BFSI : 2QFY18 preview: muted quarter for banks; stronger for NBFCs - Kotak

2QFY18E preview: muted quarter for banks; stronger for NBFCs. Weak revenue growth led by slower loan growth, NIM pressure (yoy), lower contribution from investment gains and high provisions for bad loans would remain a drag on earnings growth for banks. There would be no major negative surprises on impairment ratios and retail asset-oriented banks are expected to do well. Most NBFCs are likely to deliver strong performance supported by inventory restocking, strong festive sales, normal monsoon and near-normalization for microfinance activity.

Weak revenue growth and high provisions signal another weak quarter

We expect banks to report 3% yoy decline in earnings on the back of nearly zero revenue growth and elevated provisions. Revenue growth is partly supported by a few key divestments in the insurance subsidiaries as treasury income is likely to remain weak for the overall sector given the recent uptick in interest rates. We expect private banks to report an increase of 25% yoy while public banks could report a decline of 65% yoy. With no base rate cuts for the quarter and average deposit rates declining, we should see banks reporting marginally better NII (qoq). Banks with retail-oriented assets such as HDFC Bank, IndusInd Bank, City Union and Federal Bank are likely to report stable/better performance while other banks should report extremely weak performance.

Slippages likely to drift downwards; provisions to remain high

Discussions with banks indicate that the corporate slippages are unlikely to throw any new negative surprises with known knowns slipping for the quarter. We expect some pullback in small-ticket loans such as retail and SME, which were impacted post demonetization, but fresh unrest in Rajasthan and slow pace of reimbursement from the previously announced debt waivers in many states would keep NPLs in agriculture at higher levels. We see provisions remaining high (ageing of NPLs) and discussions to shift towards progress of cases currently under the NCLT process and the recent notification from RBI to move the next set of NPLs under IBC. We expect private banks, ICICI Bank and Axis Bank, to report weak performance primarily on account of slippages from their corporate portfolios. Ujjivan Financial Services and Equitas Holdings should be able to report better headline impairment ratios as there is evidence of recovery even from the delinquent pools. However, provisions are likely to remain high.

Growth still elusive across banks; retail still driving growth

The sector continues to face an environment of slow growth. Recent sectoral composition of credit shows growth at less than 10% yoy with corporate loans flat yoy. Only retail continues to drive growth reporting a marginal recovery back to ~15% yoy with private banks getting quite aggressive in unsecured lending such as personal loans and credit cards. Our study of private capex does not suggest an improvement in corporate loan growth as fresh capex is still elusive with the focus still on deleveraging the balance sheet at this point in time. This implies weak revenue growth for the sector, especially public sector banks.

NBFCs: a strong quarter for most

2QFY18 was likely a strong quarter for most NBFCs as (1) festive season sales were partially reflected in September, (2) there was strong buoyancy in rural India post a near-normal monsoon and (3) inventory restocking and gradual pick-up in business provided a boost. While GST implementation is likely to impact small businesses, it is not clear how much of this will be reflected during this (first) quarter. Implementation of RERA significantly affected business momentum in the real estate sector during the first two months of the quarter leading to slowdown in retail housing finance as well. Microfinance business resumed to near-normal levels. Capital market momentum was strong with record inflows to domestic mutual funds and 50% yoy growth in cash equity volumes. NBFCs with strong underlying momentum in 2QFY18 are Bajaj Finance, Bharat Financial Holdings, Mahindra Finance and IIFL Holdings.

Banks: corporate growth weak; retail loan growth showing some recovery

Loan growth remains anemic at 7% yoy

As per latest available data (September 15) for the banking system, loan growth has marginally improved to 7% yoy from 4-5% in FY2017 but much below 9-10% levels seen pre-demonetization. Credit growth is impacted by subdued demand for credit among the large corporate borrowers and slowdown in credit offtake post demonetization. Sectoral credit breakdown for August suggests continued weakness in off-take from the industrial sector (flat yoy), whereas retail growth was around ~16%, albeit lower than ~17-19% growth pre-demonetization but directionally there is an improvement.

