Banking stocks are on a roll. Buoyed by back-to-back rate hikes by the Reserve Bank of India (RBI), sustained credit growth and improvement in the asset quality, banks have shown strong performance in the last couple of quarters.
Bank Nifty index gained over 21 per cent in the last one year until November 30 compared to just 8 per cent gains in Nifty50 index. The stocks of PSU banks and regional private banks have outperformed even Bank Nifty stocks by rising as much as 40.1 per cent and 46.5 per cent, respectively.
"Banking industry has seen a healthy recovery in terms of both loan growth and improvement in asset quality. In FY22, the NPAs (non-performing assets) were at around a six year low level. The loan book quality now seems healthier as majority of the back book clean-up has been done and the recovery pace has accelerated,” says Devarsh Vakil, Deputy Head of Retail Research, HDFC Securities.
The brokerage notes that the credit offtake has remained robust across all sectors from farming, industry, services, to retail, despite increase in lending rates. “Revival in consumer demand, rise in private capex followed by rise in government spending can be further triggers for the growth,” adds Vakil.
Among individual stocks on the Nifty Bank index, Bank of Baroda rallied 141 per cent year-to-date. Federal Bank, PNB and Axis Bank gained between 40 per cent and 67 per cent, respectively.
Are most gains in banking stocks now priced in or are there more legs to the rally?
Experts believe despite recent gains, the outlook for banking stocks remains positive. “We have been bullish on the banking sector for the last one and half year, and many of the stocks we recommended have already achieved their targets for the year. We will review them again post December quarter results and re-issue our recommendations on them,” says Vakil.
Among stocks which are yet to breach their targets, HDFC Securities has ‘buy’ rating on City Union Bank, Axis Bank, ICICI Bank and State Bank of India. The brokerage sees an upside of 35.4 per cent, 26.5 per cent, 18.6 per cent and 13.5 per cent, respectively, against their respective closing prices on December 12. They have ‘add’ rating on Ujjivan Small Finance and Kotak Mahindra Bank with an expected upside of 31.5 per cent and 21.5 per cent, respectively.
Kotak Institutional Equities, meanwhile, sees more upside in PSU banks and regional banks. Morgan Stanley is overweight on Bank of India, Bank of Baroda and State Bank of India.
RBI rate hike
The RBI has cumulatively raised the repo rate by 225 bps to 6.25 per cent between May and December 2022 – the last one being on December 7. It has resulted in sharp improvement in margins.
“Lending rate on fresh loans is on a clear upward trajectory, while lending rate on outstanding loan book has followed a similar trend indicating disciplined lender behaviour,” notes a report by Kotak Institutional Equities.
Morgan Stanley expects margins to improve by 10-20 bps in the second half of FY23 before moderating in FY24. “SoE (PSU) banks should see relatively higher margin expansion compared to many private banks over FY22-FY24, reflecting 1) a higher starting point of liquidity; 2) sharp moderation in NPL formation, reducing interest income reversals; and 3) lower share of wholesale deposits relative to select private banks,” says Morgan Stanley.
The banks are hopeful the credit growth will keep rising as asset quality and capital levels have improved. “We believe that the sector is still in the very early stages of recovery post Covid. We are currently seeing a strong intent to lend from the providers of debt capital. Banks, especially public banks, which had been affected by the corporate NPL cycle, have come back strongly in recent quarters. This has resulted in credit costs declining sharply in recent quarters and strong improvement in headline asset quality ratios. We also see public banks, regional banks and NBFCs showing greater comfort to grow their balance sheet,” says the Kotak report.
Aprajita Sharma is a freelance journalist and a certified financial planner. She can be reached at @apri_sharma on Twitter and LinkedIn.