Q2 results review: Macquarie bets on HDFC Bank, YES Bank

In an interview to CNBC-TV18 Suresh Ganapathy of Macquarie reviewed the second quarter financial performance of various public and private sector banks. For state owned banks, asset quality concerns still remain and slippages are likely to continue for a couple more quarters, he cautioned.

Also read: SBI and IDBI Bank, 2 largest lenders in Suzlon debt recast

From the private banking space, he is bullish on HDFC Bank and YES Bank. "The power of compounding itself is a pretty good story in HDFC Bank because of the strong earnings growth. Yes Bank does not have exposure to the large infrastructure projects so it is far better poised to tackle the asset quality situation, he elaborated.

Below is the edited transcript of Ganapathy's interview with CNBC-TV18.

Q: We have had some howlers from some of the PSU banks in terms of NPAs do you think the worst is over or do you think things are going to remain bad for a bit longer?

A: It is too early to call the worse is over because in my view the slippage will continue for a couple of more quarters. Till the time these reforms announced by the government are not translated and implemented, I don't see a relief to the asset quality issues specifically, in mid and small enterprises where there have been pretty serious issue.

Q: The SME apart, some lumpy assets are still looking like going into stress like gas based or even coal based power projects or roads or ports that are stuck for clearance. Won't these kinds of lumpy bad loans impact all kinds of banks - private and public very shortly?

A: Restructuring will continue even for private sector banks specifically, those which are involved in infrastructure projects. The current issues have happened mainly on the SME sector -though infrastructure problems are plenty, they have not translated into large amount of restructuring, which will happen in financial year 2014 across this sector. Private banks will also see some deterioration, but it would be much better compared to the state owned universe.

Q: What exactly would your pick be within the private banking space which is pretty much secluded from the asset quality concerns?

A: I would still prefer banks like HDFC Bank where these issues are much lower in nature. The power of compounding itself is a pretty good story in HDFC Bank because of the strong earnings growth.

Yes Bank also fits pretty well from a 12 to 18 months perspective because it does not have exposure to the large infrastructure projects when it comes to term lending. Most of the loans are working capital in nature, so it is far better poised to tackle the asset quality situation related to others. HDFC Bank and Yes Bank would be my preferable picks in the private space.

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Q: With regards to exposure of private banks like Yes Bank and others which might have some amount of exposure via off balance sheet to the likes of infrastructure via performance guarantees etc. Would that be a concern at all?

A: It is a myth that Yes bank off balance sheet activities are too risky. If one looks at it in terms of proportion risk weighted assets to the overall assets - Yes Bank stands at 70 percent. Risk weighted assets do incorporate off balance sheet activities. At 70 percent of the overall asset proportion it is not very different from an HDFC Bank.

So, it is not that Yes Bank has greater amount of off balance sheet risk. Typically, the large off balance sheet activities come in the form of forex contracts, interest rate derivative contracts which are fully hedged. So, I don't see much of an issue when it comes to off balance sheet transactions specific to Yes Bank.

Q: What is your pick of the pack among the PSUs?

A: None. To be pretty honest, the issues of asset quality are going to continue for quite some time. The markets today are only reacting to the asset quality developments and not to anything like loan growth or margins. Even though there could be some positive bias towards margins because of easing of funding cost over the longer term, unless and until there is very clear visibility that asset quality situation is going to improve, I don't think public sector banks are going to perform in that environment. They are going to be in a very small trading range, but it is unlikely to see any material upsides in PSUs at these levels.

Q: Is there any differentiation you want to make for Oriental Bank of Commerce or for a Bank of Baroda which have managed assets better or on valuation counts?

A: Valuations support could be there in some of those cases, but strong upside catalyst is missing. Also, we need to understand that in cases like Bank of Baroda or Bank of India or Canara Bank, they are likely to see a channel change in the near-term. So it is much easier to exhibit a disruptive behaviour when the economy is not doing pretty well. So, these are avoidable picks at this point in time.

One risk which perhaps is getting ignored in opinion in PSUs is that the regulatory driven provision can keep earnings under pressure. One has seen the restructured assets provisioning increasing. I know that all these things have been done on a retrospective basis. There can be further increase in the restructured assets on the provisions plus the restructuring guidelines could be made tougher. Dynamic provisioning guidelines are also going to be in the making in a couple of quarter or perhaps six months later. So, all these regulatory challenges exist in PSUs which make me bit more cautious on them.

Q: What is your perspective on power NBFCs? Do you like them?

A: Yes. I am relatively a bit more favourable towards the power NBFCs compared to the other retail NBFCs. The biggest advantage with them is that the SEB debt restructuring at least in the interim, gives some more financial flexibility or freedom to the state electricity board, which will be positive for the power NBFCs.

There are talks about NIB getting established etc and all of it is sentiment positive. A lot really depends upon the ability of the government to execute and implement these projects. They can drive the future rerating, but at least the sentiment is relatively positive.

Therefore, I am bit more inclined towards the power NBFCs or infrastructure financing institutions than the retail NBFCs. From regulatory perspective, retail NBFCs are of greater challenges compared to the power NBFCs. So, even from that angle the power NBFCs look to be better poised.

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Q: Do you like both REC and PFC?

A: Yes. I would still prefer PFC over REC mainly because of the valuation support.

Q: With respect to the large NBFCs the Shriram, Bajaj, Mahindra Finance do you like the sector? Do you like any specific stock?

A: If one has to take a very longer-term view I do have a negative recommendation onMahindra & Mahindra Financial services. But that is no from a short-term or a tactical perspective. The critical issue there would be regulatory changes. The RBI committee report which talks about 180-90 day NPL recognition and increasing of capital requirements, one will start as and when they get implemented. It would affect the earnings and book value. I don't think the market is very adequately pricing that.

Secondly, the securitization guidelines have been made tougher. The full impact of the securitization guidelines whereby they have banned credit enhancement on assignment transactions is going to impact spreads and margins in the near-term. So, we would actually wait for it to materialize, an earnings downgrades to come across before we start getting positive on that name.

Q: Won’t basel III capital requirements hurt all banks like private and public for example affect the bottom-line or i.e. profitability?

A: Apart from Axis and Yes Bank, the large private sector banks like HDFC, ICICI and Kotak are pretty well capitalized. So, basel III is certainly not an issue for them atleast in the near-term. It is more an issue for the state-owned banks.

Mainly, because of the need for the government to hold a minimum 58 percent stake in all of them. Then it is going to be a big challenge considering that if one is expecting some recovery in the growth, capital requirements are going to be relatively large, so, it is a bigger issue for the PSUs than for the privates.

Q: What are you expecting for Q2 FY13 from State Bank of India (SBI)?

A: The general expectation is that the overall stressed assets formation that is slippages and restructures assets is going to be closer to about Rs 9,000-10,000 crore.

The composition may change. In the last quarter they had Rs 10,000 in terms of slippages perhaps that will come down to a level of 70-75 billion.

But, the overall stressed asset formation inclusive of restructured asset will be similar to the last quarter. Anything way above that is going to be pretty negative for the stock.