Public sector banks should be back in the green over the next five years but their ROEs will be in mid-single digits, implying a limited upside to their valuations, says BNP Paribas
The economic slowdown is likely to weigh on the credit offtake of the banking system, but brokerage firm BNP Paribas says in India the sector will recover, thanks to lower cost of funds, cost efficiencies and lower tax.
The brokerage said higher operational efficiency driven by digital initiatives and lower workforce requirements will ensure that the cost to income ratio maintains its downward trajectory.
"We believe a lower cost of funds, cost efficiencies, and the benefit from lower tax rates should lead to return on equity (RoE) accretion of 370bps for private banks. Higher RoEs should warrant much higher price-to-book ratios (P/Bs). We see a 10-15 percent upside from current valuations for private banks over the next five years," said BNP Paribas.
Given that the asset quality cycle has peaked, the credit cost should be lower than those in the previous cycle, the brokerage said.
BNP Paribas see public sector banks (PSBs) back in the green over the next five years. However, their ROEs will be in mid-single digits, implying a limited upside to their valuations over the next five years, the brokerage said.
BNP Paribas said HDFC Bank still has the potential to deliver the strongest shareholder return over the next five years– a CAGR of more than 20 percent. Kotak Mahindra Bank can also deliver a significant return by unlocking shareholder value in its subsidiaries.
The brokerage says life insurance is the next big sector.
"We believe life insurance is likely to witness its ‘Jandhan’ moment soon, where Indian consumers start looking at insurance as essential rather than optional. As awareness spreads and the insurable pool increases, insurance is likely to be more affordable," the brokerage said.
BNP Paribas expects insurance penetration to increase significantly over the next 10 years. Given most regulatory challenges have been addressed and processes are in place, insurance should witness uninterrupted growth in the next ten years, similar to what banks saw in 2005-2015.
The brokerage expects life insurance players with strong bancassurance partners to stand out over the next 10 years. "The top three private players (that) qualify as our top picks are HDFC Life Insurance Company, SBI Life Insurance Company and ICICI Prudential Life Insurance," said the brokerage.
Over the last one year, most macro indicators have worsened consistently, pointing to a slowdown across sectors.
Auto sales, cement production, IIP, rural wage growth, unemployment numbers, export growth, etc are all at multi-quarter lows.
Of the 35 macro indicators, only four have shown a positive trend for the last three months, BNP Paribas Securities said.
While there are expectations there could be a mild recovery in Q3FY20 on account of the festival season, there is a high probability that macro indicators turn negative after that.
The brokerage said the problem is not necessarily demand-related, it is likely on the supply side, too, such as manufacturers taking time to adjust to changing consumer preferences (eg better quality cars and ready to occupy houses), banks’ reluctance to lend and regulations that need easing to boost sentiment for a CAPEX cycle revival.
BNP Paribas said there are multiple cushions to help avoid a hard landing for the Indian economy.
"Our analysis of housing finance companies (HFCs) and unsold real estate (RE) inventory indicates no systemic risk. Public sector bank balance sheets are stronger with H1FY20 CET 1 at 10.6 percent against 8.3 percent in FY14, PCR is at 59 percent against 41 percent in FY14," said the brokerage.
"We estimate the corporate tax rate cut to lead to an additional CET1 of 82bps, further improving bank balance sheets. Housing affordability is back at 2006 levels. A healthy monsoon has led to a 20 percent surplus in reservoir levels. Stressed sector balance sheets are seeing a mild recovery," BNP Paribas added.Disclaimer: The above report is compiled from information available on public platforms. Moneycontrol advises users to check with certified experts before taking any investment decisions.Are you happy with your current monthly income? Do you know you can double it without working extra hours or asking for a raise? Rahul Shah, one of the India's leading expert on wealth building, has created a strategy which makes it possible... in just a short few years. You can know his secrets in his FREE video series airing between 12th to 17th December. You can reserve your free seat here.