Banking Sector - Outlook remains weak - Ambit

In this month's "Connecting the Dots", we dive into the recent RBI discussion paper on reducing NPAs and conclude that implementing the suggested measures will be challenging. Further, these measures are unlikely to solve the banks' asset quality issues in the near term and would put private sector banks at a disadvantage. On other hand, management guidance continues to remain subdued on loan growth and asset quality for the rest of FY14. With loan growth, NIMs and asset quality indicators remaining weak since end-2QFY14, we expect profitability growth in BFSI to remain subdued going forward. We remain negative on BFSI stocks with selective BUY recommendations on ICICI Bank, ING Vysya Bank, City Union Bank and LIC Housing Finance.

The RBI's discussion paper on NPAs: There is a stick but no carrot

The key focus of RBI's discussion paper (DP) on NPAs is to push banks to identify their problem loans earlier and take prompt corrective action to ensure recovery of these loans. The DP also proposes to punish wilful defaulters by disincentivising banks to lend to them and encourage banks to use asset construction companies (ARCs) for early resolution of problem loans. We believe that these measures are unlikely to solve the asset quality issues in the near term but the measures could help the banks in the long term if they are implemented properly. Moreover, the proposed measures would make it relatively difficult for banks to 'evergreen' their loans and also could put private sector banks at a disadvantage as any resolution of a problem loan will have to be in concurrence with other lenders.

Outlook still uncertain

Our discussion with management teams of various banks/NBFCs suggests that the outlook on asset quality and loan growth continues to remain subdued with most management teams refraining from giving guidance beyond FY14. Moreover, with: (i) systemwide loan growth falling back to ~14% YOY in December 2013 (vs ~18% in September 2013), (ii) wholesale rates and tenyear G-Sec yields still remaining elevated and still being 50-100bps higher than average rates in 1HFY14; and (iii) the addition in restructured assets in first two months on 3QFY14 through the CDR Cell being as high as the entire 2QFY14, we expect banks' earnings growth to remain subdued going forward.

RBI in active mode

Since the joining of new governor, the RBI has been in active mode with floating discussion paper to reduce NPAs of Indian banks, freeing branch banking, and clarifying norms on foreign banks' presence in India. In the coming months, developments around new bank licences and banks' NPA/restructuring recognition norms will be keenly watched. The effects of most of these steps will play out over the long term and raise the competitive intensity of the Indian banking system.

Recommendations

We are SELLers of all PSU banks due to continued pressure on their operating performance and asset quality along with scarce buffers in capital and provision coverage. An adverse risk-reward drives our SELL stance on HDFC Bank and Kotak Mahindra Bank. We are SELLers on Axis Bank due to the pressure on its profitability from rising credit costs. Our key BUY recommendations in banks are ICICI Bank, ING Vysya Bank and City Union Bank due to better comfort on asset quality trends and protective buffers. Among NBFCs, out top pick is LIC Housing Finance.

Source : Equity Bulls

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