What the Q1 numbers say about the health of Indian banks

Publish Date: August 30, 2018

After a dismal FY18, the first quarter earnings of banks in FY19 were not spectacular, to say the least. Bad loans, which have spooked the banking sector for a while now, still remain a worry. Earnings have dipped, thanks to higher provisioning. The cost of funds rose alarmingly for a few private sector banks, stunting top-line growth. That said, 1QFY19 wasn’t all gloom either. There are tell-tale signs of recovery that could soothe Dalal Street’s frayed nerves in the medium term.

Kotak Institutional Equities (KIE) remains positive on the outlook for the banking sector. Dalal Street may not have much to cheer about anytime soon, but here is a checklist we found to be particularly heartening.

• Setting the tone for NPL deceleration: Non-performing loans (NPLs), a sore point for the sector, showed some improvement in the April–June period. There was a decline of 30 bps quarter-on-quarter in gross NPLs for the first time in years. Slippages were tamed. Recovery and upgrades were the highest in the past few years. The Insolvency and Bankruptcy Code (IBC) has started to transform the sector, and a few large steel accounts went through the resolution process during the period.

Our take: We remain positive on the outlook for slippages. These should decline once the stock of bad loans pending to be recognized falls sharply, as the early warning indicators suggest. The expectation is that the IBC process will see banks resolving most of the cases.

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• Retail loans propel growth: Loan growth was modest at 10% y-o-y. For private sector banks, the quarter was particularly good with 21% y-o-y growth. But this was not the case for public sector banks, which remained muted at 6% y-o-y. The loan book is showing a gradual shift towards a higher share of retail loans. A few sectors where signs of recovery and increase in investment is visible are the renewable and infrastructure sectors.

Our take: Old private banks continued to record robust growth in the range of 13–31% y-o-y. Most of these banks will continue to focus on small and medium enterprise (SME) and retail loans for incremental growth.

Related: Are the troubles over for the Indian banking sector?

• Fee income raises hope: Fee income for the banks under review was up 13% y-o-y. Again, the private banks trumped public sector banks in this regard. Private banks reported an 18% y-o-y rise in fee income during the period. This was mostly driven by retail fees and cross-selling of third-party products like insurance and mutual funds.

Our take: Most banks have been increasing their tie-ups for the distribution of third-party products. This is generating significant cost savings and is expected to continue in the medium term. Fee income contribution to total income will be robust going ahead.

Related: Retails loan growth in top gear for banks

• Strong quarter for NBFCs: Non-banking finance companies (NBFCs) had a super quarter, reporting 15–35% y-o-y growth in core earnings on the back of 20–35% loan growth. Loan disbursement was healthy at 20%. However, net interest margin (NIM), which measures the effectiveness of a lender’s investment decisions, remained under pressure for most NBFCs. The loan books showed robust growth driven by high disbursements for commercial vehicles and buoyancy in rural auto finance and continuing growth in consumer finance. The overall growth for housing finance companies was a bit muted.

Our take: Most of the NBFCs have migrated to the Ind-AS set of Indian Accounting Standards which is fully converged with the International Financial Reporting Standards. The impact of the shift was negligible on the net worth of the NBFCs due to extra provisioning, with the improving credit cycle leading to a decline in provisioning requirements. It would be a challenge to directly compare financial performance across NBFCs due to different accounting treatment of several line items, which we believe may get standardised over the next few quarters.

Conclusion

The worries of the banking sector are far from over. It seems that the previous year’s woes got carried over to the first quarter of FY19. Top-line growth remained muted and higher provisioning for bad loans severely dented profits.

But there were some green shoots too. PSU banks showed resilience in enhancing their loan books after several months. As mentioned, the IBC has started yielding results. NBFCs too have put up a good show while the shift to a new accounting standard has been quite smooth.

All in all, the first quarter of FY19 has been a mixed bag for the banking sector as a whole. Its worst days could well be behind it now.




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