Sector update Banking “Present tenser” as down-cycle looks imminent,:: Centrum

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Sector update

Banking

“Present tenser” as down-cycle looks imminent, 15% downside risk to stress case despite cheap valuation

Correction in financial stocks has continued unabated in recent months as the anticipated headwinds exerted pressure on investor sentiments. So far, Bankex has declined by ~13% since our sector initiation –in line with our view of 10-15% downside risk given the domestic and global headwinds (report titled “Present Tense, Future (near) Perfect”). Having said that, new risks to the downside have emerged, since our initiation, emanating primarily from the ‘extra-hawkish’ stance adopted by RBI and rising risk aversion globally. With monetary tightening well above our expectations, we have lowered our economic growth assumptions (FY12 real GDP at 7% vs 7.6% earlier). In turn, this has led to a reduction in credit growth estimate (from 18% to 16.5% for FY12) and tightening of our asset quality assumptions. We continue to prefer large cap private banks.

m      Growth down-cycle looks imminent: RBI continues to maintain its hawkish stance underpinned by a single-minded focus on containing inflation. As a result, the repo rate has been tightened more than required in our view. Importantly, there is no indication of RBI easing its stance on tightening, if we go buy the recent commentary, despite noticeable weakening in conviction over growth. Given that monetary tightening has been above our expectations and the trends in incremental data, our economist has revised GDP growth estimates downwards from 7.6% earlier to 7% for FY2012. The downward revision of GDP growth estimate is a reflection of policy inertia, over-hawkish RBI and elevated costs of production & consumption extending beyond comfort. Moreover, the current fiscal situation leaves limited scope for fiscal stimulus when the need arises – a major difference between the situation now and back in 2008.

m      Credit growth estimate lowered to 16.5%: In line with the downward revision of GDP growth estimate (from 7.6% to 7%) and ongoing moderation in credit demand so far into the fiscal, we are lowering our credit growth estimate downwards to 16.5% with a downward bias (vs RBI’s revised estimate of 18%). Importantly, the prolonged moderation in economic growth is likely to translate into a weaker H2FY12 in terms of credit growth.

m      Asset quality cycle to reverse: Besides the impact on credit demand, the downward revision in our GDP growth estimate also implies increased challenges on asset quality front for banks and NBFCs. Given the macro challenges (slowing growth & high inflation), we believe that the deterioration in asset quality (especially SME, export oriented sectors and infrastructure) is likely to be higher than expected earlier. In turn, the macro environment will keep the slippage rate and credit costs higher during FY2012. Already, worsening credit quality has pressurized earnings of banks (especially PSBs) in past two quarters.

m      “Present Tense” likely to extend further: In our sector initiation report titles “Present tense, Future (near perfect” (released in June’2011), we had highlighted the risk of 10%-15% downside given near term headwinds. With domestic growth fundamentals heading well below last decade’s average, the current situation warrants a re-look at our estimates. Effectively, the incremental developments and data trends suggest that pain may extend beyond our earlier expectations. Our revised estimates are 5-6% below consensus estimates as we factor in implications of a slower economic growth in the form of 1) slower credit growth and 2) higher stress on loan book quality.

m      Valuations cheap but risk remains skewed on the downside (~15%): Most banks under our coverage are currently trading below their five year average forward multiple (12 month rolling) but still above -1 standard deviation. While the current valuations are definitely attractive, they could still head towards -1 SD led by 1) anticipated below average macro growth trends 2) uncertainty over global growth 3) increased probability of sovereign defaults in Europe and resulting risk aversion. Specifically, our stress case scenario analysis suggests ~15% average downside risk for banks under our coverage and hence a “pause & play” approach is advised. We continue to prefer private banks over PSBs due to better risk-reward profile at the current juncture.

Thanks & Regards,