Banking - Woes common, but pace uneven; ;Edelweiss

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Executive Summary

In our earlier report ‘Macro challenges getting serious’, dated 29th August, 2011, we had downgraded some of the state owned banks on rising asset quality concerns.  Since then macro challenges - policy paralysis, elevated commodity prices and high interest rates - have stayed put, unabated and unabridged. In this broad note, we encapsulate our stance that asset quality risks are here to stay; Q2FY12 results were a lucid curtain raiser.

Key differentiator: Meticulous slicing of stressed sectors into fine parts

The key differentiator of our NPL Analysis is our attempt - to dig up the ultimate fault line - by slicing stress sectors into outmost sub-segments, specifically in textiles, power, airlines among others. Our exhaustive analysis of upcoming private power projects suggests that ~35% of these (in MW terms) falls under `risky’ category. For airlines, risk emanates from challenging business matrix. Here, we peg the NPV hit due to restructuring at 20-25% of the overall exposure. In textile sector, we see the stress revolving around spinning companies, accounting for 25% of the bank debt. On the retail banking front, our assessment deems stress surrounding teaser loans as `manageable’   since much of the impact from ~18% rise in EMIs can be dealt with by a growth in personal incomes and an extension of tenures. As we pore over the debt exposure of top 25 business group/companies, we note the rising share (in the debt) of private business groups that has ballooned over the past five years from just 36% of bank debt to a whopping 75% now. To our discomfiture, we also observe that a large portion of this has been channelized into infrastructure projects which are braving a rough weather, having not completed a full business cycle. In a stress case scenario, we  anticipate the strain to swell further with stressed assets of banks (GNPL + restructured assets) under coverage inching up from current levels of 6.7% to 10.8% by FY13, albeit that asset quality trends might differ among banks based on their underwriting skills.

Asset quality: Private banks to endure shocks, SOE banks to get jitters

Earnings: Sensitivity of credit cost (applying LGD to stress sectors) bares the fact that private banks with high ROAs and lower exposure to stressed sectors are conspicuous in their ability to endure asset quality shocks. Large cap SOE banks like PNB and SBI could see earnings impact of about ~20% whereas mid-sized SOE banks like IOB, OBC and Union of more than 25%. Assigning a 50% probability to the stress situation, we arrive at the base case earnings estimate which are 5% below consensus.

Valuation: Cutting TPs; maintain underweight on SOE banks

Bank stocks have seen corrections (Bankex underperformed 5% over the past three months) even as investors stay Underweight on the sector. Though we believe that RBI is over and done with the tightening in the current cycle, we believe challenges would prevail for at least next 6-9 months. Stock performance in the near term could swivel more towards perception rather than fundamentals. We reiterate our underweight call on state owned banks, favouring private sector banks which are better prepared to brave an asset quality shock. To factor in the asset quality stress, we lower our target prices (to capture lower multiples) across stocks under coverage by 5-14%. Our top picks are Axis Bank, ICICI Bank, Federal Bank. We maintain ‘REDUCE’  on PNB and ‘HOLD’ on SBI. Our change of view towards the sector would be influenced more by a dilution of asset quality risks. This would be a combination of signals on the reversal of interest rate cycle, an improvement in the policy initiatives in power sector and the global scenario.