Earnings preview: Q3 to bring PAT, margin growth for banks

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India’s banks are likely to report yet another feel-good quarter of strong operating performance for Q3FY2023 as a surge in disbursements amid rising interest rates is likely to boost both the top line and the bottom line.

The heft of the liability side and the management outlook would determine which lenders would remain the market favourite.

Analysts estimate that the net profit of the banking sector could expand 30-35 percent year on year (YoY) for the third quarter on the back of a stellar 18 percent loan growth and stable to improving net interest margins.

Given the robust credit growth and margins, core interest income, too, is expected to show healthy growth. Low credit costs and provisioning needs amidst a secular improvement in asset quality would further boost profits.

Public sector banks are likely to show outsized growth in profits, led mainly by falling provisions.

Operating profit boost

The sharp deceleration in loan demand had depressed the core interest income for banks, and, therefore, operating profit growth in the previous financial years.

That changed after COVID-19 as net interest income growth bounced back. For the September quarter, net interest income growth was around 20 percent for listed banks at the aggregate level, higher than the single-digit growth reported in earlier quarters.

“The strong loan growth, coupled with improving loan-to-deposit ratio at SOE banks create a nice tailwind of better NIM/NII growth, which is also showing up in stock price movements,” said analysts at Nomura in a recent note.

The drag on treasury income is expected to be low and mark-to-market losses due to elevated bond yields may be limited. In the previous quarter, select banks had seen a sharp hit on their bond portfolios which had impacted operating profit.

“The 10-year India G-Sec yields fell 7bps in Q3FY23 to 7.33 percent from 7.40 percent QoQ and the 1-3 year India G-Sec yields fell by 5-10bps. To that extent, the hit on the treasury portfolio would not be significant, while there is a possibility of some write-back,” said analysts at ICICI Securities Ltd.

The upshot is that operating profit growth could be one of the best for banks in the October-December 2022 quarter. Analysts at Motilal Oswal Financial Services expect operating profits to show robust double-digit growth, like in the September quarter.

The penultimate margin boost

The third quarter could be the penultimate one where banks may see net interest margins remain stable or even expand. During the quarter, most banks announced large increases in their deposit rates to attract funds. As such, bulk deposit rates and rates on certificates of deposits had already climbed sharply since May 2022. This upward journey will eventually weigh on margins for banks but the impact is expected only in FY24.

In the third quarter, the increase in the cost of funds through deposit rate hikes would be somewhat offset by the lending rate hikes. “The spread between outstanding loan yield and the average term deposit rate has sustained at a healthy level, especially for private banks. Another rate hike in December 2022 has ensured that we will continue to see margin expansion in the near term, but the market for deposit rates is also getting aggressive by the day,” Kotak Institutional Equities' analysts said in a note.

Early updates of select private sector banks show that the low-cost current and savings account (CASA) deposits remained stagnant during the quarter, an indication of a shift to term deposits by customers.

This, along with deposit rate increases, would put pressure on margins in the coming quarters.

Low stress on books

The improvement in asset quality is expected to continue and fresh stress through slippages is expected to be low for the quarter.

“We estimate slippages to continue to moderate, which, along with healthy recoveries, should result in a further improvement in asset quality,” analysts at Motilal Oswal wrote in their note.

Gross bad loans, as a percentage of the loan book, have now come down to 5 percent for the overall banking sector in the September quarter, which was almost a 2 percentage point fall, sequentially. The improvement has been led by public sector banks although they still hold the bulk of the bad assets compared with their private sector peers.

Notwithstanding continued improvement, analysts believe that the restructured portfolio of lenders would need scrutiny for any stress.

“Given the high inflation pressures and aggressive rate hikes, we are closely monitoring management commentaries on business and lower income strata, including the behavior of the Emergency Credit Line Guarantee System (ECLGS) pool and restructured portfolios,” analysts at Elara Securities Ltd wrote in a note.

Those at ICICI Securities warn that seasonal slippages from agriculture loans may also weigh on banks.

Shares of banks have been on an upswing for the past year, anticipating a strong performance by lenders. The Nifty Bank index returned a handsome 21 percent in 2022, compared to 13 percent in 2021, and has continued its upward journey this year as well.

Despite the surge in shares, valuations of lenders are still modest, according to analysts. “Improving loan growth, margin tailwinds, and lower credit cost forecast, supported by well-capitalised balance sheets are positive catalysts that should allow valuation multiples to improve,” analysts at Nomura pointed out.

Within banks, big lenders such as the State Bank of India (SBI), ICICI Bank, HDFC Bank and Axis Bank have been top picks of brokerages, given their advantageous position in liabilities.

Analysts at Elara, however, believe that mid-sized banks may also live up to expectations and the valuation gap between banks may reduce.

“Cyclical tailwinds may ensure small banks may offer stronger earnings and ROE. EPS growth divergence between banks may narrow, leading to convergence in valuation,” the brokerage note said.

In all, the third quarter performance of banks may give enough reasons for the rally in shares to continue and perhaps even strengthen.