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Banking On Revival

Author: Team Finapolis/Wednesday, April 1, 2015/Categories: Stocks

Banking On Revival

The banking sector over the last few years has been beset by bad loans going up and credit off take almost stagnating. Banks being the arteries of the economic system, they’ve suffered more than other sectors as economic growth dried out. 

However, with signs of a turnaround now visible, the banking sector is expected to perform much better in FY16 compared to FY15. An expected improvement in the economy coupled with declining interest rates is expected to lead to a pick-up in credit growth and stabilization in asset quality.

Banks reporting strong performances will gain favour among investors. Private banks could outshine their public sector peers, led by better growth, asset quality, higher return ratios and better capitalization. 

The answer to the many problems facing Indian banks lies in an improvement of economic climate. With inflation expected to be benign, rate cuts by the Reserve Bank of India (RBI) have already started coming in. An additional 50-75bps rate cut seems likely by the end of FY16. Credit growth for FY15 is expected to be around 11-11.5% whereas for FY16, it is expected to improve to about 13-14%. 

 FY15 has been mixed for the banking sector. Private banks have fared much better than PSU banks. The bad loans on the books of government banks have risen. PSU Banks are likely to face higher pressure as they have sizable restructured books. 

FY15 has seen a slew of reforms despite the economic sluggishness. Economic growth has stabilized and also started reporting improvement. GDP growth is likely to improve to 5.5% for FY15 from 4.7% in FY14. An improvement in the economy and a higher GDP growth will be the key trigger for the banking sector, going forward. Overall credit growth in the system has slowed down in FY15 with most of the banks witnessing a lower credit off-take; however, private banks’ credit growth has fared much better. Also, on the asset quality side, barring a couple of private banks, all the others have reported stable NPAs while most PSBs reported a significant deterioration in their asset quality. A decline in the price of crude oil has largely contributed to a decline in inflation along with a reduction in the fiscal deficit. Despite higher prices for food articles, CPI inflation has remained lower. With much lower than expected inflation, rate cuts by the RBI have already started coming in. The RBI has already reduced repo rate by 50bps in 4QFY15 and we expect an additional 50-75bps rate cut by the end of FY16. As interest rates have already come down in the past 9 months, banks are likely to reduce their base rate either by late 4QFY15 or in 1QFY16, which will further support credit growth. 

RBI has taken a few steps to support the banking space. The special 5-25 rule for refinancing of existing infrastructure projects will provide required relief to banks which were reeling under the pressure of restructured advances. As per this rule, banks can restructure existing infra projects without the same being classified as GNPA. Private sector banks remain clear winners in 9MFY15 For 9MFY15, the banking sector has given a mixed performance with private sector banks faring much better than PSBs. PSBs have witnessed deterioration in their asset quality, and hinted at further stress on their books in the next couple of quarters. Though lower interest rates have supported the NIMs of both private banks as well as PSBs, higher asset quality stress leading to higher credit costs have led to lower earnings for PSBs. 

Currently banks have enough excess liquidity due to lower credit offtake with SLR deposits at 29% versus the mandatory 22.5%. With an improvement in credit offtake, banks can easily withdraw the excess SLR in favour of advances, thus resulting in an improvement in NIMs. Banks reporting quality performance will gain favour among investors. Individual stock performances will be more important than the sector’s performance. 

In the post election market rally, all the stocks across the banking space have shown a sharp rise on the back of an expected improvement in their performance led by an expected economic revival. An improving economy after a prolonged period of slowdown has lead to buoyancy in the valuations in the banking space. Considering long term outlook and revival of the economic cycle, there is still plenty of upside left. 

We take a look at some of the frontline banking stocks. 

Safe Bet

Axis Bank is well placed to gain from an expected revival in the economy, given its improving liability franchise and a strong focus on retail advances. 

With the Union Budget 2015-16 removing the distinction between FPI and FII holding, Axis is ripe for greater FII investment. Given its strong earnings growth, stable asset quality and high return ratios, Axis would be a good investment bet. 

