Bank of America (BofA) has slashed price targets for domestic banking stocks, citing downside risks to valuation multiples because of the deterioration in the economy. The brokerage has downgraded its rating for State Bank of India (SBI), ICICI Bank, and IndusInd Bank from ‘buy’ to ‘neutral’ or ‘underperform’. HDFC Bank remains the only banking stock with a ‘buy’ rating. However, this stock, too, has seen a reduction in its price target.
“In the wake of a historic output loss, followed by potentially a prolonged (long bottom) economic recovery during FY21-22, we further downgrade our sector view. We now move closer to a stress case scenario in FY21-22 as we expect the current economic situation will drive paradigm changes in the sector in the near to medium term. More than just the growth slowdown, we are now on the verge of a new (and unique) NPA cycle panning across the corporate and retail segments lasting through at least FY21-22,” BofA said in a note to its clients on Tuesday.
Banking stocks crumbled in Tuesday’s trade with the Bank Nifty index dropping 2.4 per cent, underperforming the Nifty index, which fell about 1 per cent.
The weak outlook for banking stocks is negative for the market as a whole, given the sector’s high weighting in the benchmark indices.
IndusInd Bank has seen the sharpest cut in its price target, followed by Bank of Baroda and SBI. HDFC Bank has seen a modest 4 per cent cut in its price target, while Kotak Mahindra Bank has seen a slight increase.
“We will likely see liability consolidators (led by HDFC Bank, Kotak Mahindra Bank, and SBI) emerge stronger over the medium term, but until the current NPA cycle peaks, we see downside risks to valuation multiples,” BofA analysts Anand Swaminathan and Nidhi Singh stated in the note.
The brokerage says banking stocks are unlikely to see a bullish phase until at least the end of the current financial year.
“Our key concern is lack of major alleviating factors in the near term as various stakeholders remain hamstrung -- 1) the RBI’s massive liquidity injections not having the desired effect due to various bottlenecks and risk aversion at banks; 2) government fiscal capacity to backstop NPA losses remain constrained given the social priorities and revenue slowdown; 3) mid-size banks and NBFCs (the key marginal risk takers over the past cycle) now forced to severely curtail their growth plans in the near term. As a result, we find it difficult to construct a bull case scenario in FY21, with some potential for surprises in FY22 if a few of these bottlenecks are fixed along with global rebound,” the note said.
BofA says valuation for the banking sector is correlated to bad loans or non-performing assets (NPAs).
“History suggests that valuation multiples have a high correlation with the NPA recognition cycle and usually bottom at best two-three quarters before the NPA peak,” it said, adding, the current NPA recognition cycle will begin only in September.