The last two weeks have been unusually busy for analysts. On one side, they had to track and listen to numerous earning calls, while on the other, they had to deal with the Union govt’s Budget arriving right in the middle of the earning season.
Since the Budget created a lot of flutter in the capital markets in terms of capital gains tax rationalization, analysts, especially on the sell side, were compelled to present more aggressive, albeit less defensible, arguments to justify valuations in their coverage universe so as not to upset the apple cart from the negative surprise on the tax hike. But the challenges didn’t end there. For those unfamiliar, brokerage research is generally referred to as sell-side. These analysts faced another hurdle: they had to formulate convincing arguments to support their carefully crafted buy theses for the banking sector, despite earnings downgrades and negative surprises in the sector’s latest quarterly earnings performance.
Are the sectors’ earning challenges just a temporary wobble, or do they signal a more serious slump that might be unfolding? Let’s dive in.
It is well known that banking as a sector has a higher weight in the benchmark indices. Consequently, what happens to banks, has a disproportional say on how the index performs, especially the Nifty and Sensex. In that sense, its criticality can never be overlooked.
For the last many quarters, it has been home runs for the banks when it comes to earnings. NIMs (Net Interest Margin) started expanding. Credit costs and asset quality were on the mend.
Loan growth was high. All these led to earning upgrades quarter after quarter. That smooth run seems to have hit an air pocket now in the latest quarter if the results declared by many of the banks are anything to go by.
June quarter results from the banking sector have been anything but inspiring. While the loan growth is moderating, especially in the retail sector, rising credit costs and deteriorating asset quality have raised serious concerns about the outlook for the sector.
This coming amid challenges in deposit mobilization and rising cost of funds has put a question mark on the sustainability of the upgrades for the sector, especially the private sector banks where valuations are at a premium.
Of course, some of the stress in the system could be because of the seasonal impact aggravated by heat waves, floods and by general elections to a limited extent. But certainly, the best of the NIMs, asset quality and loan growth are probably behind us.
RBI’s recent draft circular on the LCR (Liquidity Coverage Ratio) couldn’t have come at a worse time. The draft norms, if implemented, could put further pressure on the costs as banks will be forced to put more into liquid government securities to meet the revised norms of liquidity cover, which in turn could constrain the money available for credit growth.
In other words, banks will be forced to mobilize more deposits or borrowings, either of which will put pressure on the costs for the banks given the tight deposit environment for the industry.
As per some of the estimates, the NIM impact could vary between 7 and 10 bps, depending on the banks because of tighter LCR norms.
Do we see relief in this anytime soon? If at all, things could get harder if the latest trend of structural shift in savings from bank deposits to equities gains more traction in the coming months. With the longer-term prospects looking robust for India macro, a reversal in this trend is unlikely anytime soon.
More so, with the renewed macro focus in the recent budget. While one may have grievances over the tax tweaks in the Budget for the capital markets, no one can deny the positive rub-off for the markets from the government’s continued thrust on macro and fiscal prudence without diluting the focus on capex outlays despite the growing political pressure for doling out freebies because of recent election setbacks.
The market’s confidence stems from the sustained focus on the quality of revenue expenditure in the budget from the ruling regime. To understand this, all that one needs to look at is how the government has judiciously exercised fiscal prudence in spending the extra bounty of Rs 1.3tn (70K was already budgeted in the interim budget out of Rs 2tn windfall) they received from RBI in the form of a dividend. It did not go for funding any fiscally loose outlays or politically rewarding freebies.
Where did they go then? More than half of the windfall was channelized to lower the fiscal deficit and much of the balance was allocated to hike the outlay for an affordable housing scheme that has more multiplier effect for the economy than many other competing outlays.
Coming back to the banking story, not everything is negative. The 10-year Gsec yield had softened by nearly 10 bps since the time the Budget was presented. This fall was consequent to a reduction in the fiscal deficit and as a response to lower-than-expected borrowing numbers.
With the government’s stated objective to shift the fiscal responsibility act (FRBM) focus from fiscal deficit to the overall debt-to-GDP metric from FY27, yield may be trending lower over time, especially given the softer outlook for US interest rates amid softening inflation. This will be positive for the banks on the margin as it will mitigate the pressure on the costs side.
Overall, it is time to be cautious on banks, especially on those that have larger exposure to the unsecured lending and microfinance segment. At the same time, it is hard to say whether the current troubles in earnings for banks point to a decisive change in the NPA cycle or is it just a blip in the overall credit cycle? Only time will tell. But one thing is
clear. That is, heavy-weight lenders are unlikely to do the heavy lifting for the indices going forward. Moreover, it will not be easy for any other sector to pitch in given the weights banks enjoy in the indices. Interesting times!
