Higher non-interest income, low rates keep lenders buoyant in Q3

Asset quality remains the key monitorable with gap between proforma and reported NPAs widening

The Nifty Bank index, with gains of over 12 per cent in a month, is the clear outperformer among sector indices. On an average, bank stocks have rallied by 8-20 per cent in this period, with State Bank of India (SBI) (38 per cent gains during this period) leading the table. Much of the stock price movement is in reaction to the better- than-expected results for the December 2020 quarter (Q3).

With the loan recast contained at less than 1 per cent so far and banks on the path to end with lower than estimated restructuring requests (2-3 per cent of the loan book), analysts have given a thumbs-up to the Q3 results.

“The debate in India banks has quickly shifted from impaired loans to growth. High-frequency indicators have stayed strong, and we expect ongoing growth momentum,” note analysts at Morgan Stanley.

“Stocks have done well over the past week to three months and are likely pricing in some growth recovery. Investors have asked if the returns could moderate from here. We remain positive as growth momentum is strong, and believe the next leg of returns will be driven by valuation re-rating to much above-average valuations,” the analysts add.

Some others also sound optimistic. From being seen as an existential risk in mid-2020, Indian banks’ asset quality has been surprisingly resilient. Our channel checks further support few risks of negative surprises near term, noted analysts at BofA Securities.

In focus: Proforma Vs Reported NPA ratios

However, a granular reading of numbers indicates that the Street may have jumped the gun on two main parameters — operational improvement and asset quality.

First, Q3’s interest income growth, which on average, declined by 1 percentage point year-on-year for most banks, despite 4-6 per cent growth in loans, was marred by interest reversals. HDFC Bank and ICICI Bank were an exception with 2-3 per cent interest income growth, helped by 9-15 per cent loan growth. Therefore, much of the operational performance was guided by low interest cost, which fell by 5-14 per cent, helping net interest income grow by about 3 per cent. For YES Bank, in particular, interest expenses fell by 40 per cent, aiding net profit growth. An improvement in non-interest income after two successive quart­ers of lull also helped banks in Q3.

Provisioning cost remained elevated, up 12-40 per cent across banks. Newer banks such as Ujjivan Small Finance Bank (SFB), AU SFB, Bandhan Bank, Equitas SFB, and CSB Bank witnessed a multi-fold increase in provisioning costs.

However, what really needs attention is the growing gap between reported non-performing assets (NPAs) and proforma NPAs, or one without considering the Supreme Court’s (SC’s) dispensation on asset classification in Q3. The variation was less than 0.7 percentage points for private banks and 0.6-1.6 percentage points for public sector banks in the September 2020 quarter (Q2). In Q3 though, the picture was very different with the gap increasing for 16 of the 17 banks under review (except Canara Bank). The variation was 0.6-3 percentage points for private banks (Ujjivan SFB and Bandhan Bank being the outliers) and 0.7-2 percentage points for public sector banks.

This is where the Street may have misjudged the scenario. In fact, banks have witnessed an 8-16 per cent increase in earnings estimates for FY22 on the back of asset quality holding up in Q3. However, managements are reasonably cautious on this front, which the Street seems to be ignoring. The true picture on asset quality will be revealed once the SC vacates its stay on asset classification, which would reset the numbers to a higher base, currently not factored in by the Street.