Indian banks' stars are aligning for a favourable risk-reward ratio, according to Jefferies. Citi Research believes that some lenders have disappointed due to elevated slippage and credit costs, which has resulted in sharp earnings cuts.
"Retail delinquencies weren't as bad or as feared and can abate the risk of a surge in credit costs," Jefferies said. "Liquidity has eased as RBI diluted stance and loan-deposit growth has converged; the potential cut in cash reserve ratio and/or deposit rate will be positive. "
However, Citi believes that the second quarter narrative has completely shifted to asset quality from growth and net interest margins. "Continued elevated stress in MFI and other unsecured segments led to elevated slippages, resulting in higher credit costs," it said. "With a few banks guiding for the elevated stress in these segments to spill over in the third quarter as well, slippage/credit cost trends will be closely monitored."
Additionally, a repo rate cut in December, if any, will limit the levers to manage returns on assets in the second half of this fiscal, Citi said.
"We like leading private banks and the State Bank of India," said Jefferies while noting that the gap between banks' and Nifty's earnings per share growth is just 2 percentage points for fiscal 2024–2026, at 14 times the 1-year forward price to earnings, and banks were trading at a 35% discount to Nifty versus an average of 12%.
So far this year, while Nifty 50 has risen 11.4%, Nifty Bank added 8.11%.
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ICICI Bank and HDFC Bank are among the picks of both brokerages. Jefferies likes ICICI Bank, Axis Bank, SBI, and HDFC Bank in the sector. "Despite the narrow growth gap and improvement in the quality of franchises across banks," it said. "We hence feel that risk reward among large-cap banks looks particularly attractive."
Citi Research's preferred names include ICICI Bank, HDFC Bank, and Federal Bank. ICICI Bank's asset quality defied peer trends as it reported a sequential improvement in slippages and credit cost, it said while noting HDFC Bank’s flat NIMs at 3.65%, 18% fee growth, and contained credit cost as key positives. "Federal Bank's return on assets of 1.28% beat Citi estimates, supported by 30 basis point credit cost, steady NIMs, and fee traction," it said.
Meanwhile, the brokerage pointed out that slippages remained elevated for AU Small Finance, Axis Bank, IndusInd Bank, Kotak Mahindra Bank, and RBL Bank, leading to sequential increases in gross non-performing assets.
On margins, Citi said, "Except for AU Small Finance Bank, which saw a NIM expansion of 10 basis points sequentially, NIMs contracted for all the other banks on a sequential basis broadly led by fall in loan-to-deposit ratio (LDR), inch-up in cost of deposits, slowdown in growth of higher-yielding unsecured segments, absence of support from investment yields, and interest reversals due to elevated slippages."