Covid-19 impact: Rising asset quality fears keep investors away from banks

With the Covid-19 situation intensifying in the country and higher chances of the lockdown getting extended, albeit with some additional relief, the Street continues to shy away from banking stocks on concerns that these events will lead to higher bad loans.

A recent report by BoFA Global Research highlights that banks are now on the verge of a new (and unique) non-performing asset or NPA (bad loan) cycle panning across corporate and retail segments lasting through at least FY21-22, which would drive the sector’s return on equity closer to cyclical lows.

In fact, Sunil Jain, head of research at Nirmal Bang, says, “In case of prolonged economic disturbance, there would be systemic default that the banks would face.”

Banking stocks have lagged the market in the rebound off coronavirus lows, hit on March 23, 2020. Between December 31, 2019 and March 23, 2020, the Bank Nifty had almost halved. But since then, Bank Nifty is up just 11.5 per cent, while Nifty50 is up 21 per cent. In the past one month, too, the Bank Nifty index has declined 5.3 per cent compared to 2 per cent gain in the Nifty50.

The underperformance is not only stark as banking stocks have been at the forefront of market gains in the past, but has also cost banks their clout in the benchmark indices. The combined weightage of financial stocks has slipped from a peak of 42 per cent to below 35 per cent currently.

While the 3-month moratorium announced by the Reserve Bank of India (RBI) for March-May repayment dues offers some respite in terms of lower gross NPAs, the size of moratorium book seems disturbing as analysts see more slippages coming from the moratorium pool.

“We believe the moratorium book, which is quite large, could see higher slippages (accounts turning bad) in the near term,” says Kajal Gandhi, analyst at ICICI Securities.  Many lenders, who have declared their Q4 results so far (Axis Bank, ICICI Bank, RBL Bank, YES Bank, etc.), reported at least 25 per cent of their loan book, in value terms, under moratorium. Gandhi also believes that, there are chances of further extension of moratorium.

Notably, in the past many quarters, a lot of banks have changed their loan book mix with a higher share of retail segment, which is now exposed to the risk of defaults, thanks to lower disposable incomes and job losses.

There is little doubt that Covid-19 has significantly hurt key sectors like hospitality, aviation, real estate, small and medium enterprises, etc. This is not only impacting the income levels of individuals engaged in these sectors, but also the repayment ability of companies in these industries. Axis Bank’s management, during its Q4 earnings, said that the (corporate loans rated) BB and below (indicating higher default probability) would increase in the coming quarters due to Covid-19 impact.

Though most banks, which have announced their Q4 numbers, have shored up provisioning towards Covid-19, it seems insufficient (less than 1 per cent of loan book) given the increase in asset quality fears amid economic disruption. Many analysts and experts believe that the potential risk of default is aggravating with the situation.

What’s more, Abhimanyu Sofat, Vice president, Research, IIFL Securities, says, “To date, the government is delaying the stimulus package, and it is adding to the burden of the banks.” Sofat is also worried about the extent of write-offs public sector banks will have to entail going forward. Lower lending, lower interest earned on the amount parked with the RBI, lower fee income, etc, are other factors, directly hitting banks’ earnings and return profile.

Overall, bank stocks are expected to remain under pressure.

"Correction in the banking stocks is not enough to factor in all these concerns, which can develop in the next two-three quarters. And, concerns about the rise in new NPAs in the next two quarters is very high," said Vinod Nair, head of research, Geojit Financial Services.