Valuations of banking stocks may come under pressure amid economic slowdown

Who would have envisaged a year back, when there were first signs of stress in the form of a liquidity squeeze, thanks to the IL&FS fiasco, that it would have a cascading impact on India’s financial system.  That the count of public sector banks (PSBs) would further shrink and that there would be so much thrust on transmitting repo rate cuts that banks may have to work harder to protect their net interest margin (NIM).

But, the more important demon that they are grappling with is that of slowing loan growth. When non-banking finance companies (NBFCs) decided to go slow on loan disbursment to conserve their capital a few quarters ago, it has had a cascading effect on overall consumption sentiment, the impact of which was also visible on banks in the June quarter (Q1). Growth slowed across the board, and it was more prominent for private banks, which effortlessly grew at 20–25 per cent (especially the retail-oriented ones) in the past five years.

The recent data published by HDFC Bank and Bajaj Finance indicates that while growth has incrementally improved, replicating past trends may still be a tall order. HDFC Bank’s loan book has expanded by 19 per cent in September quarter (Q2), while Bajaj Finance added 1.9 million new customers, a growth rate of 18 per cent, well-below its past record. Analysts at Kotak Institutional Equities note that retail loan growth for July–August period came at 17 per cent year-on-year, though the pace of growth in unsecured loans has started to slow to about 22 per cent in this period vis-à-vis 35 per cent in FY19. The favourable factor is that banks are able to fill the gaps created by housing finance companies in the home loans space. Nonetheless, the brokerage feels that overall retail loan growth will witness a period of slow-down over the next few months in select segments. “The gradual slowdown in retail loans will lead to a drop in the pace of overall loan growth,” the analysts add.

Growth becomes important as it is critical to ensure that cracks don’t show up in asset quality. Barring Axis Bank and ICICI Bank among private players, other private banks have seen a steady increase in gross non-performing assets (NPA) ratio in the past year. While PSBs are seeing the NPA number shrink, it may not continue to do so amidst the ongoing consolidation. Stocks of PSBs have already absorbed this risk, while their private peers haven’t.

Meanwhile, there is enough evidence to indicate that NBFCs, real estate sector and retail loans may not presently be in a safe zone for banks to be complacent about. The three have been important pillars of growth in the past, especially for private banks, and growth in these pockets has helped the banks to garner higher valuations and investor demand. These positives, too, are being lately put to test. Valuations have eased for names such as HDFC Bank and Axis Bank, while it has cracked up for IndusInd Bank, RBL Bank and Yes Bank, given the deluge of bad news around the sector.

But here’s the good news. Analysts at Credit Suisse note that despite growth slowing, private banks are holding up well on NIMs, due to improved asset pricing and lower corporate slippages. The NIM for private banks continue to hold up in the 3.6–4 per cent range, which is way above the PSB peers who are still struggling to touch the three per cent mark. Therefore, higher profitability leaves the private banks some room to absorb the systemic weaknesses and rebalance their book more favourably towards secured retail products, even if that should come at the cost of foregoing their valuations a little more.

Better margins would also allow them to absorb the cost of linking retail loans to external benchmark, impact of which will be felt from the December quarter.  

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