The banking stocks in India have had a tumultuous two years. Having given investors big returns in 2012, they lost a lot of ground on the back of deteriorating macro-economic indicators and burgeoning bad loans. But the pace of deterioration of their asset quality has slowed, indicating good times ahead. Most banks that we have analysed have shown resilience by stemming the bad loans rot. The trend of Q2FY14 numbers indicate an early sign of revival with the pace of deterioration coming off significantly. The private banks continue to show a healthy trend backed by retail assets, which have not yet shown any significant deterioration. However, the significant slowdown in the economy has resulted in lower offtake of retail credit such as auto and home loans.
Most banks we studied grew their balance-sheet at a decent rate, except for Punjab National Bank (PNB).  Despite the RBI’s liquidity tightening measures and consequent rise in cost of short-term funds, the banks were able to by and large protect their margins, contrary to market expectations.
With the rupee recovering plenty of lost ground, and the RBI reversing its temporary moves, liquidity has significantly eased in the system. Banks have accumulated over Rs 2 trillion in foreign currency by way of non-repatriable account deposits (FCNR). The FCNRs are fixed deposit foreign currency accounts. Deposits in this account can be made in any of the major currencies such as the dollar,euro or pound sterling. This accumulation has pushed the credit deposit ratio to more comfortable levels, erasing any liquidity risk.
 Capital burning was limited for most PSU banks except for Bank of Baroda (BoB) at 39 bps in Q2, while it rose by 41 bps for Bank of India (BoI) due to the issue of Tier-II (Rs 15 billion) in Q2. HDFC Bank and ICICI Bank have seen higher capital burning of 90 bps and 50 bps respectively while ING Vysya has seen a 416 bps rise due to the equity issue of Rs 18.4 billion. Though the government has announced capital infusion for PSU banks in FY14, the move is unlikely to drive the Tier-I capital adequacy ratio of PSU banks by more than 30-40bps.
 Banks’ performance on the non-interest income front remained lackadaisical, mainly due to the lack of support from treasury income amid lower transaction-related fee income.
We take a closer look at some of the frontline banking stocks and their possible movement in the next one year.
 
Axis Bank: Macro Pain
CMP: Rs 1,185
Target Price: Rs 1,245
Potential Growth:  5%

The Management of Axis Bank has recently revised its total impairment (slippage plus incremental restructuring) guidance upwardly by 20% to Rs 60 billion for FY14. Analysts expect slippage to increase to 2.1% in H2FY14 from 1.3% in H1FY14. The bank could remain vulnerable to defaults from its medium and small scale business borrowers. Its  gross NPA could increase to 2% from the current levels of 1.2%.
 Axis Bank gives a ratings break-up of its corporate and SME loan book. Corporate loan book in the “BBB” category and below “BBB” category has increased from 19% in FY08 to 25% in FY11 and further surging to 39% as of H1FY14. On the other hand the rating of its SME loan book in the vulnerable category has slightly declined from 10% in FY10 to 7% in H1FY14.
Axis Bank’s retail segment expanded to 30% of its overall book from just 19% in FY11. Its management wants to continue to expanding the retail share. Though the retail portfolio of the overall industry in terms of delinquencies has so far done well, it also means that portfolio is unseasoned. With tremendous slowdown across the economy, the retail segment is also expected to suffer. It may be a good time to move out of the stock.
 
Bank of Baroda: Asset Quality Concerns
CMP: Rs 618
Target Price: Rs 615
Potential growth: None

While most of the PSU Banks were struggling with asset quality issues, Bank of Baroda (BoB) had an average slippage of 1.1% in FY11-12. There was a management change at the bank, yet, the slippages went up to 2.2% in FY13. Higher stress has been seen in large and medium corporate lending segments where gross NPA has increased by 50 bps to 5.6% in Q2FY14. There may be more pain in store for the bank on the front. BoB has grown its overall business at above industry pace. The average growth for the last four years has been 25% in deposits as well as advances. Its overseas business has grown at a higher average rate and now forms 32% of its total business. However, the bank’s NIMs have crashed by over 75 bps in last two years to 2.3%. There could be better buys than BoB in the PSU pack right now.

