The banking sector which has been one of the leaders of the current rally in the stock markets was expected to be a strong performer for the current quarter. Although the reported numbers coming out of banks have been pretty good and strong to look at, most analysts and the media has not bothered to go into the depth of the numbers to really look at where the reported numbers are coming for, whether they are sustainable and the stress on the balance sheets because of increasing write-offs, rising NPA’s as well as the pressure on Net Interest Margins. I believe that the quality of the earnings of the banking sector in general except for a few banks is very poor and in the current quarter banking results have got a boost due to restructured loans and trading & treasury profits. The following quarters are not going to yield trading and treasury profits of any big amount and as a result given the pressure on the core business the sector earnings are likely to take a beating in the second quarter.
In order to explain these through empirical examples I have picked out two of the large private sector banks with diverse business models and analyzed their reported results vis a vis the core performance.
(I SEEK TO GIVE NO VIEW ON THE DIRECTION OF STOCKS OF THESE BANKS BUT JUST AN ANALYSIS OF THE RESULTS)
ICICI Bank
ICICI Bank which reported results a couple of days back has come out with reported numbers that are above analyst expectations and most people are just focusing on them instead of looking at the quality of earnings. I believe that the quality of earnings is extremely poor –
– Reported profits are up nearly 21%
– The overall advances are down from Rs 2.24 lakh crores to Rs 1.98 lakh crores and deposits are down from Rs 2.34 lakh crores to Rs 2.10 lakh crores
– Net interest income is down by 5 % despite the cost of deposits coming down substantially over the last one year and ICICI Bank being one of the banks which held on the rates of advances for a long time, thus showing pressure on core business
– The net NPA’s have gone up from 1.80% to Rs 2.33% and gross NPA’s have risen by nearly Rs 1000 crores despite advances coming down by nearly 13%.
– Provisions have gone up from Rs 792 crores to Rs 1323 crores
– The most important factors to watch out in banking results are NPA’s and segmental results and if one looks at those
– Retail banking from a profit of Rs 128 crores has gone to a loss of a whopping Rs 437 crores
– Wholesale banking profits have fallen from Rs 1190 crores to Rs 576 crores, nearly half of last year same quarter results
– Treasury profits have gone from a loss of Rs 409 crores to a profit of Rs 1098 crores, a swing of nearly Rs 1500 crores. Incidentally treasury profits for the last full year were Rs 1284 crores.
– There has been a write back of provisions for derivative contracts which has not been specified
What the above facts essentially imply is that core operations are actually in a loss if there were no treasury profits the bank would in fact have reported a loss. Treasury profits cannot be given a high P/E ratio as it is not an annuity business.
HDFC Bank
HDFC Bank which has a more conservative business model also has seen a severe pressure on the core business. Although reported profits were up 30% as has been the trend with HDFC bank, the key points to be noted are
– The net interest income was up by just around 7.7%
– Provisions and contingencies nearly doubled from Rs 344 crores to Rs 658 crores
– The quality of assets remained good with net NPA’s increasing by just 0.1% from 0.5% to 0.6%. The net NPA has been kept under control mainly due to higher write-offs although gross NPAs have gone up by nearly 45%.
– Retail banking profits have halved from Rs 306 crores to Rs 144 crores. Retail banking profits for the last full year were Rs 1270 crores which will be virtually impossible to match in the current year.
– Wholesale banking profits are up from Rs 342 crores to Rs 379 crores a growth of just around 10%
– Treasury profits are up from Rs 43 crores to Rs 404 crores a jump of nearly 900%. For the last full year this was Rs 488 crores. As such treasury profits for the first quarter are almost at the same level for the last full year.
Given the above analysis I am of the view that the second quarter results for most banks will see a huge pressure as treasury profits are likely to be very low in the current quarter and the core businesses continue to be under pressure. There are also a lot of restructured loans which will go to become NPA’s.
The other important factor is that unlike in the past where different banks were focusing on different business segments, today we have a scenario where every bank wants to focus on the same segments of corporate loans. On the retail side everyone wants to be out of unsecured loans and focus on auto, housing etc loans where the competitive intensity is increasing and as such margins are likely to come down.
The cost of funds for banks is not coming down and given the excess liquidity in the system the money placed in reverse repo with the RBI is yielding just around 3% vis a vis a double of that last year at the same time. Given the slowdown in the economy the credit growth has come down and this combined with buoyant capital markets and extremely low interest rates available globally will lead to a continuous pressure on interest rates on advances. Companies have been able to raise nearly Rs 20000 crores from the equity markets over the last few weeks and nearly Rs 20000 crores more is to be raised over the next few months. This will lead to a further pressure on interest rates as a lot of immediate corporate sector fund requirements are met and companies give back loans taken at high rates from the banking segment in the short term.
Given the strong borrowing program of the central and state governments the scope for making treasury profits through bond yields coming down does not exist this year. Infact the risk of losing money on the gilts portfolio is higher.
As such I believe that in the near term it makes sense to be underweight banks as second quarter results might be very weak and the quality of earnings for the banking industry have deteriorated significantly. The possibility of losses from the treasury operations are higher as the investment book has a very low proportion of equity and the fixed income portfolios value is only likely to decline.
Its time to analyze results deeply instead of just looking at reported profit numbers.
Second quarter numbers of the banking sector might be severely under pressure.