25-quarter low GDP growth to hit bank earnings, increase asset quality pain

Besides recent corporate slippages, slowdown would impact unsecured retail loans, farm and micro finance loans, commercial real estate and NBFCs and poorly-rated corporates with risk of downgrades

A 25-quarter-low gross domestic product (GDP) growth of 5 per cent for the June 2019 quarter (Q1), indicating further slowdown in economic activities, has impacted the earnings outlook for Indian banks. The slowdown is likely to lead to greater asset quality pain than analysts had estimated earlier, resulting in higher bad loan provisioning.

In fact, after the balance sheet clean-up in the March 2018 and June 2019 quarters, banks that lent heavily to the corporate sector were expected to see a sharp improvement in asset quality and, therefore, in credit cost and earnings. However, the improvement is now expected to be lower.

Morgan Stanley recently slashed its earnings estimates for State Bank of India (SBI) and Axis Bank by 30 per cent and eight per cent for FY20, and by 17 per cent and 10 per cent, respectively, for FY21. The foreign brokerage revised its FY20 credit assumptions (provisioning as a percentage of average loan book) northward by 45-50 basis points for these lenders due to likely additional bad loans amid economic slowdown and new recent corporate slippages.

Notably, the expected asset quality stress is not limited to the corporate segment, but some pockets of banks’ retail book are also expected to be impacted by economic slowdown.

As per Ambit Capital, besides the recent corporate slippages, the economic slowdown would impact unsecured retail loans, agriculture and micro finance loans, commercial real estate and non-banking finance companies and poor-rated corporates where there is risk of downgrades. This indicates likely upward revision in the stressed loan book of banking sector in the near term.

In fact, in Q1 too, besides corporate slippages, some banks had indicated the increased pain in non-corporate book mainly agriculture, retail and small and medium enterprise segments. HDFC Bank and ICICI Bank, for instance, had rising delinquencies in their respective personal loans, including credit card and some other retail segments in Q1.

However, these retail impairments aren't significant yet and seem to be cyclical, and analysts also see some recovery ahead. Also, the overall credit cost in the next two years is likely to be better than the previous two years. Banks such as Axis Bank, SBI and HDFC Bank are also expected to benefit from good operating performance.

Some of these expectations on bad loans, though, are also reflecting in the Nifty Bank index, which is down 13 per cent the past three months, versus an eight per cent fall in Nifty 50.

Overall, investors looking for an exposure to banks are advised to be selective.