We see value in Indian financials, though this may not be an instant gratification
trade. We think near-term challenges persist – a near-inevitable NPL uptick, weak
GDP growth, bond market volatility and currency tail risk. The positives are: a)
the rate cycle seems to have peaked out and b) valuations discount unrealistic
distress levels on asset quality. We adjust our EPS estimates and PTs to the new
post-July reality - our top picks are now ICICI, SBI and IDFC.
Strong underperformance. The CNXBANK has corrected 27% from the midMay peak, and 17% since the RBI tightening on 15 July. The PSUs have led the
correction, along with Yes Bank and IDFC.
Asset quality deterioration. We believe valuations overestimate asset quality
pressures, acute as they seem to be at this stage. Our estimates are that current
valuations build in ~2x rise in adjusted NPLs (NPLs +30% of restructured
loans) from here, while we forecast expansion of only 30-40%. This is on the
basis of a detailed analysis of the composition of credit in the system, and its
comparisons with 2001-03, when NPLs rose to 15%. The infra segment should
see large restructuring over the next 6-7 quarters, but that’s likely to be at lower
losses to lenders than manufacturing NPLs.
PPOP risk limited. We see very limited risk to PPOP (ex-M2M losses). We see
loan growth at ~15%—helped by higher inflation, the weaker rupee and the
issuer migration from bonds to loans. There will be some margin pressures from
higher funding costs but pricing power on lending should largely mitigate that.
Impact of M2M losses minimal. We think that current levels of bond yields are
unsustainable and should decline significantly before FY14-end. Moreover, the
RBI has given significant leeway to the banks to mitigate the provisioning via
amortization and HTM transfers, though these may be ignored by the market as
cosmetic factors. PSU banks have a significant offset via pension provisions.
Weak macro discounted. We expect the macro to remain weak through
FY14E—the currency/rates shock of July/August has pushed back the recovery
to FY15E at the earliest. This will have a negative impact on asset quality but
we believe this is in the price. Also, we think the weak macro should drive
declining rates in CY14E, with or without RBI easing
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trade. We think near-term challenges persist – a near-inevitable NPL uptick, weak
GDP growth, bond market volatility and currency tail risk. The positives are: a)
the rate cycle seems to have peaked out and b) valuations discount unrealistic
distress levels on asset quality. We adjust our EPS estimates and PTs to the new
post-July reality - our top picks are now ICICI, SBI and IDFC.
Strong underperformance. The CNXBANK has corrected 27% from the midMay peak, and 17% since the RBI tightening on 15 July. The PSUs have led the
correction, along with Yes Bank and IDFC.
Asset quality deterioration. We believe valuations overestimate asset quality
pressures, acute as they seem to be at this stage. Our estimates are that current
valuations build in ~2x rise in adjusted NPLs (NPLs +30% of restructured
loans) from here, while we forecast expansion of only 30-40%. This is on the
basis of a detailed analysis of the composition of credit in the system, and its
comparisons with 2001-03, when NPLs rose to 15%. The infra segment should
see large restructuring over the next 6-7 quarters, but that’s likely to be at lower
losses to lenders than manufacturing NPLs.
PPOP risk limited. We see very limited risk to PPOP (ex-M2M losses). We see
loan growth at ~15%—helped by higher inflation, the weaker rupee and the
issuer migration from bonds to loans. There will be some margin pressures from
higher funding costs but pricing power on lending should largely mitigate that.
Impact of M2M losses minimal. We think that current levels of bond yields are
unsustainable and should decline significantly before FY14-end. Moreover, the
RBI has given significant leeway to the banks to mitigate the provisioning via
amortization and HTM transfers, though these may be ignored by the market as
cosmetic factors. PSU banks have a significant offset via pension provisions.
Weak macro discounted. We expect the macro to remain weak through
FY14E—the currency/rates shock of July/August has pushed back the recovery
to FY15E at the earliest. This will have a negative impact on asset quality but
we believe this is in the price. Also, we think the weak macro should drive
declining rates in CY14E, with or without RBI easing
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