Bank of India: Pressure Eases A Bit
CMP: Rs 233
Target Price: Rs 265
Potential Growth: 14%

The average slippages for Bank of India (BoI) have eased significantly to 2.1% in the last 4 quarters as against 3.5% in H1FY13. The bank’s management expects pressure on asset quality to ease progressively. Unlike its peers, the BoI has relatively lesser exposure to vulnerable sectors such as infrastructure, metals, mining and textiles.
Even after accounting for equity infusion by the government, BoI’s tier-I capital is expected to remain below 8%. The lack  of capital can be a roadblock for its growth. A target price of Rs 265 per share looks reasonably gettable for BoI.
 
DCB: Smart Turnaround
CMP: Rs 58
Target Price: Rs 70
Potential Growth: 22%

DCB has demonstrated improvement in its asset quality. In response to extreme stress in the retail category, the Bank allowed its unsecured personal loans segment to run off thereby de-risking the portfolio. Its average incremental slippages for past three years are within 1.3% (comparable to other private sector banks).
The Bank is well-positioned to gain market share in next three years. While it contracted its unsecured retail book, it grew its mortgage and SME credit business by 80% and 35% annually.
On the liability side, the bank has been able to increase current and savings account (CASA) and retail deposits, lowering dependence on bulk deposits. The recent rating upgrade of its tier-II bonds and certificate of deposits would help the Bank in reducing its cost of funds and improving funding opportunities. Its strategy of metro-centric branches has worked. It currently has 94 branches but plans to aggressively roll out 20-30 new branches every year.
DCB has so far been able to manage its cost successfully by bringing down the cost-to-income ratio to 70.7% in FY13 from 86.7% in FY10. Unlike some of its peers, DCB doesn’t have unionized employees which enables it keep a tight leash on costs. DCB’s Management has targeted to improve cost-to-income to 60% by FY15. Entering the stock with a target price of Rs 70 may be a good idea.

HDFC Bank: Is There Room To Grow?
CMP: Rs 673
Target Price: Rs 725
Potential Growth: 8%

HDFC Bank’s asset quality has shown tremendous resilience in the last three years, while its slippages declining to 0.9% in FY12, which is even better than the expectations of its management. Its gross NPA remains stable at 1%, with no major restructured assets. It would be very difficult for the bank to further improve on this front, given the composition of its loan book.
HDFC Bank’s credit growth remains strong and it continues to grow 4-5% above the industry average. However, the growth has off-late come more from the retail segment, whereas the corporate segment has relatively slowed down. The Bank’s CASA – which used to be more than 50% – has declined to  about 45% in Q2FY14.
Despite difficult conditions backed by its strong deposit franchise, the bank has been able to maintain the NIMs of 4.5%, which is best in the industry. The Bank’s cost of funds is one of the lowest at 5.7%. Despite the decline in CASA, the bank has been able to maintain its NIMs on the back of shift in portfolio mix from corporate to retail. Its management believes it’s possible to maintain NIMs at the current level.
 
ICICI Bank: Rearing Rewards of Conservatism
CMP: Rs 1,055
Target Price: Rs 1,190
Potential Growth: 13%

There has been substantial improvement in the asset quality of ICICI Bank with its gross NPA improving by more than 200 bps in three years compared to the deterioration most of its competitors have witnessed. Its restructured book at just 2.1% of the loan book seems to put it in a zone of comfort. According to the bank’s management, the credit cost – including restructuring related provisioning – would remain within 0.75% of the loan book in FY14. The company says it has a restructuring pipeline of Rs 20 billion for H2FY14.
Picking up the pace, the bank’s balance-sheet growth has started growing marginally above the industry, compared to the underperformance last year. Though the bank’s retail credit has shown initial signs of revival, it has shifted significantly away from the unsecured retail credit business. It has now built a strong CASA base of 43.3% in Q2FY14 up from 28.7% in FY09.
The Bank’s NIMs have improved by 60 bps over the last three years to 3.2%, with a push from domestic as well as the international segment. With CASA at comfortable levels, it won’t be very difficult for the bank to maintain the NIMs at current levels. You could enter the stock with a target price of Rs 1200 per share.

