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Financials: Q3FY19E Preview – Banks grow, NBFCs slow

Key sector highlights for 3Q: 1) Banks’ loan growth accelerated to 14.7% yoy and 4.5% qoq driven by loans to NBFCs that were facing liquidity crunch. 2) Deposit growth at 8.6% yoy / 1.1% qoq continues to lag loan growth leading to an incremental CD ratio of 128%. 3) Bond yields eased across maturities with the 10 yr yield declining 50 bp qoq to 7.52% which would lead to good trading gains versus losses last quarter and will also result in write-back of investment depreciation. 4) The rupee appreciated by 3.8% in 3Q versus depreciation of 5.9% qoq in 2Q, which would mean that banks will not report exchange driven slippage in 3Q which was chunky in the last two quarters. 5) We expect NIMs to rise for state banks and fall for private banks other than IIB where NIMs will likely remain stable. 6) Some banks where IL&FS and subs are overdue for more than 90 days will have to report these loans as NPLs. IIB and YES Bank are most exposed to IL&FS in our universe. Most could report their divergence which will likely be small for most banks other than YES Bank in our view. 7)  The two recoveries this quarter were Binani Cement and Uttam Galva Steel where mostly state banks are lenders. 8) Essar Global has paid off its remaining dues of Rs63bn to ICBK, AXIS and Stan C. While this was announced in 4Q, it is likely that banks show it as recovery in 3Q itself. This will lead to a decline in NPLs. Banks would be carrying 15-20% provision on this account. Power resolutions under SBI-led Samadhan have been slower than expected due to lack of approval from 100% of lenders. Takeover/ resolution of SKS Chattisgarh and Prayagraj have been approved by lenders and are awaiting state government clearances. 9) NBFCs will slower AUM growth and lower margins following the liquidity crunch. Asset quality of real estate remains a key concern but we do not see any major slippage in 3Q.

Key expectations for retail private banks: Performance of retail banks will remain similar to 2Q with strong loan growth. We expect earnings growth of 19% yoy for KMB and 16% for HDB. For IIB while loan growth will be strong and NIMs will be stable qoq, provisions will remain high yoy and qoq due to IL&FS exposure. We expect PAT for IIB to increase 0.6% yoy and 2.3% qoq. Core PPOP will grow 20% yoy and will be flat qoq.

Key expectations for corporate private banks: For ICICI, we expect profit of 18.7bn growing 13% yoy and 106% qoq. We expect loan growth of 14.2% yoy and 6% qoq, 10 bps decline in NIM and higher trading gains versus loss in 2Q.  We expect slippage to decline to Rs24bn from Rs31bn qoq as there will be no currency related slippages. We expect the Essar Global repayment of ~20bn to be factored in 3Q. Provisioning will decline to Rs34bn from Rs39bn qoq but still remain elevated.  For AXIS we expect a small 5bps decline in NIMs and loan growth of 10% yoy and 2% qoq. Loan growth will be lower than the sector’s due to slower corporate growth. Also AXIS has not actively bought NBFC portfolios unlike other corporate banks. We expect slippage of Rs48bn, higher than Rs28bn qoq for AXIS as corporate slippages are volatile. There is a possibility that the new CEP does a major cleanup of corporate loans so that the overhang of corporate NPLs goes away. For YES Bank divergence, slippage and cost of funds are the key monitorables. We are not sure if YES Bank will report divergence in 3Q but divergence will remain a key overhang on the stock till reported.

Key expectations for state banks and NBFCs: We expect state banks to show higher earnings with higher trading gains and higher loan growth, though RoAs will remain weak. SBI can report strong loan growth of 6% qoq and 14% YOY. SBI has been most active in buying loan portfolios from HFCs which will boost its loan growth and margins. It will also show higher trading gains, investment write-backs and flat qoq provisions. Slippages will be similar to 2Q. We expect SBI to report PAT of Rs49.6bn versus 9.4bn in 2Q which would be the highest in the last many quarters. BoB will also likely report a strong PAT driven by high domestic loan growth, higher qoq NIMs and stable provisions. The liquidity crunch will result in slower loan growth and lower NIMs for NBFCs and HFCs. However AUM growth for MMFS at 19% yoy and 3.6% qoq has remained strong in 3Q due to festival demand.  With strong growth, lower qoq NPLs and stable credit cost, we expect profit for MMFS to remain strong.

Key recommendations: ICICI Bank and HDFC Bank are our key picks. We reiterate buy on AXIS but will wait for the new CEO’s outlook on loan growth and CASA revival. We reiterate Underperformer on YES Bank with uncertainties around divergence and capital raise.  We believe volatility in earnings of state banks will continue with changing yields and low RoAs. As such we prefer owning private banks. If one must invest in a state owned bank it would be SBI. In our view, SBI’s 3Q earnings will be very strong. But given the weak RoA, we refrain from being too bullish on the stock. We expect SBI’s QIP before results.