Corporate loan growth remains weak. With a sharp slowdown in fresh investments, loan disbursements to the corporate segment have fallen sharply. The recent data on corporate cycle suggests that this trend is unlikely to reverse in FY2018. This is hurting public banks given that their exposure in the corporate book is >50% of loans. Also, many of the restructured loans are now completing their moratorium period, which implies that the pace of repayment of existing loans could have also accelerated or resulted in slippages. A combination of this has hurt corporate loan growth, which is flat yoy. There was some expectation of a recovery in loan growth led by GST implementation given that the taxes are paid early by the entire supply chain. However, discussions with banks did not elicit any favorable response on increase in credit limits and higher utilization of undrawn limits but we probably need to wait for a few more quarter as there would be bottlenecks at the start of this program and we were also in a seasonally weak quarter.

Medium-term growth outlook for corporate loan growth remains weak given (1) ongoing deleveraging of large corporate borrowers, (2) lack of large-ticket capex and (3) regulatory thrust towards moving exposure of large borrowers from banking system to bond markets. Interaction with market participants suggests intense competition within banks to chase top-rated companies both in the loan and bond markets.

Project Uday to have an impact on public banks. We see public banks reporting a sharp slowdown in loan growth as Project Uday was completed in FY2017 wherein loans was shifted off the books of the bank.

Growth recovery in small-ticket loans but weaker than pre-demonetization trends. Retail has been an important growth driver for most banks in the past few years. While retail loan growth for banks remained around 20% yoy pre-demonetization, it fell to ~12% by end of FY2018. 2QFY18 growth of ~16% yoy shows some recovery but we are still below pre-demonetization trends. Channel checks reaffirm these trends. Banks with established retail loan machinery such as Axis Bank, HDFC Bank, ICICI Bank and SBI will be better-positioned These banks (except HDFC Bank) have a sizable proportion of long-tenure housing loans where the short-term impact will be lower. Regional banks with their thrust on SME loans may find it difficult to grow their loan book given the weak demand environment for working capital, even as recent sharp growth in commodity prices may have a positive impact.

Small banks: growth is showing some signs of life

Ujjivan and Equitas have been impacted on account of demonetization due to high dependence on cash, especially for repayments and sharp rise in delinquency levels. However, there seems to be an improvement on the ground as recovery levels are steadily catching up in regions affected by the crisis. Channel checks indicate that UP was probably the best in recovery while parts of MP and Maharashtra is still quite weak. On the back of better recovery trends, we have seen a few MFI/SFBs stepping up disbursements in their portfolio. We believe that a few players have seen their disbursements moving back to pre-demonetization levels.

We expect provisions to remain high for Equitas and Ujjivan partly to write off part of the overdue loans, which have remained unpaid at the end of the quarter. Equitas has PAR>0 of ~7%, while it is much higher for Ujjivan at ~9% though a lot of this has been declared as NPLs. This reflects in our estimates leading to higher earnings impact for Ujjivan. Loan growth will likely remain soft. We expect <10% yoy AUM growth for Equitas and Ujjivan in 2QFY18.

Deposit growth moderates to 10% yoy as demonetization tailwinds fade

Banking system deposit growth was relatively strong at 10% yoy, albeit lower than 13-15% levels in FY2017. While there have been outflows after the peak inflows, banks have been significant beneficiaries of strong deposit flows with major banks reporting improved CASA ratios.

From a liquidity standpoint (i.e. LCR), growth in retail deposits may lead to higher ratios leading to lower reliance on G-Sec to meet minimum LCR ratios. Positive impact of this will only play out once lending opportunities come forth in a meaningful way.

Margins to be stable in the short term but cyclically still in a weak position

Given the benign liquidity situation, there is intense competition on rates both on the corporate (well-rated) and retail side. However, banks have not been cutting MCLR rates since 4QFY17 while deposit rate is likely to move downwards as the re-pricing continues offering some near-term relief on NIMs for the quarter. 2QFY18 NIMs may see banks reporting a flat NIM or marginal improvement for most banks. Higher CD ratio and lower slippages may provide some comfort.

Taking a short-term call on NIM may be difficult but over the medium term, we clearly see pressure on core NIMs on account of (1) sharp cuts in MCLR announced in January, (2) greater competitive intensity, which will bring down excess spread over benchmarks, (3) part convergence between base rates and MCLR and (4) comfortable liquidity position in the money markets. We believe until we see a credit growth revival, banks with strong liability franchises will continue to be aggressive on rates and aim to gain market share from other banks and NBFCs.

