From overweight to underweight, how sentiments have changed for banks

Large brokerages are fast losing their conviction on the sector that has multiple challenges

Last week’s move by Christopher Woods, global head, equity strategy, Jefferies, to remove HDFC Bank and ICICI Bank from the brokerage’s Asia ex-Japan thematic equity portfolio, after retaining them for almost a decade, came as a shock. Ridham Desai, managing director, Morgan Stanley, turning neutral on banking stocks on Tuesday was another big blow. Such moves are an indication of how big money is behaving.

Morgan Stanley removed banking stocks from its model portfolio when it slashed its weighting on the sector by 500 basis points. Financials was Morgan Stanley’s favourite sector, having an overweight position and accounting for 25 per cent of its model portfolio. “Since the summer of 2013, following the taper tantrum sell-off, financials led the ensuing bull market,” Desai and Sheela Rathi mention in their note. “Given this starting point and emerging issues around Covid-19, it appears that the breath of performance in the sector could narrow considerably and be concentrated in top two or three names,” they add.

Morgan Stanley and Jefferies are not alone in turning negative on the sector. Several foreign brokerages, such as UBS, JP Morgan, and Credit Suisse, of late, have also become less optimistic about banking stocks. While the reasons for turning pessimistic on the stocks are widely known — a likely steep fall in the loan growth rate and potential asset quality issues, which may play out in the next six–12 months — the question for analysts is whether they would reverse their stance soon.

 

 

Quite unlikely, many feel, given the extent of pain ahead is yet to be sized up. “The investment case for Indian financials at this point looks weak given dislocations and the second-order impact on growth and asset quality,” analysts at JP Morgan warn. 

For one, unlike in the earlier instances of asset quality issues, the current round of pain may be widespread, affecting various loan categories, which were key growth pillars for banks in the last three-four years, especially private lenders. Analysts at UBS spell out that commercial vehicle (CV) loans, unsecured retail loans (personal and credit cards), microfinance loans, vehicle loans, and loans to small and medium businesses are most likely to be under pressure. “National-service risk (need for interest holidays and bailouts) is also rising for the sector, in general,” Vishal Goyal of UBS adds.

Most analysts concur with Goyal’s views. Consequently, the sector is now faced with earnings cut of 30–80 per cent across banks for FY21. Investors should expect these numbers to be revised (mostly downwards) once the Street has a better sense of how the March 2020 quarter panned out. For instance, HDFC Bank, IndusInd Bank, and Axis Bank, which have published Q4 numbers so far, have seen another wave of earnings cut by 10–25 per cent for FY21 after the downgrades.

Given the quantum of uncertainties ahead, regaining the Street’s confidence may take at least two years, say analysts. “A pick-up in FY22 earnings will be largely dependent on the government and the stimulus from the Reserve Bank of India in the coming months and a consequent recovery post the lockdown period,” says Suresh Ganapathy of Macquarie Capital. Their ability to conserve/ raise capital will also have a bearing of sentiment. While IndusInd Bank and HDFC Bank remain comfortable on capital position post Q4 results, Axis Bank (which was more conservative in estimating the Covid-19-related pain) saw its capital adequacy dipping to 17.53 per cent, from 18.2 per cent in Q3.

For investors, the recent uptick in stock prices or the correction from their year’s highs shouldn’t lure them into banking stocks. “When large fund houses and brokerages have turned negative, it’s a good cue for retail investors, too,” said a fund manager.