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Financials: Q3FY18 Earnings Preview - Investment depreciation and NCLT provisions in focus

Key sector highlights for the quarter: 1) While the yoy loan growth has picked up to 10% due to base effect from demonetization, the sequential growth remains weak at 1%. Corporate loan growth remains subdued while retail loan growth for the sector has picked up to 17% yoy up from 15% in 2Q. Within retail, unsecured loans and credit cards have registered the strongest growth. Growth in housing remains steady at 13% with non-priority housing (22% yoy) growing faster than priority housing (7% yoy). The sectoral data is available only up to November.  2) Deposit growth slowed to 3.5% yoy due to base effect. Sequentially deposits have declined marginally by 0.8%. If deposit growth fails to pick up on a sequential basis, banks may have to raise deposit rates. 3) Bond yields hardened during the quarter with the 10 year bond rising 66 bps qoq and the 5-year 47 bps. This will result in lower bond trading gains and mark to market provisions for most state owned banks. Except BoB, most state owned banks will see a huge increase in MTM provisions. BoB’s threshold yield is high at 7.3%. PNB will likely offset MTM provisions with gains from the stake sale in PNBHousing. HDFC has booked gains of Rs52bn on sale of stake in HDFC Standard Life. 3) As for asset quality, JSPL will be on the divergence list for most banks but most banks will downgrade and upgrade it simultaneously, so it will not be part of gross NPLs. AXIS that had already downgraded JSPL in2Q would be in a position to upgrade it. HDFC Bank will show JSPL as part of of NPLs in 3Q (they had already provided for it in 2Q). HDFC Bank will upgrade the account only when RBI permits. Reliance Communications will also become non-performing in 3Q as the SDR dispensation is over. While the resolution plan is already in place, banks will be able to upgrade it when the plan is actually implemented possibly in 4Q.  4) NIMs will stay flat at best for most corporate banks. For AXIS, NIMs will rise on a low base. For ICBK NIMs have likely peaked and will likely correct. 5) Provisioning will remain high as banks will have to start providing for the second batch of accounts that will have to be referred to NCLT by March 2018. 6) Apart from AXIS, HDBK and YES, all banks will disclose their divergence in 3Q. We believe for ICICI Bank the divergence will be Rs65-75bn with a large portion already classified as NPL in the earlier quarters or already part of the watch list. As such for ICBK, divergence will not be a negative, in our view.

Stock specific – loan growth: 1) Loan growth will remain modest for most state banks 2) Loan growth for AXIS will accelerate to 22% partly due to base effect.  For ICICI, loan growth will be closer to 10% (7% in 2Q) with retail growing at 18%. 3) For HDFC Bank, IIB and YES loan growth will remain strong 4) KMB’s yoy loan growth will also remain strong at 23%. 5) Disbursement growth for MMFS will improve to 15% after no growth in 2QFY18, with the impact of the festival season kicking in. AUM growth will remain steady at 15%. 6) HDFC will see strong disbursal and AUM growth. 7) LICHF will likely report AUM growth of 15%. 8) SHTF  will continue to see strong AUM growth of ~17%.

Stock specific – earnings expectations: IIB, HDBK, YES, KMB are expected to report healthy earnings growth among banks. Earnings for state banks will remain weak with slow loan growth, low NIMs, MTM provisions and higher loan loss provisions. For ICICI Bank earnings will decline yoy. For AXIS earnings growth will be strong due to a low base both qoq (due to high slippages) and yoy (due to demonetization). For Kotak earnings growth will be healthy at 18% though lower than 23% in 2Q. MMFS and SHTF will see strong earnings growth. HDFC’s net profit growth will be strong due to gains from HDFC Std Life. Core PBT growth will slow to 11% from 16% in 2Q as the excess spread from lower cost of funds will fade. LICHF’s earnings growth will be modest at 7% yoy due to lower NIMs.

We continue to prefer retail over corporate banks and private over state owned. We believe on most parameters including loan growth, capitalization, future NIMs, asset quality and RoE state banks continue to rate poorly. IIB and HDFC Bank remain our top picks. Among corporate banks, we prefer ICICI over AXIS though earnings growth for AXIS will be higher in 3Q due to a low base. Among state banks, SBI, PNB and BoB will likely outperform the others (though it may be noted that the probability for earnings disappointment in SBI in 3Q remains high)

Companies that will post strong earnings: IIB, HDB, YES, MMFS, SHTF

Companies that will post weak earnings: Union, BoI, LICHF, SBI

Key short term triggers: Newsflow on implementation of IFRS, bank wise allocation of government’s capital infusion, resolution details of cases referred under the NCLT, implementation of an external benchmark rate.