“We believe that current valuations across our coverage do not adequately capture potential downside risks to earnings under scenario III & IV (see table below), especially after the recent run up,” wrote Darpin Shah, analyst at HDFC Institutional Equities, along with Aakash Dattani, and Punit Bahlani in a sector report dated June 25.
They have built-in four scenarios where proportions of bad loans rise with each situation. For the four categories of loans -- agricultural, corporate, SME/service, and retail loans – increase in GNPAs vary from 5 per cent to 30 per cent.
“We have built a greater increase in SME/services and retail/ personal loan GNPAs (relative to industry/ corporate and agri GNPAs) as the former are more vulnerable, contextually. Consequently, banks with a higher proportion of retail and SME/service credit (AU Small Finance Bank, DCB Bank, Federal Bank and IndusInd Bank) show a greater rise across scenarios,” they noted.
That apart, several banks could see more than a 45 per cent increase in provisions under scenario IV, where GNPAs increase by 30 per cent (retail and SME), and 20 per cent (corporate and agri).
ICICI Bank sees the greatest increase of provisions across scenarios with a 62.8 per cent increase under scenario 4, while RBL Bank sees the lowest increase across scenarios with just a 22.9 per cent (largely due to a higher base) increase under scenario IV, shows their analysis.
Impact on earnings
According to Goyal of UBS, FY21 pre-provision operating profit (PPOP) is at risk due to narrowing margins and reduced fee income. He expects gross NPL formation (slippage) ratios of 7 per cent/5 per cent in FY21/FY22 (vs 8 per cent/6 per cent earlier) in his base case and 10 per cent/7.5 per cent in the downside scenario. The brokerage has cut FY21-22 earnings estimates for large private banks by 2-31 per cent.
For HDFC Institutional Research, banks with weak pre-provision operating profit (PPOP) profiles and/or high base case provisions may register the greatest decline in earnings. “Karur Vysya Bank and SBI could report a loss in FY21E under scenario III/IV. RBL Bank could also record a significant decline in earnings. Kotak Mahindra Bank and AU Small Fin Bank may display the greatest earnings’ resilience across scenarios,” they say.
“The four key trends we expect in Q1FY21 are: (1) credit growth should largely hold-up as banks gained share in corporate lending, (2) deposit growth will show improvement as inflows have been strong and customers haven’t spent and many have taken moratoriums which will lead to deposit levels rising (3) slippages are likely to be marginal as loan were under moratorium and (4) loans under moratorium should show a decline,” says Prakhar Sharma, equity analyst at Jefferies.
However, net interest margins (NIMs) could be lower due to excess liquidity/risk-aversion/low-retail lending and sharp fall in fees.
Analysts at UBS say the markets
still have not fully priced in the impact of lockdown. Banks have corrected sharply at the bourses and reflect the increased risk in the system, but valuations remain above global financial crisis (GFC) levels, they said. UBS has a ‘buy’ call on ICICI Bank and Axis Bank with a target price of Rs 450 and Rs 550, respectively due to their small stressed assets’ portion and favourable loan mix.
HDFC Institutional Research, meanwhile, prefers ICICI Bank and Axis Bank. SBI, too, remains its pick, despite its earnings vulnerability, due to favourable risk reward trade-off. Amongst the mid-tier banks, it prefers City Union Bank.