RBI's new disclosures on weighted average lending and deposit rates reflect the decline in lending and deposit rates over the past few years. Weighted average lending and deposit rates have fallen by ~60-70 bps respectively in the last one year.

Lower support from treasury but insurance listing to help large banks

We expect contribution from non-interest income to be lower for the quarter. We note that yields have hardened from June levels with largely unidirectional movement. The relatively higher contribution by ~20-30 bps for the quarter is mainly on account of the gains on account of listing of the general insurance by ICICI Bank and the life insurance business for SBI. Adjusting for these two, the gains would be sharply lower for the current quarter.

Other issues on non-interest income line would continue as we don't see an immediate recovery in fee income, exchange income or recovery from written-off loans. Our broad discussion with a few banks continues to indicate that the core fee income growth would be subdued as the capital expenditure cycle is yet to revive and intense competition on retail front will limit retail fee growth. Income from forex could be marginally better due to volatility this quarter.

Incrementally positive outlook on fresh impairments and resolutions

Overall we expect most banks to report a fairly a better performance on impairment ratios. The previous quarter saw a higher contribution from small-ticket loans due to the loan waiver as well as the lagged impact of demonetization. We expect a pullback in the retail and SME loans but recovery in agriculture is likely to be slower. States that announced a loan waiver in FY2017 have started to reimburse banks but it has been slower than expected. On the other hand, we have seen states such as Rajasthan looking to make some announcements on loan waiver, which should result in elevated NPLs for the sector. Slippages will likely decline for the banking system overall. There is likely to be volatility among banks due to timing mismatch of recognizing some of the large corporate accounts as NPL. We don't expect the corporate sector to report any major new negative surprise. There could probably be a few banks discussing their exposure to a few telecom companies that are under stress but we do note that the share of these loans is quite insignificant compared to the overall size of the sector. We would look forward on an update on the cases being referred to NCLT under the IBC framework as well as the next set of NPLs that is likely to move under this process as per the recent recommendation from RBI to accelerate decision making for these loans. We expect the frontline private banks to have a relatively weak quarter. Axis Bank and ICICI Bank would report weak performance as they report high slippages from their corporate portfolio. For ICICI Bank key monitorable is the impact of recent deal (Essar Oil) on the watchlist exposure and provisions. For Axis Bank high exposure to power sector under watchlist may be an overhang on future slippages. Resolution through IBC route is a rather risky experiment with long-ranging benefits if successful. Given the 180/210 days limit to find a resolution, banks will need to address the problems quickly or risk very high level of provisions for liquidation cases. RBI mandated banks to maintain 50% provision on all secured and 100% provision on unsecured loans taken to the IBC for resolutions. Most top-tier banks have provisions of 40-45% on top-50 NPL accounts and we should expect further improvement as mandated by RBI. We think RBI's dispensation to spread the provisions over four quarters will provide relief.

NBFC: A strong quarter for most

QFY18 was likely a strong quarter for most NBFCs as (1) festive season sales were partially reflected in September, (2) there was strong buoyancy in rural India post a near-normal monsoon and (3) inventory restocking and gradual pick-up in business provided a boost. While GST implementation will likely impact small businesses, it is not clear how much of this will be reflected during this (first) quarter. Implementation of RERA significantly affected business momentum in the real estate sector during the first two months of the quarter leading to slowdown in retail housing finance as well. Microfinance business resumed to near-normal levels Capital market momentum was strong with record inflow to domestic mutual funds and 50% yoy growth in cash equity volumes. NBFCs with strong underlying momentum in 2QFY18: Bajaj Finance, Bharat Financial Holdings, Mahindra Finance and IIFL Holdings.

Strong growth in earnings

We expect most NBFCs to deliver 10-30% earnings growth. Core earnings of Mahindra Finance (up 1.9X yoy) are driven by strong recoveries leading to better NIM. Stronger growth trajectory of BAF, LTFH and PNBHF will drive ~30-40% growth in core earnings. Pressure on NIM and muted loan growth will lead to decline in core growth for PFC and REC.

Loan growth on a high

We expect 10-40% loan growth for most players. Growth will be influenced by (1) festive season sales being partially reflected in September, (2) strong buoyancy in rural India post a near-normal monsoon and (3) inventory restocking and gradual pick-up in business providing a boost. Our feedback from the third-party agents in the home loan market suggests a slowdown in conversions in 2QFY18 with the festival season being relatively muted. RERA implementation may have second-order impact on retail home purchases thus impacting fresh sanctions.

