Editor’s note: In part-1 of our special coverage of the economic impact of the coronavirus pandemic on the banking industry, we evaluated the macroeconomic environment. Considering unprecedented and tough market conditions that we are passing through at present, it would be unintelligent to assume that everything will be fine for the banking industry in the foreseeable future. There will be slippages, defaults, higher provisioning and slow growth; but the response of banks to these adversities might differ individually. Banks that will survive the present downturn with minimum financial casualty might emerge stronger when the business environment slowly returns to normal.
Banking and financial sector stocks are an indispensable part of any diversified portfolio. This is primarily because of their high weightage in India’s most-tracked index, the Nifty 50—which was nearly 40% at the market peak. That was an impressive run from the weightage of approximately 27.5% in March 2014. However, with massive erosion during the ongoing pandemic situation, the weightage dropped to 36.2% at the end of April 2020.
Many frontline banks and financial institutions have announced their Q4 numbers. Management commentary of some frontline banks suggests that 4 factors will be more crucial in times to come:
Before we study these factors in detail, let’s quickly check out the report card of some large private and public sector banks. You see, banks that enjoyed a higher Price-to-Book (P/B) multiple so far have managed not only to grow faster than the industry but they have maintained their asset quality pretty high as well. On the other hand, for the banks quoting at lower multiples it was argued that they might be re-rated soon after the 10-year old NPA cycle is over.
Now that we are likely to see another round of NPAs, it’s become all the more crucial to be wary of poor asset quality.
Since social distancing is likely to continue even beyond lockdowns, offering a seamless online banking presence has become even more crucial for banks. Some leading private sector banks seem to have started working on this aspect already.
For instance, Kotak Mahindra Bank reported that in FY20, 44 lakh accounts came from 811—a full-service digital banking initiative by Kotak Mahindra Bank. This translates into 12,050 accounts per day. During the lockdowns, this run rate improved to 14,000 accounts per day.
Similarly, ICICI Bank, another leading private sector bank, launched a comprehensive digital banking platform which offers more than 500 services—of which many are first-in-the-industry, it claims. In Q4FY20, ICICI’s mobile banking transaction volume grew at 98% on a Y-o-Y basis.
Banks that can engage more customers through their digital platforms would have an edge over banks depending on conventional modes of banking. This is because, even if you consider a time period of 1-year for a normal business environment to return, by that time, technology-ready banks would not only grab the market share from laggards but would also shape future trends in the habits and preferences of customers.
Intelligent use of technology would help banks save costs too. In other words, banks would try to cut back their fixed costs and increase net-profit-per-employee.
Provision Coverage Ratio (PCR) hints at a part of profits kept aside to deal with bad loans. For example, the PCR of 87% indicates that, over 4/5th of NPAs have already been provided for. Lower PCR of say 33% suggests that the bank has a higher risk exposure on the existing NPA book. If bad and doubtful loans rise in future, on account of the pandemic or even otherwise, banks with lower PCR would carry greater risks.
It’s noteworthy that leading banks have already provided higher amounts than what is required by RBI on their SMA-2 exposure. Such a conservative approach would make them well-equipped to handle slippages pertaining to the coronavirus pandemic. Any bank that has a PCR of below 70% and a GNPA above 2% (under the current environment) or has a rising trend of GNPAs in FY20 vis-à-vis FY19, should raise a red flag.
This is one of the trickiest parts in evaluating a bank during the pandemic times and beyond. A bank may not show higher GNPAs in FY20 but if corporates and MSME form a substantial part of the loan book of the bank, then one must monitor it carefully. Similarly, the growth trend in FY20 should also be considered crucial.
For example, ICICI Bank grew its MSME book by 27% in Q4FY20; but that formed just 3% of the bank’s total loan book. If the segment accounted for say 20%, it could have been a matter of concern because, higher growth of Q4 might potentially translate into higher NPAs in the subsequent quarters if the downturn becomes uglier than previously expected.
Leading private sector banks have been focusing on retail banking ever since the NPAs in the corporate segment started ballooning up 10 years ago. India’s largest retail bank, HDFC Bank, derives 51% of its business from the retail loan book while the retail segment makes up 63% of ICICI Bank’s loan book and around 60% of that of Kotak Mahindra Bank.
Loan book under moratorium as well as that under Commercial Vehicle and Equipment Financing would also require meticulous monitoring, going forward. This is not to suggest that a greater proportion of loans in moratorium would automatically become NPAs in the subsequent quarters. But if that portion doesn’t get enough attention, it might certainly upset the calculations of provisioning.
Deeper analysis throws up some interesting facts. For example, Mahindra Finance stated that 75% of their retail borrowers have opted for the moratorium facility. This is despite 65%-70% of districts remaining relatively unaffected by the pandemic, according to the Company estimates.
In contrast, the percentage of HDFC Bank’s borrowers that opted for the moratorium 1.0 was in single digit. Whereas, close to 26% Kotak Mahindra Bank’s borrowers and 35% Federal Bank’s borrowers have opted for the moratorium facility.
According to RBI guidelines, the minimum tier-1 Capital Adequacy Ratio (CAR) of a bank shall be at least 7% of risk-weighted assets. Higher the Tier-1 capital base of a bank, greater is its loss absorption ability. Despite being adequately capitalized, some banks are raising capital even during pandemic situations mainly for two reasons—to strengthen balance sheets and create a higher capital base for catering to future growth opportunities.
For instance, Kotak Mahindra Bank recently took the Qualified Institutional Placement (QIP) route to raise Rs 7,500 crore.
If a bank has tier-1 capital of less than 10%-12%, it might face difficulties in case the NPA cycle takes an ugly turn over the coming quarters. Moreover, banks with lower capital base might miss growth opportunities despite having a large network of branches—some PSBs might fall under this category.
Under the present scenario, it appears that large private sector banks are well-placed to gain market share. You see, many other banks would have growth constraints; they may not have deep pockets to up their technology play to match that of some leading private sector banks. Furthermore, the bottom line of large private sector banks is also supported by income accruing through investments in their subsidiary businesses.
While you invest in any banking stock, don’t just look at Price-to-Book (P/B) to gauge attractiveness of valuations. Instead, use a combination of factors such as technological readiness, adequate provisioning, composition of loan book and value of subsidiary businesses to finally make a judgment on whether or not the valuation is attractive.
Quite often, banks get lower multiples for extremely valid fundamental reasons. Don’t make a mistake of falling in a value-trap. Balancing between quality and valuation comfort is the key for investing in banking stocks during the pandemic and even thereafter.
Please Note (read as a disclaimer): None of the stocks discussed in the article constitutes a recommendation to buy, hold or sell. References to such stocks could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.