ING Vysya: Steady Performer
CMP: Rs 581
Target Price: Rs 630
Potential Growth: 8%

The bank’s credit growth has increased substantially, outpacing the industry average, especially after the appointment of a new management. The bank’s balance sheet growth slowed down a tad thanks to the management’s cautious approach in FY13.
With the recent follow-on offer, the bank has the gained strength to leverage its balance sheet in the coming days. ING Vysya’s asset quality has shown a sharp improvement over the past three years compared to its peers. It has negligible exposure in any of the ailing sectors like aviation, state electricity boards, realty or energy companies. The bank mainly focuses on providing working capital for business houses, where it has better control of its cash-flow. The bank’s gross NPA of 0.3% in the SME segment is remarkable. The bank has so far been able to successfully manage its cost by bringing down cost-to-income ratio to 57% in FY13 from 83.4% in FY06. The proportion of unionized staff has declined from 30%  to about 35% of the total workforce. As a long-term strategy, ING Vysya plans to bring down the cost-to-income ratio close to 50% in next three years. Investors who have exposure to the scrip could hold on to it for a reasonable upside in the region of Rs 630 per share.
 
J&K Bank: Improving Fundamentals
CMP: Rs 1,385
Target Price: Rs 1,755
Potential Growth: 27%

Unlike other PSU Banks which are struggling with sharp deterioration in their asset quality, J&K Bank has improved its gross NPA by 20 bps over the last two years. This outperformance can be attributed to superior domain expertise in the SME and trade segment within the state of J&K. A majority of personal loans within the State relates to housing loans to state government employees. Almost all employees have their salary account with J&K Bank. Greater economic activity within the state of J&K has helped the bank. For lending outside the state of J&K, it sticks to well-rated corporate houses.
J&K Bank’s NIMs are on an upswing. It has reported NIMs  higher than 4% in the last four quarters. Higher CASA (39%) and better liability franchise have helped in managing the total cost of deposits lower than its peers.
Its NIMs have improved on the back of improvement in credit-deposit (CD) ratio and tilting its advance portfolio in favour of the state of J&K. CD ratio has improved by 600 bps over last two quarters to 67%, yet it is significantly lower than industry average of 77%, which suggests further scope for expansion.
The bank enjoys one of the best RoE and RoA profile compared to its peers, which has consistently improved over past few years on the back of higher NIMs, operational efficiency and lower slippages resulting in lower credit cost.
J&K bank looks a good buy with a target price of Rs 1755 per share.

PNB: Biggest Beneficiary of Likely Economic Turnaround
CMP: Rs 601
Target Price: Rs 730
Potential Growth: 21%

Punjab National Bank’s credit growth has slowed down to 6% as against over 20% CAGR in last the last eight years. The substantially lower growth indicates the management’s commitment towards asset quality restoration at the risk of foregoing credit expansion.
PNB is trading at discount to BoB and SBI mainly on account of higher slippages and restructuring. In the earlier interest rate cycle, the bank mostly traded ata  premium to its PSU peers on account of its better NIMs and return on equity profile.
On account of deterioration in its asset book, PNB’s credit cost has taken a huge hit over the past two years. Despite the situation worsening, the bank has been able to maintain its provision coverage at around 55% for the last five quarters. With expected improvement in economy and recovery cycle along with interest rate cuts, the bank will be a big beneficiary going forward. Its share price shoot up to Rs 730 over the next few months.
 
SBI: The Big Biff
CMP: Rs 1,641
Target Price: Rs 2,100
Potential Growth: 28%

State Bank of India (SBI) has witnessed huge pressure on its asset quality with gross NPA increasing by 140 bps over the last two years. Resultantly, the bank has accounted for higher credit cost, while keeping provision coverage stable. With expectations of a gradual recovery in the economy, expect incremental slippages and credit cost to start trending downwards. Slippage significantly eased to 3% in Q2FY14 compared to a worrying 5.2% in Q1FY14. More than half of the  slippages are from the mid-corporate segment. SBI’s NIMs (domestic) underwent a significant compression of about 15 bps over the last four quarters. 
Pressure on its NIMs is expected to continue going forward on account of the slowdown seen in the high-yielding SME segment and discounts offered in the retail segment.
The overall slowdown in SBI’s corporate credit is a cause of concern. The bank has significantly tightened its lending standards for mid-sized corporates and SME segment, which has seen higher slippages. A majority of the incremental growth will be driven by retail and large corporate segments in the months to come. SBI can be entered now with a target price of Rs 2100 per share.