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Financials: Q1FY20E Preview – Asset quality issues will resurface from second quarter

1QFY20 may turn out to be the best quarter of FY20 in terms of slippage. Despite a sharp rating downgrade cycle and bond defaults, no large account may have slipped in 1QFY20 as NPLs are recognized on 90 dpd. However these downgrades could result in higher slippages 2Q onwards. Also, residential real estate continues to remain a stressed sector for banks and NBFCs. Similarly for all major NBFCs, the market is factoring a better second half (2HFY20) for AUM growth where the risk of revision is on the downside given no specific consumption impetus in the budget. FY20 looks to be a challenging year with a new NPL cycle forming and continued delay in resolutions of large stress groups including DHFL, ADAG. In addition to slippages, movement in BB portfolios will be a key monitorable. We believe the downgrades by rating agencies will reflect in the BB portfolios with a lag as banks do take time in syncing internal ratings with external. (See Exhibits 8 and 9 for incremental stress and the list of rating downgrades). The successive cut in benchmark interest rates by RBI do come as a relief but the transmission will be restricted by a slowdown in deposit growth which will keep retail deposit rates sticky.

Key sector highlights for 1QFY20: 1) Sector loans grew 12.1% yoy, slower than 13.2% in 3Q and 14.7% in 3Q. QoQ sector loans have declined by 1.2% 2) Deposit growth slowed to 9% yoy from 10% in 4Q and still lags credit growth. 3) There was a sharp correction in bond yields with the yield on the 10-yr declining 47 bp qoq while yields on 1 yr to 5 yr declining by 17-25 bps . This will give banks enough room to book bond gains and reverse some MTM provisions.  4) We expect NIMs to remain broadly stable for banks. 5) While NCDs of many large borrowers including DHFL, Reliance Home and Reliance Commercial have been downgraded to D and mutual funds have already written down their exposures by 75-100%, banks are required to take only 25% provisioning in 1Q based on FIMMDA benchmark. 6) Expected lumpy recoveries from Bhushan Power and Steel, and Essar Steel could not come through even in 1Q. 7) Slippages will decline sequentially for all banks except YES. While YES will likely see a sequential increase in slippage, it will still be small in proportion to our estimate of total stress loans for the bank.  8) Both IIB and BoB will report consolidated numbers.

Key expectations for retail private banks: Loan growth for retail banks will remain strong though slower than the earlier quarters. HDFC Bank has already disclosed its loan growth of 17% yoy for 1QFY20 which is the slowest in the last 10 quarters. Despite slower balance sheet growth, HDFC Bank’s CASA has declined 240bps to 40%. We expect earnings growth of 20% yoy for HDFC Bank. We expect KMB to report strong earnings growth of 34%. IIB will announce merged numbers. Standalone IIB earnings will revive qoq on lower provisions and lower slippage while loan growth will remain strong. We expect standalone PAT of 12.2bn and consolidated PAT of 13.6bn. Standalone credit cost will fall sharply to 60bps from 3.5% qoq.

Key expectations for corporate private banks: YoY earnings growth will look strong for corporate banks due to a low base last year (the base was low due to high provisions following the Feb 12 circular). Slippages will decline qoq. For ICICI NIM will decline 12bps qoq in 1Q (in 4Q lumpy/one-time income accounted for 25bps of NIM). We expect ICICI to report profit of Rs15bn growing 56% qoq. We expect loan growth of 17%yoy/ 3%qoq. We expect slippage of Rs20bn against Rs35bn qoq.  For AXIS we expect stable NIMs and loan growth of 15% yoy and 2% qoq. We expect slippage of Rs28bn lower than Rs30bn in 4Q. We expect PAT of Rs17.3bn for AXIS growing 16% qoq and 146% yoy. For YES, we expect slippage of Rs47bn higher than Rs35bn qoq, higher provisioning, lower NIMs and a net loss of Rs6bn.

Key expectations for state banks and NBFCs: YoY and qoq earnings growth for SBI will be strong driven by lower credit cost, a small improvement in NIMs and higher trading gains. We expect PAT of Rs26bn for SBI against a loss last year and a low base of Rs8.5bn in 4Q19. We expect slippage of Rs70bn versus Rs80bn qoq. We expect Union and PNB to post losses while BoI will report a small profit on a low base. BoB will report consolidated earnings in 1Q. We expect slippage of Rs48bn with slippage of Rs33bn for standalone BoB and 15bn for Dena and Vijaya. We expect consolidated PAT of Rs4.7bn in 1Q19 versus a standalone loss Rs9.9bn in 4QFY17 and standalone PAT of Rs5.3bn in 1QFY19. AUM growth of HDFC will remain strong at 14% yoy and 4% qoq. Asset quality will likely remain stable. 30% of the lumpy stake sale in GRUH will be utilized for making provisions towards standard stressed real estate exposures, as has been the practice in the past. Spreads will decline by 10bps qoq. LICHF’s AUMs will grow 2% qoq slower than 7% qoq in 4Q due to slower growth in developer loans. Developer NPLs could rise given the weakness in that segment. NIMs will likely decline 9bps qoq. We expect disbursement growth of MMFS to remain weak at 2% qoq (was negative in 4Q). AUM growth will decelerate from 27% in 4Q19 to 19% in 1Q20. GNPAs will rise 20% qoq due to seasonality and a low base of 4Q. Credit cost could move back up to the level of 1.5% seen in 3Q19 after being negative (because of a write-backs) in 4Q. AUM growth will remain weak for SHTF at 6% yoy and 2% qoq while credit cost will remain stable qoq.

Key recommendations: ICICI Bank and HDFC Bank are our key picks. We reiterate buy on AXIS but the stock has already outperformed the sector. We reiterate Underperformer on YES Bank as we expect a prolonged increase in credit cost and a prolonged deterioration in core operating performance. IIB’s earnings will be strong after two weak quarters, but we need to take a longer term view on the bank’s corporate exposures. Concerns about IIB’s stress book being larger than management’s estimates will continue to be a drag on valuations till there is evidence of a revival in the corporate cycle. If one must invest in a state owned bank it would be SBI. Among NBFCs, we recommend HDFC and MMFS. While earnings for MMFS will likely be stronger than other NBFCs we have concerns around sustainability of strong AUM growth in FY20.