Financial contagion risks beat down premium valuation of bank stocks

Published: April 15, 2020 1:45 AM

Organisations such as the World Bank have stated that India’s GDP growth for the calender year would be at 1.5% to 2.8% for the current year.

Banks with a greater proportion of retail deposits, retail assets and liabilities have a better yield and lower credit costs. Banks with a greater proportion of retail deposits, retail assets and liabilities have a better yield and lower credit costs.

By Urvashi Valecha

Fears of a health crisis turning into a financial one have impacted the premium valuations of banking stocks, with even the marquee stocks trading at half their five year average price to book valuations. Market experts are of the view that the pain for financials isn’t yet over, as a protracted lockdown would lead to deterioration in asset quality even in the retail segment.

Even as the broader indices such as Nifty50 has corrected 26.17%, Nifty Bank has fallen by 39.29% since the start of the year, as the market expects financial crisis to emerge from the current lockdown. Be it HDFC Limited or IndusInd Bank or Bajaj Finance, most financial stocks have been beaten down since the novel coronavirus started spreading across the length and breath of the country. Shares of IndusInd Bank are currently trading at a one-year forward price to book (P/B) valuation of 0.8 times whereas its five year average price/book valuation stands at 4.4 times. Other banks such as HDFC Bank and Axis Bank are trading at a one year forward P/B valuation of 2.9 times and 1.3 times. The historical five year average P/B value of these banks was 4.5 times and 1.3 times. Public sector banks such as Punjab National Bank and Bank of Baroda have witnessed a similar correction in their one-year forward P/B values.

Even though the RBI has granted a three-month relief to borrowers across the board, wage cuts and job losses arising out of the lockdown could lead to a spike in NPAs. Kajal Gandhi, vice-president – research analyst, ICICI Direct, believes that because of the economic uncertainty caused by the Covid-19 pandemic, investors are in a wait and watch mode when it comes to banking stocks. “Valuations of most banks have bottomed out but, if the asset quality issues are larger than earlier anticipated then there could be further pain for banks,” she said. Emkay Global Financial Services is of the view that the first set of NPAs are likely to be seen from June itself.

Organisations such as the World Bank have stated that India’s GDP growth for the calender year would be at 1.5% to 2.8% for the current year. In such a scenario, the credit growth is anticipated to slowdown. “If the economy won’t grow at a GDP of 2% to 3%, then credit growth for the year won’t be more than 6% to 7%, making FY21 a complete washout,” said Kajal Gandhi of ICICI Direct.

The lockdown is not expected to have a far-reaching impact on the FY20 earnings of banks since disruption caused by the lockdown was limited to the last 15 days of the quarter. Market experts are not attaching too much importance to the results of the first quarter of FY21 because of the RBI moratorium on loans. Kotak Institutional Equities, in its report, said: “We expect banks (under coverage) to show healthy earnings growth primarily due to lower provisions, lower tax rate (DTA costs were adjusted for private banks in Q2FY20 while we await the status of the same for a few public banks) and higher treasury income.”

Banks with a greater proportion of retail deposits, retail assets and liabilities have a better yield and lower credit costs. According to a recent report by Ambit Capital, banks with higher share of retail deposits, high liquidity coverage ratio (LCR), strong brand name and low credit to interest-bearing liabilty (IBL) ratio are better placed in the current environment. The report shows that IndusInd Bank has the lowest share of retail deposits and Federal Bank has the highest share.

Additionally, the report also stated that microfinance, unsecured loans, CV/CE, SME loans and real estate segments should see the highest pressure on asset quality. SBI has a strong position on liquidity and low exposure to riskier segment, say analysts.

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