Bond(s) To The Rescue Of Indian Banks

Indian banks, weighed down by bad loans and large provisioning requirements, may see some relief this quarter as a drop in bond yields comes to the rescue of otherwise strained balancesheets.

Government banks and private corporate lenders are expected to report weak asset quality trends in the second quarter of fiscal 2017 as the bad loan clean-up continues. Gross non-performing assets (NPAs), which hit Rs 6.3 lakh crore at the end of June, may rise further but at a slower pace, say analysts. However, banks will need to keep setting aside additional provisions as they try and strengthen their balancesheets by March 2017 – a deadline set by the Reserve Bank of India.

Bank earnings will likely decline 15 percent year-on-year as banks make high provisions for bad loans, said Kotak Institutional Equities in their earnings preview report dated October 5. “We see public banks reporting lower slippages quarter-on-quarter, but high provisions will continue. Axis Bank/ICICI Bank will likely see very weak results on slippages,”said the brokerage house.

Ambit Capital shared the view and said that the addition to gross NPAs will be low this quarter but credit costs will remain high.

The aggregate net interest income of ten widely tracked private and government-owned banks is expected to grow 4.4 percent in Q2FY17, show estimates compiled from Bloomberg. However, the aggregate net profit of this set is expected to decline by 3.1 percent as compared to the corresponding quarter last year, dragged by a 79.5 percent rise in provisions.

The ten banks include HDFC Bank, ICICI Bank, Axis Bank, Kotak Mahindra Bank, Yes Bank, State Bank of India, Canara Bank, Bank of Baroda, Punjab National Bank and Bank of India.

Treasury Gains To The Rescue

What will aid banks this quarter is the potential for large treasury gains emerging from a fall in bond yields. Government bond yields which started declining in mid-June continued to fall through the second quarter.

The benchmark 10-year bond yields dropped by 63 basis points in the July to September 2016 period. Since most banks are carrying excess government securities on their books, they could have chosen to book profits as bond prices rose. Bond prices and bond yields move inversely.

Operationally, the quarter may be a muted one with retail credit driving growth for most lenders. Banking system credit grew in single digits at 9.8 percent in the second quarter due to the absence of large investment demand for credit.

Smaller government lenders have seen a contraction in their loan book due to lack of adequate capital even as private lenders have managed to grow their portfolio by focusing on refinancing and on retail credit.

Most analysts expect lending margins to remain stable during the quarter.

What To Expect From The Large Banks?

Government-owned banks and private corporate lenders like ICICI Bank and Axis Bank may report another weak quarter while HDFC Bank may continue to outperform.

State Bank of India, which reported a 31 percent decline in net profit in the first quarter, had guided towards a slower build-up of bad loans during the rest of fiscal year 2017. Analysts will be watching to see if this guidance holds. In comments made during the quarter, Chairman Arundhati Bhattachaya had also said that treasury profits can help reduce the pressure on bank balancesheets.

Bank of Baroda is expected to see a three-fold jump in net profit over last year as a sharp fall in fresh slippages could lead to lower provisions. Bank of Baroda has also set aside excess provisions in previous quarters to strengthen its balancesheet, which may allow the bank to book higher profits this time around.

Investors will also watch three smaller government banks – Indian Overseas Bank, United Bank of India and UCO Bank – for any further rise in bad loans. IOB has the highest gross NPA ratio in the industry at over 20 percent. UCO Bank and United Bank have bad loan ratios of 17 percent and 15 percent respectively.

Qualitatively, analysts point to the following factors to watch for individual banks:

HDFC Bank: Performance of retail loan portfolio and trends in digital banking.

ICICI Bank: Movement of watch-list accounts, impact of stake sale in various ventures and trends on restructured loans.

Axis Bank: Quantum of slippages from the stressed asset watch list which was pegged at Rs 20,295 crores as on 30 June, 2016.

State Bank of India: Asset quality performance, update on stake sales in non-core assets and merger of associate banks. SBI subsidiaries are expected to see a rise in NPAs as classification is brought on par with parent's standards.

Punjab National Bank: Outlook on asset quality as net stressed loans remain among the highest in the industry, capital raising plans and sale of non-core assets.

Bank of Baroda: Any further build-up of stress, particularly in the international book.

Bank of India: Addition to gross NPAs along with recoveries and loans rescheduled under the 5:25 scheme.

Here's a quick look at the NPA trends of these banks over the last four quarters.

These expectations have been compiled from reports of HSBC, Morgan Stanley, Kotak , Ambit and Motilal Oswal.