By Jyotivardhan Jaipuria
After a dream run for the banking segment in FY23, investors wondered whether the sector’s share prices had peaked. There were apprehensions on whether non-performing loans (NPLs) had peaked and credit cost would inch up again. Banking results for the June quarter have again reinforced our view that the sector is on a strong footing. We continue to remain bullish as valuation for banks remain at long-term averages and outlook for earnings remains strong.
Net interest margins (NIMs) for banks have largely peaked but the decline would be manageable in our view. As assets re-price faster than liabilities, banks witnessed sharp uptick in NIMs in a rising rates environment until FY23. With rates stabilising, asset yields have peaked though deposits continue to re-price upward to align with system rates leading to some pressure on NIMs. Banks have witnessed flattish to ~40 bps compression in NIMs in Q1. Most banks, however, in their commentary have stated that the worst in terms of deposit mobilisation at higher costs is behind them and the increase in deposit costs Q2 onwards is likely to be more calibrated. Most banks have guided that the pressure on NIMs could ease post Q2FY24.
Asset quality across segments continues to remain benign with credit costs not showing meaningful signs of deterioration. Despite higher rates, most segments (including riskier segments like MFIs and MSMEs) have reported a meaningfully benign performance on asset quality. Credit cards segment has admittedly seen some surge in credit costs. Overall, credit costs will remain significantly lower than long-term averages given the high provisioning coverage ratios that banks carry on balance sheet. With overall asset quality holding up well, credit costs will likely remain benign. That said, migration to ECL (expected credit losses) could lead to an uptick in credit costs and will be the key thing to watch for.
Capital adequacy ratios remain comfortable for the banking sector with tier I ratios of banks meaningfully higher than regulatory requirements given the strong profitability and capital raising by banks during Covid. In the backdrop of a strong credit growth (16.3% y-o-y in June) and migration to ECL base provisioning, some banks might raise capital in the medium term. However, we do not view this as a negative as growth rates remain strong and recent surge in stock prices (especially of mid-sized banks) would mean that book values won’t get diluted despite capital raising.
Despite the surge in stock prices over last 12-15 months, valuations are largely reasonable at long-term averages on P/B multiple for most banks. Outlook on earnings remains robust and banks are likely to witness improvements in return on assets (RoAs) and return on equity (RoEs) over the next few years. This will help drive stock price returns. Despite the meaningful re-rating over the last couple of quarters, some of the mid-sized banks trade are favoured by us. These have mid-teen RoEs and trade at relatively attractive valuations on price to book.
The writer is founder and MD, Valentis Advisors