Rise in bank shares likely to limit gains

Rally won't sustain because of credit quality pressure and moderate loan growth

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Banking stocks have outperformed the broader markets in recent weeks but the rally wouldn't sustain, feel analysts.

They fear credit quality pressure, moderate loan growth and required provisioning for un-provided mark-to-market (MTM) losses (writing down assets in line with current valuations) would keep earnings growth weak.

Also, the recent rise in banking shares has made some of these stocks expensive, making them less attractive to investors.

"The rally in the past two months in the India bank index has been driven by a combination of macro improvements and some hope of being built in of a favourable political outcome... As some of this hope seems to be built in, near-term risk-reward on a broad basis is less attractive in our view," said Adarsh Parasrampuria and Pritesh Bumb, analysts with Prabhudas Lilladher, in a note to their clients.

While the BSE Bankex gained around 27 per cent in the past two months, the benchmark index Sensex rose 11 per cent during this period. This has made some of the banking stocks relatively expensive and prompted analysts to downgrade their ratings.

"With the recent rally, we downgrade State Bank of India (SBI), Punjab National Bank (PNB) and Union Bank of India from 'buy' to 'hold', as current valuations adequately capture any near-term improvement in fundamentals," said Hatim Broachwala, analyst with Karvy Stock Broking. He, however, remained 'bullish' on some of the state-run banks as they continue to trade at 'huge valuation discount'.

Most analysts expect banks' fourth-quarter earnings performance to remain weak due to slow growth in loan book, declining traction in core fee income, asset quality deterioration and higher provisioning on account of un-provided MTM losses.

They, however, admit that green shoots of recovery have started emerging for the banking sector and continue to prefer private sector banks over their state-run rivals.

"Improved visibility on growth, healthy core operations and return ratios, top managements' continuity, lower asset quality issues, adequate capitalisation, strengthening liability franchise and low hanging fruits (ability to capture market share from state-owned banks due to superior service), among others, will maintain private banks' premium valuation. We remain selective with our top picks being ICICI Bank, HDFC Bank and SBI," said Alpesh Mehta and Sohail Halai, analysts with Motilal Oswal Securities, in their fourth quarter earnings preview note.

Angel Broking has recommended a cautious stance on public sector banks as a segment because of the challenges they face in capital adequacy and core profitability, and due to increase in competition.

"From a cyclical perspective, improvement in the macro environment (as and when it happens) is likely to benefit all banks, including our preferred picks amongst large private banks like Axis Bank and ICICI Bank. That said, albeit with a higher risk profile, some of the public-sector banks with relatively higher capital adequacy and well diversified asset books can be considered from a cyclical revival point of view. These mainly comprise some of the larger public sector banks like SBI and PNB," said Vaibhav Agrawal, vice-president for research - banking at Angel Broking.