Over the past several years, the bank has been focusing on its retail business, leading to the share of retail loans increasing to 38 % of total loans. Higher share of retail loans has helped the bank in strengthening its reach as well as supported its net interest margins (NIM). Over FY10-14, advances of Axis Bank have grown at a faster pace of 22% versus the industry average of 17%. It’s likely to stay a step ahead of industry average. 

The share of retail deposits for the bank as a percentage of total deposits has improved from 39% in FY11 to 62% in now aided by its deeper retail penetration. Axis  Bank’s asset quality has been more or less resilient. The bank’s GNPA and NNPA currently stand at a very respectable 1.34% and 0.44%. 

With improved growth in advances, moderating credit costs and strong business focus, we expect the return ratios to remain stable, going forward. The earnings of the bank are expected to grow by 16% over FY14-17. Investors could look at a target price of Rs 735 for the stock representing upside in excess of 30%. 

Fortunes Turned Around

DCB has been nursed back to a healthy state by its management with an all- round improvement in all the operating parameters, in spite of negative macro-headwinds. A rapid expansion in secured advances has helped towards an improvement in the asset quality. Continuous improvement in cost to income ratio along with strong growth in advances will support its earnings growth. Its earnings could grow at a CAGR of 27% over FY17 led by a 25% growth in its advances. 

Post FY2009, the bank has turned its focus to relatively more secured assets category. DCB de-risked its portfolio in favour of secured mortgage and SME/MSME advances from high ticket and unsecured advances. During FY10-14, strong growth in mortgage (37% CAGR) and SME (22% CAGR) segments led to a 24% CAGR in loan growth. Its corporate loan book reported a slower growth of 17% (CAGR) over FY10-14. Going forward, advances are expected to grow at a CAGR of 25% over FY14- 17. 

The bank opted for consolidation in FY09 and FY10 and shifted its focus to secured retail and SME loans. The bank’s asset quality has improved since then, as is reflected in GNPA and NNPA having reduced to 1.9% and 1%. 

Driven by strong growth in advances, improving operating performance and asset quality, and strong capital adequacy of 14.4%, expect the return ratios to improve going ahead. Over  the next 12 months the stock could soar to Rs 138 representing a 27% upside on its current valuations. 

Firing On All Cylinders

Federal Bank is a south-based bank with major concentration in the state of Kerala. The bank is well placed to capitalize on the macro economic revival in the country. Post the consolidation phase in FY14, the bank has addressed most of the constraining issues (higher focus on secured advances) and is likely to report improved performance, going ahead. The bank is mainly focused on retail and SME advances for loan growth. We expect an improvement in return ratios for the bank which will make it a strong growth candidate. Earnings could grow at a CAGR of 22% over FY14-17, led by 19% growth in advances. 

Post the consolidation in advances in FY14 where the bank’s loan book declined by 1.5%; however, the bank is now all set to bounce back sharply. It is reducing its focus on corporate advances and increasing concentration on high yielding and better rated retail and SME advances. The share of corporate advances to total advances has declined from 39% in FY10 to 30% in Q3FY15. The bank is now primarily focusing on SME and retail advances to improve its advances growth. We expect the advances of the bank to grow at a CAGR of 19% over FY14-17. 

Federal Bank’s asset quality has been improving since FY14. The asset quality had deteriorated sharply post FY12- 13, leading the bank to go for consolidation. Since then, the bank has witnessed lower slippages and higher recoveries, leading to an overall improvement in the GNPA. The GNPA declined from 3.4% in FY13 to 2.2% now.  Strong advances growth, and stable NIMs and asset quality, are likely to lead to an improvement in return ratios. The stock is currently trading at 1.3x FY2017 ABV. In the next one year the stock could reach levels of Rs 182 representing a growth of 33%.