LICHF will continue to increase share of LAP in FY2018E as well. HDFC will likely tap into windows of opportunities such as commercial real estate financing. Bajaj Finance will continue to deliver strong (~40%) growth in loans. The company will benefit from the early onset of festival season. Management has guided for continued slowdown in business loans.

We expect MFI (Bhafin) to resume its growth trajectory now that incremental stress is low/negligible. Growth momentum (14% yoy growth) will pick up to accelerate to 50% by 4QFY18.

We expect moderate growth of 11-15% for CV financiers Chola and STFH. Medium-to-long-term impact of GST roll-out remains key variable for our expectations on loan growth. The rural story remains strong on the back of strong collections in 2QFY18 and a normal monsoon; we expect high growth in rural cars, UVs tractors, etc. as well; key beneficiaries are Mahindra Finance, Cholamandalam and L&T Finance.

With limited capex, likely oversupply in power sector and likely push by state governments towards low-cost bonds, PFC/REC may report muted growth.

Key highlights of large NBFCs

- Bajaj Finance will likely report 42% loan growth in 2QFY18 translating into 39% earnings growth (42% in 1QFY18). Early kick-off of festival season this year may lead to some surprise on AUM growth in segments such as consumer durables, personal loans cross-sell, EMI and 2-wheeler loans. Commentary on LAP/mortgage market in the backdrop of GST/RERA will be watched out for.

- We expect Bharat Financial Inclusion to deliver stable quarter after high provisions over the past two quarters. Incremental business trends post March seem to be stable, i.e. in line with pre-demonetization period. We expect the company to deliver 7% qoq loan growth.

- We expect Chola's loan growth to remain stable at 15% yoy versus 14% in 1QFY18 (up 5% qoq as compared to 2-5% qoq in preceding three quarters). Strong CV volumes (18-20%) in recent months will augur well for AUM growth. Collections will likely improve qoq, in line with seasonal trends. NPLs in the home equity segment will likely remain high.

- We expect moderation in HDFC's loan growth to 14% yoy from 18% yoy in 1QFY18. Slowdown in overall business momentum in the first two months of the quarter due to implementation of RERA is the likely reason. We do not expect any major rise in NPLs or provisions; large dividend income from HDFC Bank will support reported earnings.

- IDFC Bank's performance will be impacted by lack of growth (flat qoq; 6% decline yoy) in the loan book due to the overhang of infrastructure loans, coupled with pressure on NIMs due to sale of loans to ARC and repricing of operational infrastructure projects. Initiatives on retail front (rural and mass affluent segments) are likely to remain on track. Provisioning expenses are likely to remain low.

- IIFL Holdings' securities business will benefit from strong equity volumes (cash up 50% yoy) and investment banking business. Wealth business will see momentum due to strong MF flows as well as buoyant IPO market benefiting IIFL Wealth Finance. Loan growth in the NBFC will be around ~25% yoy.

- LICHF's loan growth will moderate to about 13% from 15% in 1QFY18, with individual loan growth expected to be lower at 11% compared to 14-15% range over the past four quarters - a likely impact of RERA implementation. Earnings growth is expected to be ~11% as NIM is stable yoy (up 10 bps qoq on lower base). Provisions are likely to remain low.

- Mahindra Finance's earnings will rebound sharply (up 1.9X yoy), driven by weak base and improvement in collections driving 40/50 bps yoy/qoq improvement in NIMs and ~30% yoy decline in provisions. AUM growth is expected to be similar to past few quarters at close to 13% yoy.

- Muthoot's gold loan book will grow 5/4% yoy/qoq supported by high gold prices and growth in non-gold business. Improvement in NIM (100 bps yoy and 10 bps qoq) coupled with stable expenses and declining provisions lead to 23% yoy growth in earnings.

- Shriram City Union Finance's business momentum will continue to inch up post demonetization with 18% yoy loan growth in 2QFY18. Focus on higher-yield business loans and falling borrowings cost will boost NIM. The company will, however, maintain a conservative provisioning policy.

- Shriram Transport Finance will likely deliver 19% earnings growth on the back of 11% yoy loan growth (9% in 1QFY18); while falling borrowing costs provide tailwinds to NIMs, provisions will likely remain high.

Source : Equity Bulls

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