Q3 FY19 Earnings Season - Highlights

(1) Corporate Lenders are decisively getting back on track

The cycle is turning for all corporate banks from “Recognition of and Provisioning for NPAs” to “Recoveries and Resolutions”. Whilst all corporate banks will benefit from the tail winds that come with a combination of the following factors, a few select banks across the ownership divide, will benefit much more and will see their stocks getting re-rated quicker.

  1. Reaching near-target provisioning coverage levels after taking the pains of increasing the provisions quarter after quarter in the past two years. Provisions have sharply dropped indicating that they peaked at the end FY 18 post RBI’s Feb 12th circular. Provisioning coverage levels have also become quite comfortable for most banks and in particular on the NCLT exposures. This bodes well for future provision write backs. The SMA 1 and 2 books indicate quite a modest residual risk of NPAs for the banks in our portfolio.


  2. The leading corporate banks such as SBI, ICICI Bank and Axis Bank have delivered strong profits and we expect their RoEs to sharply move up to between 13 – 15 % by FY 20.


    Portfolio Companies EPS Growth RoE% Progression
    FY2018 FY2019E FY2020E FY2018 FY2019E FY2020E
    ICICI Bank -31% -21% 224% 8% 5% 15%
    Axis Bank -93% 1600% 124% 1% 7% 14%
    HDFC Bank 19% 16% 18% 19% 17% 17%
    Kotak Mahindra Bank 17% 15% 23% 13% 13% 14%
    Federal Bank -8% 38% 32% 8% 10% 12%
    RBL Bank 42% 35% 35% 12% 12% 15%
    Indusind Bank 26% 10% 35% 17% 14% 15%
    State Bank of India NA NA 508% -3% 1% 7%
    Bank of Baroda NA NA 214% -6% 7% 16%


  3. Lending to Retail continues to maintain the strong growth momentum; secured retail such as housing and auto for state-owned banks and unsecured retail for private sector banks.


  4. We expect the pace of NCLT resolutions to pick up in Q4 after a rather disappointing Q3 in this regard. The impact of such resolutions on state-owned banks is much more pronounced.


(2) Significant improvement in India’s macros

India’s macros have significantly improved in the recent past as the following factors have played out:


  1. Brent crude oil collapsed from the high of USD 86 to around USD 60 per barrel


  2. USD/INR has dropped from 75 to nearly 70


  3. Benchmark Government bond yields have dropped from 8.2% to 7.5%


  4. CPI prints have undershot RBI’s estimates provoking RBI to cut interest rates after a gap of 18 months. The tone of the commentary, during the monetary policy announcement on 7th February ‘19, indicates a high possibility of one or two rate cuts in 2019.


(3) The definition of Corporate and Retail lenders needs to change

It may surprise many that some of the erstwhile corporate lenders have more retail advances as a proportion to their overall advances than the so-called retail lenders. For example, ICICI Bank had 54% of advances as retail on December 31st, which is the highest proportion amongst all major banks. As the re-rating process intensifies for such banks, the market will start classifying banks more appropriately.

(4) Advantage: Corporate Banks

After the recent NBFC / HFC liquidity and credit stress events, the balance has shifted decisively in favour of banks with strong retail deposit franchises. All NBFCs / HFCs are turning to such banks for selling their asset pools to raise wholesale funding. This gives these banks an attractive opportunity to cherry-pick high quality retail assets. There is no denying the fact that many NBFCs / HFCs have strong credit origination and underwriting skills. But, in the changed environment of constrained institutional funding support from Mutual Funds, these non-banking lending franchises will no longer be able to build large balance sheets to hold these assets and will thus have to originate and sell-down to banks.

In addition, banks will have an increasing edge in competing for top credits themselves as they will benefit from lower cost of funds. These factors will keep the pressure on valuation multiples of most NBFCs/HFCs. So while in a few cases, the de-rating of their stocks has been fierce and possibly overdone, they do not present a huge upside over the next few quarters.

Portfolio Commentary:

  • Overall,we were quite pleased and satisfied with the performance of most of the banks inour portfolio
  • The two leading lenders, Axis Bank &ICICI Bank, impressed us the most with an improvement across most metrics and this result has kick started their re-rating process. Together, these two banks represent almost 30% of the portfolio.
  • Yet again, Federal Bank has delivered a bang-on performance. However, anymeaningful improvement in the bank’s return ratios will take a bit longer.
  • Yes Bank is a “Special Situations” corporate lender and the bank’s stock performance will depend on key milestones such as raising of capital after the new CEO takes charge.
  • Bank of Baroda (BoB) reported strong earnings but will need to navigate the merger related challenges.
  • State Bank of India (SBI) is on the path of surprising most investors with a sharp turn around post key NCLT resolutions and thereafter BaU in FY 20.

Our Outlook

The process of re-rating of the best-in-class Corporate Lenders has well begun as Institutional Investors, both foreign and Indian, have started re-balancing their portfolios in favour of these banks at attractive valuations. The recent data suggests such shifts in preferences.

While the national elections will keep the volatility quite high, the once-in-a-decade (or two decades…) opportunity of the re-rating of select corporate lenders is just too compelling to miss.


Nikhil Johri

Nikhil Johri
Founder & Chief Investment Officer