Q3FY14 was operationally steadier than Q2 and we expect the banking sector?s pre-provisioning operating profits (ex-trading gains) to increase by 9.5% year-on-year. However, carried-forward MTM (marked-to-market) losses from Q2 and continued high credit costs are likely to drag earnings growth to +1% y-o-y.
The large earnings gap between private and government banks would sustain with private banks? earnings increasing by 17% y-o-y vs a decline of 18% for PSU peers.
While credit growth in Q3 has slowed to 15% y-o-y, deposit growth accelerated as banks accessed relatively cheap offshore funding (thanks to the RBI?s special swap window). This is likely to ease funding pressure and keep NIMs (net interest margins) stable.
Asset quality pressures should be largely unchanged with slippages likely to remain high, but restructured assets are likely to stabilise in the near term. The sector has outperformed the Sensex (+9%) over the past three months and valuations are now closer to historical averages.
While the PSU stocks are cheaper, they will be volatile as economic growth revival remains uncertain and PSU banks will need to continuously access the capital markets to strengthen their balance sheets.
Key earnings drivers: Q3 should be a steady quarter operationally with stable NIMs, lower fees and slightly higher cost pressures keeping core operating profit growth at a modest +9.5% y-o-y (+31% y-o-y for private banks and -6% y-o-y for PSU banks). However, carried-forward MTM losses on bond portfolios would be a key earnings drag. Asset quality pressure would be unchanged?incremental slippages and restructurings would remain high (but not worsen), so will credit costs. Overall, it would be an unremarkable quarter, with +1% growth in profits.
Key stocks to watch: (i) Axis Bank would continue to register modest earnings growth (+13% y-o-y) due to asset quality concerns, could see near term stock corrections.(ii) HDFC Bank is expected to have another quarter of sub-30% earnings growth even as NIMs stabilise and loan growth revives. (iii)
Indusind Bank is likely to have carried-forward MTM losses, but low credit costs should support healthy (+27% y-o-y) earnings growth. (iv) SBI?s earnings should remain under pressure (-29% y-o-y) on low fee income and high operating and credit costs.
Sector outlook: Indian banks recently outperformed the broader indices taking cues from stable currency and interest rates as also optimism of improving growth environment. Sector valuations are now close to historical averages and factor in most of the ?good news?. We believe political and economic uncertainty has increased recently and should cap valuation upsides, especially for PSU banks. We continue to prefer private banks with Axis Bank, ICICI Bank, HDFC Bank and IndusInd Bank as our top picks.
?IDFC
