Buy Banks - Early signals of Recovery visible – Angel Broking

Indian nominal interest rates have remained high compared to global rates over the past two-three years because Inflation remained elevated at 8-9%, even as growth continued to falter. Recent sustained moderation in Inflation is a big positive for Indian economy and specifically for Indian Banks, as it would have a cascading impact on a lot of macro parameters. It would have a positive impact on savings and investment rates (including deposit growth and with a lag on credit growth). It would also construct a downward bias for interest rates and would eventually create a positive environment for growth and improvement in the asset quality. In our view, with sustained moderation in inflation, the mechanism for slow and gradual economic recovery is clearly underway, which in our view, makes it an opportune time to invest in banks.

Cooling bond yields to result in significant treasury gains: Specifically, recent moderation in inflation has created a downward bias for bond yields, which would be sustainable, in our view, given the fact that the real interest rate differential between India and advanced economies is at a decadal high. In the first three fortnights of the fiscal year 2014, Indian Bond yields have eased considerably. Both sovereign and corporate bond yields, across various maturity buckets have reduced anywhere between 60-100bp and are expected to maintain a gradual and sustained southwards trajectory here on. In such a scenario, Indian Banks would be expected to witness significant treasury gains in FY2014. Considering AFS positioning as of March 31, 2013, amongst PSUs banks like Allahabad, Canara, Dena, Corporation and United, and within private – Axis Bank, are expected to witness relatively higher treasury gains compared to others.

Extent of asset quality deterioration shows diminishing signs: Asset quality stress has remained at elevated levels for banks, thereby impacting sector's performance and outlook. However, over the last two quarters, sector's overall asset quality performance, particularly incremental slippages, recoveries and upgrades, suggest a moderation in overall asset quality pressures. During FY2013, the increase in annualized slippage ratio was 26bp yoy, much lower than the increase of 38bp and 57bp yoy witnessed in 9MFY2013 and 1HFY2013, respectively, suggesting that 2HFY2013 has been better than 1HFY2013. Sustained moderation in inflation, apart from leading to faster than earlier expected downward movement in interest rates, should also ease margins pressures for corporate and SME borrowers and eventually revive growth. Overall, we believe that asset quality pressures should gradually moderate from current levels.

Opportune time to buy banking stocks? Significant treasury gains owing to correction in bond yields should increase the headroom available for banks to make provisioning for bad assets and hence, in our view, the banks should prudently prefer to shore up their provisioning coverage over increasing their earnings to the extent of higher treasury gains this time around.

We would prefer to maintain our Buy rating on AXSB and ICICIBK, within the private banks. Also, even after the recent increase in their prices, most PSU banks are trading near their historic low valuations. In our view, the time is right to invest more in them, before their prices starts reflecting an eventual economy turn-around, early signs of which are visible now. We would recommend investing in those PSU banks, which would stand to gain the most from an eventual turn-around, which would lead to lower re-pricing of high-cost deposits (relative benefit for low-CASA banks) and higher recoveries (relative benefit for banks that have experienced maximum asset quality pain, and importantly, also provided for it already). For PSUs, we would recommend a basket investment strategy, as we still do not rule out possibilities of a single negative surprise in asset quality affecting a bank's quarterly performance. Screening for these criteria, as well as Tier-1 capital adequacy and valuations, amongst large caps we would prefer SBI, PNB and BOB and amongst midcaps, currently we recommend Buy on INDBK, CRPBK, ALBK and UTDBK.

Source : Equity Bulls

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