Bank stocks still not fully pricing in Covid-19 lockdown impact: Analysts

An analysis by HDFC Securities shows that adjusted book value (ABV) for banks could fall up to 22 per cent in the worst case scenario, while return on average assets (ROAA) could dip 25-70 bps in FY21

Despite improving loan recoveries in June 2020, analysts believe the situation for the Indian banking sector remains fluid as the economic impact of Covid-19 is far from over. While the moratorium given by the Reserve Bank of India (RBI) will optically limit gross non-performing assets (GNPAs) till the first half of financial year 2020-21 (H1FY21), asset quality deterioration is inevitable, they say.

Vishal Goyal, research analyst at global financial services firm UBS believes that corporates rated BBB or below (pre-Covid-19) or where earnings before interest, tax, depreciation, and amortisation (EBITDA) to interest cover is less or equal to 2x are at greater risk of default.

“For banks under our coverage, around 25-50 per cent of total loans from retail books are to the self-employed and SME segments, which are at a higher risk of default than the rest. The regulatory relief (moratorium and guarantee scheme) likely to reduce the NPL pressure for banks, in our view,” he wrote in a report dated June 26.

On Monday, Nifty Bank index declined 2.6 per cent on the National Stock Exchange (NSE), while Nifty PSU Bank index and Nifty Private Bank index dipped 3.6 per cent, and 2.7 per cent, respectively in the intra-day trade after S&P Global Ratings on Friday warned that NPAs could rise up to 13-14 per cent in FY21 due to Covid-19 pandemic.

On the other hand, an analysis by HDFC Institutional Research shows that adjusted book value (ABV) for banks could fall up to 22 per cent in the worst case scenario, while return on average assets (ROAA) could dip 25-70 bps in FY21

“We believe that current valuations across our coverage do not adequately capture potential downside risks to earnings under scenario III & IV (see table below), especially after the recent run up,” wrote Darpin Shah, analyst at HDFC Institutional Equities, along with Aakash Dattani, and Punit Bahlani in a sector report dated June 25.

 

They have built-in four scenarios where proportions of bad loans rise with each situation. For the four categories of loans -- agricultural, corporate, SME/service, and retail loans – increase in GNPAs vary from 5 per cent to 30 per cent.

“We have built a greater increase in SME/services and retail/ personal loan GNPAs (relative to industry/ corporate and agri GNPAs) as the former are more vulnerable, contextually. Consequently, banks with a higher proportion of retail and SME/service credit (AU Small Finance Bank, DCB Bank, Federal Bank and IndusInd Bank) show a greater rise across scenarios,” they noted.

That apart, several banks could see more than a 45 per cent increase in provisions under scenario IV, where GNPAs increase by 30 per cent (retail and SME), and 20 per cent (corporate and agri).

ICICI Bank sees the greatest increase of provisions across scenarios with a 62.8 per cent increase under scenario 4, while RBL Bank sees the lowest increase across scenarios with just a 22.9 per cent (largely due to a higher base) increase under scenario IV, shows their analysis.

Impact on earnings

According to Goyal of UBS, FY21 pre-provision operating profit (PPOP) is at risk due to narrowing margins and reduced fee income. He expects gross NPL formation (slippage) ratios of 7 per cent/5 per cent in FY21/FY22 (vs 8 per cent/6 per cent earlier) in his base case and 10 per cent/7.5 per cent in the downside scenario. The brokerage has cut FY21-22 earnings estimates for large private banks by 2-31 per cent.

For HDFC Institutional Research, banks with weak pre-provision operating profit (PPOP) profiles and/or high base case provisions may register the greatest decline in earnings. “Karur Vysya Bank and SBI could report a loss in FY21E under scenario III/IV. RBL Bank could also record a significant decline in earnings. Kotak Mahindra Bank and AU Small Fin Bank may display the greatest earnings’ resilience across scenarios,” they say.

“The four key trends we expect in Q1FY21 are: (1) credit growth should largely hold-up as banks gained share in corporate lending, (2) deposit growth will show improvement as inflows have been strong and customers haven’t spent and many have taken moratoriums which will lead to deposit levels rising (3) slippages are likely to be marginal as loan were under moratorium and (4) loans under moratorium should show a decline,” says Prakhar Sharma, equity analyst at Jefferies.

However, net interest margins (NIMs) could be lower due to excess liquidity/risk-aversion/low-retail lending and sharp fall in fees.

Investment Strategy

Analysts at UBS say the markets still have not fully priced in the impact of lockdown. Banks have corrected sharply at the bourses and reflect the increased risk in the system, but valuations remain above global financial crisis (GFC) levels, they said. UBS has a ‘buy’ call on ICICI Bank and Axis Bank with a target price of Rs 450 and Rs 550, respectively due to their small stressed assets’ portion and favourable loan mix.

HDFC Institutional Research, meanwhile, prefers ICICI Bank and Axis Bank. SBI, too, remains its pick, despite its earnings vulnerability, due to favourable risk reward trade-off. Amongst the mid-tier banks, it prefers City Union Bank.