Analysts are still hopeful on banking stocks

Since most banks needs to raise capital going forward, they would like to clean their books as soon as possible

The sharp rally seen in the month of January 2015 was led by banking stocks. The general mood in the market was that banks are first sector to benefit from a change in economic scenario. PSU Banks especially were expected to be the biggest beneficiary as their share of corporate loan is nearly 75 per cent of all banking loans and they were relatively undervalued as compared to private sector banks.

However, when Union Bank, one of the first PSU banks announced its results the music suddenly stopped. By the time other PSU banks came out with their numbers panic had already set in. The last straw that broke the back of investors in banking sector was when ICICI Bank numbers were announced and they gave the impression that toxic assets were spreading to private sector banks.

So is the banking rally over for the time being? Bank of Baroda’s management in their interaction with analysts said that they expect weakness to continue over the next few quarters. Broking firm Emkay has a ‘Reduce’ rating on the bank and has commented that they expect the weak asset quality to persist. Slippages for the bank increased to 3.3 per cent as compared to a modest 2 per cent in the previous quarter. Further, loan restructured were at Rs 1,600 crore (1.6 per cent of loans). Gross Non Performing Assets (NPA) was up 18 per cent and Net NPA rose by 24 per cent respectively. The bank has lost 17.5 per cent in value since the time of announcing its results.

Union Bank too did not meet its guidance on NPA’s, margins and restructured loans. Losing 17 per cent since the announcement of its results, analyst has been cautious on the bank. Broker Prabhudas Lilladher says that the weak asset quality and capital position coupled with sustained pressure on margins will impact stock performance in the near term which otherwise has done well in anticipation of improving earnings trend.  

The biggest surprise however was when ICICI Bank announced their results. Higher impaired assets and lower loan growth coupled with a weak outlook caught analysts across the board on wrong foot. IDFC Securities points out that asset quality of ICICI Bank was weaker – stressed asset creation was higher at 3.5 per cent annualized, NPAs increased to 3.5 per cent of all loans, credit costs moved higher by 107 basis points and coverage levels reduced to 64 per cent. Restructuring pipeline at Rs 2,300 crore and management guidance suggests similar trends in slippages and credit costs in Q4FY15.

Though the results of the banks have been below expectation, analysts feel that buoyant economy will improve the situation. IDFC Securities commenting on Bank of Baroda’s performance, which has been the worst performer among all the banks, says that improving economic activity is likely to benefit BOB’s growth, NIMs and asset quality medium term. Its relatively better operating profitability, higher capital adequacy (9.6 per cent Tier 1) and healthy deposit franchise should support stock price. Goldman Sachs too says that a macro revival will drive re-rating and not QE related liquidity that has pushed up prices of these stocks.

Analysts are also of the view that since most of the banks needs to raise capital going forward, they would like to clean their books as soon as possible, which is why we see higher reporting of bad assets that too across sectors. But higher NPAs restrict a bank’s ability to issue new loans. This is witnessed in all the banks that have reported higher NPAs and lower loan growth.

Though analysts continue to be cautiously bullish on banking sector their key assumption is that economic activity picking up will wash out all sins. The first number on economic activity coming – HSBC’s Manufacturing Purchasing Manager’s Index has fallen to a three month low after touching a tow year high in December 2014. Further, with budget just round the corner little activity can be expected from the banks in the current month too. That would leave only the month of March for banks to perform better than they did in the third quarter.

It seems fundamentally banks are still some distance away from reporting strong numbers. But market sentiment had already lifted them higher ahead of any change in fundamental; chances are that it might continue to do so again.