Positives Priced In 

HDFC Bank is one of the best performing banks in India. It is the second largest private sector bank in the country, and reports impeccable asset quality, higher than industry level advances growth, and strong return ratios. Lack of headroom for FIIs to invest in the bank has however led to narrowing down of the valuation gap between HDFC Bank vis-a-vis its peers. HDFC Bank’s current valuations price in most of the positives and we therefore may only have limited room for appreciation.

Despite the sluggish domestic economy, the asset quality of HDFC Bank has remained strong. Led by strong underwriting policy and stringent recovery procedures, HDFC Bank continues to report best in class asset quality. GNPA of the bank has remained at 1-1.2% for the past several years. The bank also provides for all its NPAs adequately. NNPA also continues to remain firmly under control for the bank. 

Historically, HDFC Bank has always focused on outpacing the industry by 4-5%. The bank has a balance between advances in the retail and corporate segments. Growth in corporate loan segment is mostly driven by working capital loans whereas on the retail side, auto and home loans are the key drivers. 

HDFC Bank reports strong advances growth, higher CASA and NIMs, best in-class and stable asset quality, lower credit cost and strong return ratios. However, the valuation premium that the bank enjoys over its peers (Axis Bank, ICICI Bank, Yes Bank) has contracted, owing to lack of headroom for FIIs to invest in the stock. It could be a good stock to hold on to. Over the next year it could appreciate about 10%-15% to levels of Rs 1200. 

Strong Core

India’s largest private sector bank, has reported an impressive performance post its consolidation phase. Led by its 5C strategy of Credit Growth, Credit Quality, CASA, Customer Centricity, and Cost Efficiency, the operating parameters of the bank have improved sharply. With all the subsidiaries adding value, ICICI Bank is in a sweet spot.

The bank has shifted its focus to secured retail advances post FY11 over unsecured credit cards, personal loans as well as unsecured corporate advances. About 26% of the bank’s advances are contributed by overseas book and the bank will likely continue to maintain its focus on the overseas business. We expect overall advances to grow by 20% over FY14- 17. 

Focus on SME and retail advances, strong focus on CASA deposits, repatriating of excess capital by overseas subsidiaries and an improving credit deposit ratio have also contributed to improvement in NIMs. GNPA for the bank has improved from 5.1% in FY10 to 3.1% in FY14 though it increased for the first time in 19 quarters in Q3FY15 to 3.4%. The bank expects the asset quality to be under pressure for the next two quarters. GNPA could remain higher in FY15, but decline going ahead in FY16 and improve to 2.8% by FY17. Its shares could reach levels of Rs 433 in the next year representing a 30% upside.

All Round Rebound

Yes Bank has grown at a healthy pace in the past few years and has emerged as the fourth largest lender in the private banking space. The bank is increasing its footprint in the retail segment by expanding its branch network and is as a result witnessing a consistently improving share of retail advances and deposits.  Strong return ratio of the bank is set to continue, backed by improvement in NIMs and robust asset quality.  Led by an improvement in economic activity, along with continuous focus on balance sheet expansion, Yes Bank is likely to report a strong growth in its lending activities in the coming years. Though the bank has traditionally been strong in corporate lending, it is now increasing its focus on the SME and retail business. Advances are expected to grow at a CAGR of 29% over FY14-17. 

Yes Bank is aggressively expanding its footprint in the retail sector by expanding its branch network. Offering a higher interest rate for savings bank deposits is one of the steps adopted by the bank to increase its CASA base. CASA deposits have increased from 10.5% in FY10 to 22.6% currently. Against a total deposits growth of 29% (CAGR) over FY10-14, the CASA deposits have reported a much stronger growth of 55% over the same period. 

Yes Bank has been consistently delivering higher return ratios over the past several years. In spite of its aggressive growth strategy, Yes Bank has been able to maintain its strong asset quality as well as above-average returns ratios. The stock has largely outperformed the BSE Bankex in the past few months. Yes Bank’s stock price has risen by 102% in YTDFY15 versus a 56% rise in the BSE Bankex over the same period. It is currently trading at 2.5x P/ABV FY17. It could reach levels of Rs 980 in 12 months representing a 22% upside. 

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