existing NPAs; (b) sharp decline in profitability from treasury operations; (c) muted growth in core operating income; and (d) weaker system-level credit growth.
However, the banks/ NBFCs with relatively higher exposure to retail and MSME segments will continue to deliver strong numbers.
We expect the banks with significant exposure to corporate term loans to report elevated level of slippages and higher provisioning expenses. Ageing of existing NPAs and write-down of security receipts from sale to the ARC will keep their credit cost at elevated level in 2QFY18 and 2HFY18 as well.
The Reserve Bank of India (RBI) has further identified second set of larger stressed corporate accounts and asked the banks to refer them to Insolvency & Bankruptcy Code (IBC). Further, the RBI has also asked the banks to provide more than 50 per cent on all these accounts, which will negatively impact their profitability. The central bank has provided a 6-month timeframe to resolve large stressed accounts.
In case the banks fail to resolve these accounts by the given timeframe, they may have to refer them to insolvency board and provide 100 per cent towards these accounts. Hence, we expect the earnings profile of the corporate focused banks to remain subdued in 2QFY18. However, the banks with higher retail/consumer portfolio will continue to show stable trend in their asset quality. Hence, the banks with larger focus towards retail segment will continue to perform better on earnings and asset quality front.
Banking system credit growth continues to remain at multi-year low of 6.8 per cent in the fortnight ending September 15th, 2017. YTD growth in loan book stood at-1.3 per cent, which clearly indicates muted growth in loan book during 1HFY18, especially for corporate-focused public and private sector banks. Further, deposit growth remained higher led by massive inflow of deposit during the demonetisation drive.
Lending rate fell sharply on the back of liquidity overhang, which resulted in moderation in net interest margins (NIMs). This along with pressure on NIMs will curb NII growth for these banks in 2QFY17 as well as in full FY18.
Further, the sector has got negatively impacted by sharp rise in bond yield due to deteriorating conditions on fiscal deficit front both at centre and state level. Fiscal deficit of the Central government touched 96.1 per cent of the budget estimate for full FY18 at the end of Aug’17, as the government continued spending spree to support the economy. Resultantly, the benchmark G-Sec bond yield jumped to 6.66 per cent as of 2QFY18-end compared to 6.51 per cent as of 1QFY18-end.
Increase in G-Sec yield will result in mark-to-market (MTM) loss on non-HTM investment portfolio of the banks as well as sharp dip in treasury income. As the banks have deployed major chunk of excess liquidity from the demonetisation drive in these government bonds, they have no other option but to report MTM loss from this portfolio.
We expect our banking sector coverage universe to report a NII growth of 17.1 per cent YoY and 3.5 per cent QoQ led by PSU banks (17.9 per cent YoY and 3.4 per cent QoQ) and private sector banks (16.3 per cent YoY and 3.7 per cent QoQ).
However, other income of our banking universe is expected to decline by 21.8 per cent YoY and 10.3 per cent QoQ led by sharp fall in treasury income. Thus, on pre-provisioning profit front, we expect decline of 6.5 per cent YoY and 2.8 per cent QoQ. Overall, we expect our banking sector coverage universe to report 4.9 per cent YoY and 8.3 per cent QoQ growth in PAT led by private banks with 12.7 per cent YoY and 4 per cent QoQ growth vis-à-vis 11.8 per cent YoY decline for PSU banks.
Outlook & valuation
Lower operating profit, subdued income from treasury operations and higher credit cost on ageing of stressed assets will negatively impact sequential performance of the banks in 2QFY18. As the recent steps by the RBI and the government of India clearly indicate that the banks will have to accelerate their efforts to resolve issues on asset quality front, we expect further surge in provisioning expenses in full FY18. We expect overall return will continue to remain depressed over FY18E for the banking sector in general and corporate term loan focused banks in particular.
Further, we believe that incremental deterioration in asset quality has been aptly addressed in last few quarters, however speedy resolution will continue to impact banks’ profitability. We expect improvement in banks’ core operating performance in coming quarters due to peaking of NPA recognition cycle and improvement in non-corporate credit demand. As we expect the demand for retail loan to pick-up before any rise in infrastructure/corporate loans, we prefer the banks having higher exposure to consumer and business banking portfolio. We expect asset quality stress to decline along with relatively moderation credit cost from FY19E onwards.
IndusInd Bank, DCB Bank, HDFC Bank and Federal Bank among private sector banks and SBI, BoB and Indian Bank among PSBs.