Yes Bank, Axis Bank, ICICI Bank top picks: Angel Broking

1QFY2013 snapshot - Asset quality woes continue: The slippage levels in 1QFY2013 for PSU banks were higher by 27.7% qoq compared to an 11.2% qoq rise in 4QFY2012. However, slippages for State Bank of India (SBI) constituted 36.6% of the overall slippages in 1QFY2013 as compared to 18.9% in 4QFY2012. Hence, looking at the PSU segment excluding SBI, the slippage levels remained flattish sequentially (though high on absolute basis). Private banks vis-à-vis PSU banks continued to fare well on the asset quality front. However while for 4QFY2012 private banks had managed to reduce their gross and net NPAs levels by 2.0% and 8.6% qoq respectively, for 1QFY2013 they witnessed a 6.4% and 11.3% qoq rise in their gross and net NPA books.

Private banks, aided by a strong performance at the operating income front, reported a 32.2% yoy growth in PBT levels, while PSU banks owing to higher margin compressions and provisioning expenses managed to grow their PBT by a moderate 10.3% yoy, which too was aided by a sharp decline in PCR, leading to a 17% qoq increase in net NPAs.

ROAs expected to have a downward bias: Margins for the banking sector remained under pressure in 1QFY2013 on account of asset quality stress, with 19 out of 27 banks under our coverage reporting sequentially lower margins. Banks with higher NPAs during 1QFY2013 such as SBI and Bank of Baroda (BOB) witnessed the highest qoq margin compression. Any material downward movement in the lending and deposit rates for the banking sector is likely to be restricted given the high persistent inflation and the corresponding rate action outlook of the Reserve Bank of India (RBI). Meanwhile, the decelerating economic growth environment and elevated interest rates are pointing towards further economic stress and are expected to lead to further asset quality pressures for the banks. Hence, in our view, the movement in overall core ROAs is expected to have a negative bias over the coming quarters.

Economic environment remains challenging: Continue to prefer private banks: The downward interest rate movement, going by the monsoon deficiency and recent rally in commodity prices, is expected to be much slower than anticipated earlier. In fact, inflation levels have the potential to inch up further from the current levels, thus certainly delaying the start of the downward interest rate cycle. The slippages which started off from particular stressed sectors of the economy such as real estate, airlines and textiles have become more broad-based in nature. Deficient monsoons and declaration of drought by some state governments could lead to fresh agri slippages and further aggravate the prevailing asset quality situation.

Margins expected to have a downward bias:

Margins for the banking sector remained under pressure in 1QFY2013 on account of asset quality stress, with 19 out of 27 banks under our coverage reporting sequentially lower margins. Banks with higher NPAs during 1QFY2013 such as SBI and BOB witnessed the highest qoq margin compression.

Fee income performance modest for the quarter:

Fee income growth (excluding treasury) was moderate at 11.5% yoy for banks under our coverage. The better performers on the fee income front within the PSU segment were Oriental Bank of Commerce (OBC), Bank of India (BOI) and Andhra bank (witnessed significant jump in recoveries from written-off accounts). Most banks however saw their fee income revenues moderate on account of slowing capital market activities and lower credit off-take and sanctions.

Restructuring books too become heavier:

 Almost all banks resorted to higher restructuring during 1QFY2013 similar to last quarter with loans to state electricity boards (SEBs; discoms majorly) again being the primary contributors to bad loans. Canara Bank (up 78.0% qoq) and Allahabad Bank (up 68.8% qoq) witnessed highest sequential rises in their restructuring books.

Mid PSU banks such as Central Bank (13.4%), Indian Bank (10.6%) and Allahabad Bank (9.7%) have the highest restructuring book as a percentage of their total advances, while private banks’ restructuring books only amounted to 0-2% of their total advances.

While most banks have stated that a majority of discom restructuring is over for them, fresh approvals through the CDR route (Rs17,957cr in 1QFY2013 vs Rs8,001 in 4QFY2012) however, are likely to lead to higher private restructuring in the coming quarters. Hence, although the pace of fattening of restructuring books is expected to slow down, large ticket size private restructuring is expected to keep the restructuring pipeline of most banks active.

Outlook and valuation:

The downward interest rate movement, going by the monsoon deficiency and recent rally in commodity prices is expected to be much slower than anticipated earlier. In fact, inflation levels have the potential to inch up further from the current levels thus certainly delaying the start of the downward interest rate cycle. The slippages which started off from particular stressed sectors of the economy such as real estate, airlines and textiles have become more broad-based in nature. Deficient monsoons and declaration of drought by some state governments could lead to fresh agri slippages and further aggravate the prevailing asset quality situation.

Private banks, having structurally stronger balance sheets and cyclically better asset quality profile hence remain our preferred segment choice with Yes Bank, Axis Bank and ICICI Bank being our top picks. While the entire PSU segment is relatively more burdened with rising asset quality concerns, few banks such as PNB and Union Bank are available at their 8-year low valuations and hence provide a case for value buys from an 18-24 month perspective.

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