A weak FY19 wrap-up to give way to stronger FY20 for banks
The combination of interest rate hikes and cash recoveries from legacy bad loans will boost banks’ interest income and, in turn, margins
Indian banks didn’t have an easy 2018, but the next two quarters are likely to be better than the previous ones. Most bank chiefs have sounded sanguine on credit growth and, hence, business. Public sector lenders are hopeful in getting big recoveries from insolvency cases. That said, analysts believe these factors would take a year to significantly show up on banks’ earnings. The one-year ahead earnings per share (EPS) estimate for banks has seen just 4% increase, while the two-year forward EPS estimate is far higher at 24%. Here are five points that give investors comfort on banks in the medium-term:
Past missteps in corporate lending landed banks in big trouble with top banks such as State Bank of India (SBI) witnessing bad assets growing to almost 10% of their books. Most banks had pruned lending and shifted decisively to retail borrowers. Those who did not were forced to reduce corporate lending under prompt corrective action (PCA). This is expected to change in 2019 and signs that banks are getting back to corporate lending slowly are already visible.
Data from the Reserve Bank of India (RBI) shows that loans to large corporates grew 3.8% in October compared with just 1% six months ago. Ergo, banks such as SBI, ICICI Bank and Axis Bank are likely to find favour with investors given that valuations are modest. With the government panning to recapitalise some banks soon, credit flow will get a further boost, although it remains to be seen if these banks would display better discipline in lending practices.
No more bad blood
In the current fiscal year, banks saw the accretion of bad assets slow down. Hence, the bad loan stock of 40 listed banks fell 2% sequentially in the September quarter. Fresh slippages are expected to continue their downward trend in the coming quarters as well. However, much of the benefit of slowing slippages is likely to be seen in the second half of 2019 as investment demand gains traction. The biggest risk to this is a potential announcement of subsidies or waivers by the government given the election next year. That could see fresh stress from the farm sector.
Money back guarantee
Marque cases such as Essar Steel are close to resolution. Hence, lenders are looking at big recoveries in the coming quarters. Of the dozen big cases that the RBI asked banks to refer under the insolvency code initially, four are in the final stages of resolution while two have gone into liquidation. The haircuts estimated originally by banks has also come down.
Old money, new margin
The combination of interest rate hikes and cash recoveries from legacy bad loans will boost banks’ interest income and, in turn, margins, according to analysts. Net interest margins had seen hardly any improvement, barring a few private banks so far in the current fiscal. Add the pick up in loan growth, margins are likely to see better days. “As the investment cycle gathers steam, we expect not only loan growth, but also margins to improve for banks, particularly given the reduced competition from NBFCs,” said analysts at Credit Suisse in a note.
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