JPMorgan has turned selective on the Indian banking sector, downgrading four private and public sector banks, citing expensive valuations and asset quality concerns. Kotak Mahindra Bank and State Bank of India were downgraded to ‘neutral’ while IndusInd Bank and Punjab National Bank were cut to ‘underweight’ by the brokerage.
“We turn incrementally selective on the sector, looking at stocks based on funding and pricing leverage on loans and valuations,” said a research note by the brokerage.
JPMorgan also said that it expects non-performing loans (NPLs) for the sector to rise nearly 50% from levels in the first quarter of the current fiscal year and believes that markets may have overdiscounted this development.
“However, there is the risk that some of this stress could be front-ended in FY14 itself — this would drive continued stock volatility, especially during the earnings season in October,” the note added.
“Wholesale lenders remain more vulnerable even as the immediate pressure is seen coming from outside the infra space,” said JPMorgan.
The interest rate curve also continues to be a point of concern for the banking sector. While JPMorgan expects short-term yields to flatten further, it noted that the extended period of an inverted yield curve would create balance-sheet stress. NBFCs and banks with fixed-rate retail books are considered most vulnerable due to acute margin pressures.
The brokerage observed that although nearly its entire coverage universe is facing earnings pressure from both rates and asset quality, valuations have not adjusted for that in some cases.
Thus,the rating downgrade for Kotak Mahindra Bank is attributed to stretched valuations though it considers the bank to be resilient for the long-term. The downgrade of IndusInd Bank was based on high valuations and a view that the near-term margin pressure have not been discounted enough. The rating cut on SBI was based on expectations that the near-term NPL pressure for the lender is likely to stay intense and that the recent growth could aggravate margin pressures.
Recently, a compilation of bank valuations in terms of price-to-book value showed that both Kotak and IndusInd stocks traded close to their five-year average valuations