With only private banks (PVT) having reported earnings so far, we take a look at some interesting trends, predominant amongst which is the sharp and sustained expansion of the gap between their incremental loan market share vs outstanding market share—a reflection of the stresses evident at PSU banks. PSU banks face multiple stresses including asset quality, potential consolidation-related stress, wage revision coming up in
Nov-17, and IFRS-related stress. These are exerting further pressure on their ability to grow. We see this being reflected in sharply improving incremental loan share at PVT banks, especially from Q2FY14 onwards.
Higher quality corporate share gains: PSU banks are losing higher-rated corporate customer business to PVT banks. While this is expected to result in some impact on PVT banks’ loan yields (5-30bp), leading to our earnings cut of 1-7% in FY17-18e, we believe this is conducive to better credit quality in the medium term as well as building up better cross-sell opportunities with these corporate customers.
Maintain ratings; TP changes: Subsequent to our earnings cuts as well as moving to a lower cost of equity, we raise our target prices. We maintain our Buy ratings for HDFC Bank (an HSBC Asia Super Ten constituent), IndusInd Bank, ICICI Bank, and YES Bank, and maintain our Hold rating on Axis Bank. We stick to our barbell strategy of preferring re-rating candidates at one end (ICICI, YES) and defensive stocks (HDFC Bank, Indusind) at the other within our PVT banks’ universe. We continue to avoid PSU banks given their lower growth and profitability outlook.
Private banks’ growth remains well above that of the system, ranging from 12-30% y-o-y vs. system growth of 10%
This has manifested in their increasing market share, which is in a range of c.1.5%-6% currently.
However, more interestingly, their incremental market share has sharply increased since Q2FY14, reflecting the onset of stress at the PSU banks, and this gap between the incremental share and their outstanding share is near its peak.
Importantly, HDFC Bank has been the biggest gainer with incremental loan market share of 14% versus its outstanding loan market share of 6%. IIB and YES Bank are closely following HDFC Bank’s footsteps, with its incremental loan market share rising to over 3% versus outstanding loan market share of ~1-1.5% of the system. Axis and ICICI also have gained higher incremental market shares, but their gains have been smaller as they are tackling the asset quality issues on their books.
Breaking this down into retail vs. wholesale, it is becoming quite clear that much of this incremental share is coming through in the wholesale segment—i.e. corporate credit—particularly large, higher-rated corporate loans. Retail loan growth has historically been higher at the PVT banks vs. PSUs and that is nothing new.
As a consequence of this rather new trend, we also see the impact being felt on loan yields (apart from the impact of rate cuts), which are trending down, almost coincident with the period when the incremental share started sharply rising—Q2FY14.
This is not entirely negative as not only is the earnings impact manageable at 1-7% for our PVT banks universe, but this improves prospects of credit costs in the medium term as better quality credit is increasing in the loan mix. Also, there are improved cross-sell opportunities with these corporates.
The bottom line is that the polarisation in growth and profitability between PVT and PSU banks is likely to continue, as stress factors plaguing PSU banks appear unrelenting. Hence, we continue to prefer PVT banks as a group (mainly Buy-rated stocks) over PSU banks (mainly Reduce-rated stocks). Within the PVT banks, we continue to maintain our barbell strategy of stock selection—i.e. potential re-rating candidates on one side (YES, ICICI) and defensives on the other (HDFC Bank, IndusInd).
ICICI is trading at 1x 12-month forward P/AB, which we believe is more than adequately discounting the asset quality stresses over the next couple of years; hence, its valuations should improve as the asset quality issues are resolved over the next 4-6 quarters. We like YES Bank as its structural growth story remains intact. The retail mix in its balance sheet should improve further over the next few years, which is likely to be reflected in higher and sustainable profitability and with this, its valuations should also improve. On the defensive side, we like HDFC Bank and IIB, in which we expect stable earnings and high profitability keeping the investors invested in them over the medium term. We prefer to maintain Hold on Axis Bank as at the current multiples, we believe the upside is fully priced in.
As seen above, private banks are gaining significant incremental market share of system loans— mainly from PSU banks. As indicated by the management of several banks, these market share gains reside primarily in the corporate book and within that, in the better-rated corporates. As we expect these trends to continue given the multiple pressures faced by PSU banks—including asset quality stresses, stresses linked to potential consolidation within PSU banks, anticipated wage hikes and IFRS-related pressures—this market share shift should continue with continued migration of corporate credit to the PVT banks. Hence, we are now building in slightly lower lending yields over FY17e and FY18e in our estimates, leading to earnings reductions of 3% and 5% (on average) in FY17e and FY18e, respectively, tabulated below.
Over the past four quarters, the asset quality stress has been building up at Axis Bank. With the guidance of more stress likely in FY17e, we expect profitability to suffer due to lower margins and higher credit cost. RoA as a result is likely to drop from 1.7% in FY16 to 1.4% in FY17e.
HDFC Bank continues to deliver impeccable growth and profitability despite the sector being in one of the worst asset quality cycles in the past 15 years. Credit cost has remained at low levels, while RoA has remained steady at around 1.9% and is likely to remain in a similar range going forward.
Apart from Axis Bank, ICICI Bank has also suffered from worsening asset quality, part of which has been due to the exposure to the steel and power sector, which has seen significant external risks. With the management giving a cautious outlook, we are building in higher credit costs and lower profitability over the next 2 years.
YES Bank and Indusind Bank have taken advantage of their small size and have grown aggressively without taking on too much risk. They have improved the retail mix of their business, which has improved profitability. We expect both of them to continue to deliver quality growth and profitability in the medium term.