Bank stocks could gain if credit growth picks up

If FY15 growth is 12% instead of the market expectation of 15%, earnings could grow 5-6% more

Bank stocks tumbled on Tuesday, as the Reserve Bank of India (RBI) kept key rates unchanged. With credit growth falling below 10 per cent and the interest rate cycle not turning, the sector’s earnings could come under pressure. The Street, however, believes the sector looks attractive. Brokerages such as Morgan Stanley and Credit Suisse have upgraded the sector. Bank stocks have run up 36 per cent year-to-date against the 25 increase in the Sensex.

Bank stocks have done well so far on the expectation the economic environment would improve. From here, if the rally has to sustain, credit growth has to pick up. The second leg (of the rally) for bank stocks, says Morgan Stanley, is when economic growth starts picking up and revenue momentum picks up - it’s not just about non-performing loans normalisation in this stage. But this is not likely to happen in the coming months, as loan growth takes time to pick up. Also, the investment cycle is not showing any meaningful signs of recovery. The assumption is that there is a pent-up demand for credit, which will surface soon. In FY15, analysts expect loan growth to be driven by working capital requirements, retail and small and medium enterprises. In FY15, Morgan Stanley expects loan growth to be at 15 per cent. However, if loan growth is closer to 12 per cent, earnings could be impacted by five to six per cent, says Macquarie Capital.

Many would argue that since nothing much has changed on the ground and credit growth falling below 10 per cent levels, a sustained increase in stock prices is not possible as stressed assets account for nearly 10 per cent of banking assets. But the perception on this too is changing due to two reasons. First, the hindrances to business were primarily due to the previous government. Second, the gross fixed capital formation has rebounded. Credit Suisse says: “For three years, GFCF has been lagging consumption growth in India, exactly the wrong thing to happen in a supply constrained economy and a recipe for future inflation.” The cyclical improvement in the economy should help further.

Though stressed assets might have peaked for state-owned banks, analysts continue to remain cautious on these as they continue to be starved of capital. Capital constraints of PSU banks will constrain their loan growth too. Most analysts are sticking with private sector banks like Axis Bank, ICICI Bank and YES Bank even though some of them are exposed to highly indebted groups.