Low base to boost Q2 earnings

However, muted demand, pressure on margins remain a worry

A weak financial performance in the second quarter of 2013-14 could prove a delayed blessing in disguise for banks, as this low base is expected to propel their earnings performance in July-September this year. This is despite muted loan demand, depleting fee income, rising operating expense and waning credit quality.

“We expect strong earnings growth for banks at 28 per cent year-on-year (y-o-y). Higher provisions for investments and lower treasury income (during the second to fourth quarter of 2013-14) hurt earnings and this is likely to act as a base for the next three quarters. We expect public sector banks (PSBs) to report around 40 per cent y-o-y growth in earnings and private banks to report around 20 per cent growth,” said Kotak Securities, in an earnings estimate report for banks and financial institutions.

Analysts expect strong performance in lenders’ treasury income portfolio in the just concluded quarter. A year earlier, the Reserve Bank of India (RBI) had to step in aggressively through a series of regulations to stem rupee depreciation. The steps resulted in the 10-year government security’s yield rising sharply by 63 basis points in 15 days. These increased by 130 basis points (bps) during the quarter. While RBI allowed lenders to distribute the investment depreciation provision in equal instalments over the financial year, most private banks made the entire provision in the second quarter (of 2013-14) itself.

With no such concerns this time, banks are expected to report growth in treasury income. Also, on a sequential basis, yields have softened, albeit marginally by 15-30 bps at the longer end, offering banks an opportunity to improve treasury income on a quarter-on-quarter basis.

“The fall in bond yields will add to treasury profits of banks. Even in the current quarter, the gains might continue. By the end of December, the yield on the 10-year bond might fall to 8.3 per cent, as there has been bond buying by traders,” said the treasury head of a PSB.

Traders claimed they’d been buying bonds in anticipation of a rate cut during the next financial year. The sharp appreciation in equity markets is also a positive for select banks that have equity investments in their portfolio.

“We expect a better quarter for Indian financials, with overall earnings for banks under our coverage universe reporting a growth of 28 per cent y-o-y, due to lower credit cost and higher treasury income, linked to a declining trajectory in bond yields and a strong rally in equity markets,” Alok Kapadia, analyst with Antique Stock Broking, said in a note to his clients.

However, analysts also believe improved profitability is unlikely to ease the pessimism surrounding the sector. “At the end of the day, there is still slow credit growth, which will affect the core performance and impact the core return on assets. Trading profit might provide a temporary cushion but issues are expected to persist. That remains a worry,” said Dhananjay Sinha, economist, strategist and head of institutional research at Emkay Global Financial Services.

Last week, RBI noted that non-food credit growth decelerated in September, the lowest since June 2001, despite liquidity conditions remaining comfortable. This, experts feel, will have a cascading impact on banks’ net interest income and net interest margin, as deposit rates continue to stay high.

Core fee income growth is also expected to be muffled as fresh loan sanctions have remained weak, while income from foreign exchange is seen lower because of the volatility of the currency this year.

Analysts also believe that asset quality troubles are not over, though fresh impairments might be lower on a sequential basis. "We believe the slippage levels would remain elevated, though a large share of the slippages are now coming from the restructured loan portfolio as banks are reporting a rising share of failed cases of restructuring," said Kotak Securities.

A few also believe that the Pradhanmantri Jan-Dhan Yojana, introduced in August, will lead to an increase in operating expenses, especially for state-run lenders. "The second quarter might not reflect the full impact of Jan-Dhan Yojana but it is one of the concerns," said an analyst with a local brokerage.

A GLIMMER OF HOPE

• Analysts expect strong performance in lenders’ treasury income portfolio in the just concluded quarter
• Yields have softened, offering banks an opportunity to improve treasury income on a quarter-on-quarter basis
• Sharp appreciation in equity markets also a positive for select banks that have equity investments in their portfolios