Understanding investor attitude

Given that Axis Bank declared horrendous Q4 results and faced a leaderhip crisis, it would have been understandable if investors had stampeded out of the stock. Axis posted its first-ever net loss, of Rs 21.8 billion in January-March 2018. It would have been worse if the bank had not taken a tax write-back of Rs 13 billion. Gross non-performing assets (NPAs) soared to 6.77 per cent of all loans (up from 5.3 per cent in October-December  2017), rising by Rs 165 bn in the quarter. Net NPAs rose to 3.4 per cent (2.5 per cent in Q3). The chief executive officer (CEO) saw her tenure curtailed. 

But the stock jumped up almost 10 per cent in one session. Investors believed asset quality had improved due to the brutal write-offs and asset quality is expected to improve further over the first half (April 2018-September 2018). Analysts claimed that the bank would see sustained expansion of its Return on Assets ratio over the next two fiscals. Brokerages maintained ‘buy’ ratings. 

ICICI Bank had similar problems. The CEO is embroiled in controversy. ICICI Bank also saw consolidated profits sliced down to Rs 11.4 billion from Rs 20.8 bn, a year ago. Gross NPAs grew to 8.9 per cent of advances, rising by Rs 157 billion in Q4.  Provisioning rose to Rs 66 billion from Rs 36 billion (Oct-Dec 2017), and the Net NPA ratio was 4.8 per cent. Once again, analysts and investors saw a glass half-full and bid the stock up strongly after the results came in. 

Meanwhile, HDFC Bank delivered a rise in net profits of Rs 48 billion, up from Rs 40 billion a year ago. Gross NPAs were held at 1.3 per cent of total advances, which is almost the same as the 1.29 per cent it registered a year ago. Net NPAs stood at 0.4 per cent, down from 0.44 per cent in Oct-Dec 2017. The stock barely moved up because consensus estimates of profitability were missed! 

Commentators used much the same phrases to justify the strong rallies in ICICI Bank and Axis Bank: ‘The worst is over’. Is it really?  The Reserve Bank of India (RBI) reckoned last year that NPAs in the Indian banking system would peak in September 2018 and then gradually level off, and reduce. 

That was before the Punjab National Bank (PNB) scam became public knowledge and of course, other scams have surfaced in PNB's wake. This could mean that the quantum of NPAs will be materially larger than the RBI estimated last year in its Financial Stability Report. It could also mean that those NPAs will be flushed out earlier.  The really big public sector banks, such as PNB, SBI, Bank of Baroda release their results late in the earnings season. Those balance sheets will be critical for assessing the error margin of RBI estimates. 

It's possible that well-run private banks will pull out of the NPA trough earlier and that NPAs will continue to reduce henceforth, in private bank portfolios. However, it's arguable if either Axis Bank or ICICI Bank is being run well at the moment, given the magnitude of loans that have gone sour. 

It is also possible that the estimates and future projections are badly wrong across the entire sector, public and private. Effective due diligence when sanctioning credit is an art as much as a science. It's something most banks seem to have got consistently wrong. It's likely enough that more standard loans will turn into NPAs in the next six months. Investors are also relying on assumptions of strong earnings rebounds across sectors.  

Such positive assumptions like improved asset quality, sharp NPA reductions, fewer future NPAs are already baked into the share prices of private banks. The Nifty Bank, which is heavily weighted in favour of private banks due to the free-float methodology, is running at a price-to-earnings (PE) of 32 and a price-book value (PBV) of 3.2. It is up 4 per cent in the last 30 days. The Nifty Private Bank index, which is up 5.5 per cent in the last 30 days, is also valued at PE 31 with PBV ratio of 3.5. 

The Nifty PSU Bank index is down 8 per cent in the last 30 days. It has a PBV of 1 and no meaningful PE ratio due to losses logged by big PSU banks. The divergence in direction and the differences in valuations indicate the differences in investor attitude.

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