Bear Case Firmly in Play
Banks have lagged index by 11% since first RBI action. Should we buy / sell now - there maybe rallies but we would sell these. Macro is unwinding; we believe next 3-4 quarters will see sharp spikes in impairments (slowing growth and higher rates). Sharp rate decline is the bull case.
Increased probability of bear case for Indian banks: Recent rate move is likely to lift defaults on loans over the next 6-12 months. Interest rates (3 month CP) are now up ~300bp over July, and with continued currency depreciation, are likely to stay elevated. With growth slowing, the pressure on profitability will go up. We have reduced our bear cases meaningfully and increased the probability of our bear case in our weightings.
Corporate leverage at decadal high: This has caused a sharp increase in impaired loans. Currency depreciation will also hurt given that corporate external debt is ~ US$225bn and about 50-60% is unhedged. Hence, pace of bad loan creation will jump (we expect impaired loans to increase to 12% by F2015 in our base case and 15.5% our in bear case from 9.2% currently).
Loan growth likely to fall to ~10%: Demand is likely to drop given slowing growth. As well, most big borrowers over the last 3-4 years are struggling with existing debt (and unable to borrow). SOE banks (75% of system) will likely struggle given lack of capital (net impaired loans at some larger banks are now more than equity).
We would stay away from corporate lenders: Given the likely increase in impaired loans, corporate lenders will likely struggle. Wholesale funded banks should also lag given the spike in funding costs. Our top picks remain HDFC Bank and HDFC. We would avoid Axis, SBI, and PNB.
Where we could be wrong: If growth picks up or interest rates come off, underlying fundamentals will improve. The stocks to own if macro improves would be Yes and IIB given leverage to rate and growth cycle.
Increased probability of bear case for Indian banks: Recent rate move is likely to lift defaults on loans over the next 6-12 months. Interest rates (3 month CP) are now up ~300bp over July, and with continued currency depreciation, are likely to stay elevated. With growth slowing, the pressure on profitability will go up. We have reduced our bear cases meaningfully and increased the probability of our bear case in our weightings.
Corporate leverage at decadal high: This has caused a sharp increase in impaired loans. Currency depreciation will also hurt given that corporate external debt is ~ US$225bn and about 50-60% is unhedged. Hence, pace of bad loan creation will jump (we expect impaired loans to increase to 12% by F2015 in our base case and 15.5% our in bear case from 9.2% currently).
Loan growth likely to fall to ~10%: Demand is likely to drop given slowing growth. As well, most big borrowers over the last 3-4 years are struggling with existing debt (and unable to borrow). SOE banks (75% of system) will likely struggle given lack of capital (net impaired loans at some larger banks are now more than equity).
We would stay away from corporate lenders: Given the likely increase in impaired loans, corporate lenders will likely struggle. Wholesale funded banks should also lag given the spike in funding costs. Our top picks remain HDFC Bank and HDFC. We would avoid Axis, SBI, and PNB.
Where we could be wrong: If growth picks up or interest rates come off, underlying fundamentals will improve. The stocks to own if macro improves would be Yes and IIB given leverage to rate and growth cycle.