While the global banking sector is in shambles, the Indian banking industry, while facing its own battles, has been building advantages. Fund managers and research outfits reckon that the sector will have to gear up to the slowdown as well and focus on asset quality in the times ahead. At the moment, things look rather smug.
Analysts at Prabhudas Lilladhar reckon that the Indian banking sector has remained relatively unscathed from the global meltdown and has reported strong operational performance, with many banks reporting the highest profit in a single quarter. A majority of the players witnessed lower-than-expected deterioration in asset quality at both gross and net NPA levels, along with healthy provisioning coverage.
After speaking with several bankers, Prabhudas Lilladhar analyst say, ?Most banks conceded that they had enjoyed excellent pricing powers during Q3FY09, which they had not seen in their entire banking careers spanning close to 20-25 years.? However, these times are set to change fast as sub-PLR lending has started again and the margins will be under pressure.
IIFL analysts, in a banking sector report, also mention that margins will be under pressure and fee income would also be lower in the days to come. ?Over the last couple of months, banks have been cutting both lending and deposit rates, and at the same time, wholesale borrowing costs have come down significantly from their November 2008 peaks,? they add.
?Asset quality will hold up as the bulk of restructuring and rescheduling is expected in Q4FY09. Real NPL issues could surface from Q2FY10 onwards, if the stimulus packages don’t succeed in reviving industrial activity and the resultant economic growth,? say analysts at Enam Securities.
Analysts with Morgan Stanley research take a harsher view. They expect gross NPLs for the system to rise to 4.6% in FY2010 and 6.1% in FY2011. This will take credit costs to about 55-60% of operating profits for the system (on average – some banks will be more affected). ?We believe this is a mild estimate. If we add restructured loans to NPLs in March 2008, NPLs for the system were already close to 3.5-4%, in our view. Moreover, RBI’s change of view on provisioning and asset classification policies for risky assets, shows that the underlying problem is severe – they are essentially asking banks to increase exposure to these assets. If the economy remains sluggish for a protracted period of time, NPLs can rise to 8% in 2 years, in our view.?
Overall, Indian banks had a weak 2008 and we expect 2009 to be a replay of 2008; that is, while there will be some rallies, we expect a material downside from the current levels for most of the private banks. The stocks continue to trade at rich premiums to the rest of the Asian financials. In our view, these premium multiples are not justified, says the Morgan Stanley report.
However, analysts at CLSA are more optimistic. They reckon that having steadily declined for more than 10 years, gross NPLs would triple in absolute terms from 2.4% of loans in FY08 to 4.8% by FY2011. ?However, based on our analysis of banks’ exposure to industries, we argue that concerns on NPL rising to levels of the previous cycle (around 20%) are exaggerated.?
The reasoning is that when compared to the 1990s, borrowers are less leveraged now and margins, although under some pressure, have improved due to cost rationalisation. Banks also have better risk-management systems and legal framework for recoveries. ?Key risks to our view include a delay in the 2HFY2010 economic recovery forecast by our economics team, an extended commodity downturn globally or a reversal in monetary policy direction,? the report adds.
Fund managers at the moment are looking at the banking sector closely, their focus has been to identify banks with a strong current account savings account (CASA) base and then looking at the ability to maintain strong lending with a focus on asset quality. As a fund manager puts it, ?Banks are where the money is. Any step up in economic activity will have to be routed through the banks and if we believe in the India story, then ignoring bank sector stocks should be done at your own peril.?