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Financials: Q2FY19E Preview – More of the same

Key sector highlights for 2Q: 1) Banks’ loans grew 13% yoy and 2% qoq. There has been a pick-up in loan growth of August and September at 1.3% and 2.2% mom mainly due to rising yields that led to corporates borrowing less via NCDs and more from banks. 2) Deposit growth at 8% yoy / 1.7% qoq continues to lag loan growth leading to an incremental CD ratio of 91%. We believe the CD ratio will cool off in 3Q with alternate investments such as MFs looking less attractive amidst volatility in the markets that will drive higher deposit growth 3) The 10-yr yield rose 12 bps qoq, lower than in 1Q. However yields on 1-3 yr bonds rose sharply by 21-60 bps qoq. 4) Exchange depreciation at 5.9% in 2Q was similar to 5.1% in 1Q, as such the rise in overseas NPLs/slippage for banks on account of exchange depreciation will be of a similar magnitude as in 1Q. 5) We expect sequential NIMs to fall for all banks except HDFC Bank. For retail banks, NIMs will fall because of their fixed loans that reprice only on maturity while cost of funds has already increased. For corporate banks, NIMs will fall because of no lumpy recovery in 2Q. In 1QFY19, Bhushan and Electrosteel added as much as 12-17 bps to NIMs. The only big resolution that happened in 2QFY19 was Monnet Ispat which was not as bulky as the ones in 1Q. Also the haircut in Monnet of 72% was higher compared to the other two which means that there was no excess for most banks to write back through NII. 5) There was no big account that slipped in 2Q. However, a few banks could report their divergence which could lead to an increase in NPLs. One banks that we closely monitoring for divergence is YES Bank. 6) Recoveries will be lower with no lumpy NCLT resolution. We do not see ARC sales making up for the lack of lumpy recoveries. 7) The issues around liquidity and IL&FS happened towards the end of the quarter and will likely have an impact on earnings 3Q onwards. 8) We expect profit of private banks to decline 11% yoy and grow 23% qoq. We expect state banks to report loss of Rs14.6bn in 2Q19 versus loss of Rs50.6bn in 1Q19 and PAT of Rs11.5bn in 2Q18. We expect NBFCs to grow earnings by 32% yoy and 15% qoq.

Key expectations for retail private banks: Retail banks will continue to post strong earnings growth. We expect earnings growth of 23% yoy for IIB, 16% yoy for KMB and 20% for HDB. Operating trends will remain similar to 1Q for IIB and KMB which would mean lower qoq NIMs, strong loan growth and lower trading gains. For HDB, NIMs will likely improve qoq because of the equity issue and an increase in qoq CASA. 

Key expectations for corporate private banks: For ICICI 1) we expect profit of Rs10.4bn versus loss in 1Q as provisioning will ease. We expect slippage to remain stable qoq. We expect NIMs to decline 7 bps qoq. For AXIS 1) we expect stable slippage, decline of 6 bps in NIM and PAT of Rs8.8bn for 2Q versus Rs7.0bn for 1Q19 and Rs4.3bn for 2Q18. For YES that has already reported key balance sheet numbers, we expect NIM to decline 10 bps qoq. We expect slippage to rise qoq but on a low base. We note that divergence if released this quarter could be the key swing factor for slippage and credit cost. We expect YES to report earnings growth of 29% yoy and 3% qoq.

Key expectations for state banks: We expect slippage to reduce qoq for most state banks. We expect NIM to decline for all. With lower trading gains, lower NIMs and credit cost remaining high (though lower qoq), we expect all state banks except BoB to continue to report a PBT loss. Even SBI will likely report a loss because Essar Steel (exposure of Rs108bn) will likely move to the 100% provisioning bucket. This could keep provisions for SBI as high as in 1Q. If RBI gives a special dispensation to SBI to not make 100% provisions on Essar in view of the impending resolution, provisions could be lower by Rs40-50bn and the bank could report a PAT. We are currently going with a loss scenario. BoB, on the other hand, will see a revival in earnings with better qoq NIMs (while domestic NIMs may compress, overseas NIMs have revived) and lower provisions.

Key expectation from NBFCs: We expect NBFCs to report strong AUM growth, more or less stable margins and stable asset quality. As the liquidity crunch happened in the last 10 days, its impact will be seen in 2H not 2Q earnings of NBFCs.

Key recommendations: We retain our preference for private over state banks. HDFC Bank, IIB, ICICI and AXIS are our key picks. Concerns on merger of weak banks with stronger ones, rising bond yields, low capital adequacy and compulsion to lend to MSMEs make us reiterate our Underweight on state banks. If one must buy a state owned bank, it should be SBI. Within NBFCs, MMFS remains our key pick. 2Q.

IL&FS could slip in 3Q: Banks collectively have an exposure of Rs575bn to IL&FS. There was no slippage from this group in 2Q but we believe the group could slip in 2H. Banks that have a high exposure to IL&FS in our universe are IIB and YES among private banks and BoI and BoB among state owned banks.

All accounts of IL&FS are standard other than IL&FS Tamil Nadu Power: All loans of the IL&FS group are standard across banks except for IL&FS Tamil Nadu Power which is an NPL for SBI but standard for most other banks. SBI’s exposure to this company is not large at Rs4bn.