Bank stocks not pricing in asset quality risks, investors must book profits

As Supreme Court vacates stay on NPA recognition, bad loans are set to spike; weak growth may also compound the problem

Over the past three weeks, global rating agencies such as S&P Global and Moody’s have been warning that the Indian banking sector may not have come out of the woods yet. While they agree that the bad loan levels of FY18 may repeat, the gross non-performing assets (NPA) at 7.6 per cent in September quarter (Q2) isn’t telling the entire story either. September quarter (Q2) was helped by two months of moratorium and subsequently by the Supreme Court’s intervention on NPA recognition. “For the banks, their NPAs would have generally been higher by 10-60 basis points (bps), in the absence of the court ruling. And for finance companies, this differential was somewhat greater,” say analysts at S&P Global.

What’s more, Moody’s 2021 outlook report for banks, noted that those in the Asia Pacific region uncertain trajectory of asset quality is among the biggest risks for banks as operating environments remain fragile amid ongoing health concerns and for India in specific noted that capital declined will be larger without public or private fund injection.

Yet, banking stocks have moved in a manner completely defying caution and what’s more analysts too, based on the management commentary particularly that on improving collection efficiencies and low enquiries on loan recast, have upgraded their credit cost ratios for private banks from 200–250 basis points (bps) to 150–200 bps. Considering that S&P Global hasn’t revised its expectation of loan delinquencies, it appears that analysts may have jumped the gun on this aspect. To put things in context, those borrowers affected by the pandemic and qualifying for recast under the August 6, 2020 circular, have just another month to firm up the arrangement with their bankers. With banks also on a tight rope, S&P Global expects restructured loans to rise to five per cent in coming quarters of FY21 from 0.37 per cent in Q2.

While one could argue that the lesser than anticipated decline in gross domestic product and the recently gone by healthy festive demand should support banks in the December quarter, the question is that of sustainability. “We keenly watch out for the sustainability especially as pent-up and festive demand tapers, inventory replenishment is possibly over, labor market stress continues; and effective fiscal policy stimulus remains sub-optimal,” say analysts at Emkay Global Financial.

In all, while Q2 may have excited the Street, it doesn’t factor the risks going ahead. Bank credit data remaining on a slow-mode with the trend catching up in personal loans, investors should consider booking profit on banking stocks.