Risks remain in banking sector but margin picture positive

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Risks remain in banking sector but margin picture positive

Prabhudas Lilladher has come out with its report on India financials sector. According to the research firm ICICI Bank remains the top pick.

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Prabhudas Lilladher has come out with its report on India financials sector. According to the research firm ICICI Bank remains the top pick.

Sector outlook: Risks remain but some positives at the margin: Moderating economic growth and sticky rates would continue to impact loan growth and asset quality trend would remain volatile over the next two quarters, with some more pain expected from SME/Agri portfolios. However, at the margins, NIMs have bounced back and peaking rate cycle would be a sentiment positive. Also, FY12 has seen a strong beginning for the much needed power sector reforms, which over the next two years, will help address significant asset quality concerns.

Asset quality: Analysing pain points: (1) SME asset quality remains weak, while large corporates continue to remain robust. Stress sectors (excl. Infra) are ~18- 22% of PSU's exposure v/s ~12-15% for private banks. (2) PSU's Discom exposure (3-5%) would need to be restructured but strong policy moves and steep tariff increases would help bridge the gap and secure incremental funding from banks/FIs (3) Fuel remains a risk for IPPs and our detailed analysis indicates that ~16% of incremental projects could face significant challenges.

Valuations discounting some risks: Valuations at ~25-30% discount to historical average do indicate asset quality risks being priced in. Impact on book value factoring in write-offs of 10% in power fund and non-fund based exposure, 5% in other Infra exposures and 2-4% inch-up in gross NPAs in other stress sectors, is ~9-13% for ICICI/Axis and 14-20% for PSU banks. Valuations adjusted for the write-offs still remain ~15-20% lower than historic valuations for ICICI/Axis and at par with historic valuations for PSU banks.

Top- down strategy: Prefer ICICI/Axis over defensive private banks and PSU names: With valuations at ~25-30% discount to average and no large negative asset quality surprises expected in the near term, we prefer beaten down private banks like ICICI/Axis reflected in our 'BUY' rating. We do not see any cracks in the near-term retail asset quality. However, valuation premium for defensives is already at 2009 levels and we expect no further outperformance on sharp market declines reflected in our 'Accumulate' rating on HDFC Bank (HDFCB)/HDFC. PSU banks' valuations look interesting; however, we expect near-term asset quality volatility to continue.

Bottom-up stock Ideas: ICICI is our top pick as we believe market continues to factor risks from lumpy Infra exposure but is ignoring offsets from high retail exposure and sharp core ROE improvement which would narrow lending business valuations gaps with peers. Among defensives, Kotak Bank (KMB) is the least preferred because at par P/E valuations with HDFCB, it does not factor in ROA compression under a normalised credit cost scenario which will not the case with HDFCB/IIB. Among PSUs, SBI is our preferred pick as near-term negative surprises are largely priced in but market is ignoring SBI's low risk power exposure and operating profit resilience due to high margins. We have an 'Accumulate' on Punjab National Bank (PNB)/Bank of Baroda (BOB) and 'Reduce' on Bank of India (BOI).

Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

To read the full report click on the attachment