Banking stocks surge up to 100% this year so far; can they sustain their bullish run?

Most banking stocks have witnessed mouth-watering gains this year so far. Stocks like Bank of Baroda have turned multibagger, surging 106% year-to-date (YTD).

Stocks such as Indian Bank (up 97.39%), Union Bank (up 74.65%), Canara Bank (up 62.52%) and Federal Bank (up 61.93%) have clocked strong double-digit gains.

The Nifty Bank index is up 20% this year against a 5% gain in the benchmark index Nifty50. The Nifty Private Bank index is also up 20%. The Nifty PSU Bank index has jumped 58% YTD.

Why are banking stocks jumping?

Market sentiments have turned in the favour of banks in the last few months due to healthy quarterly earnings, improving asset quality and upbeat credit demand.

"Gross non-performing assets (GNPA), which is an indicator to gauge asset quality is, in its best shape right now. The bad loans have been the lowest in the decade and on a continuous decline since FY18," Apurva Sheth, Head of Market Perspective and Research, Samco Securities, pointed out.

"On the front of capital adequacy, over the past years, the capital ratios of the banks have significantly improved and most banks are sitting on healthy cash. Systemic credit demand is also strong and leading banks are reporting high double digits advances in growth," said Sheth.

After a muted credit growth in the past couple of years, the demand for bank credit has started to pick up.

Healthy Q2 show

Most banks beat Street's estimates in Q2FY23 due to healthy loan growth, margin expansion, and sustained moderation in provisions.

As brokerage firm Motilal Oswal Financial Services pointed out, loan growth was led by sustained traction in the retail and SME segments, along with a sharp revival in corporate loans. Deposit growth, however, was tepid, with CASA deposits under pressure. Large Banks saw a moderation in the CASA mix, while small and mid-size banks reported an increase, said Motilal Oswal.

Motilal Oswal expects earnings to remain resilient, guided by robust traction in loan growth and an improving margin trajectory (aided by rate hikes) and asset quality.

However, high inflation and aggressive rate hikes can adversely impact the pace of a demand recovery.

"Banks, with a higher CASA mix and floating loans, are well-positioned to navigate the rising rate environment, even as funding cost is likely to increase. Large Banks, with a strong liability franchise, are well-placed to gain incremental market share," Motilal Oswal said.

Brokerage firm Prabhudas Lilladher observed its coverage banks’ saw a strong quarter with core profits jumping 31% year-on-year (YoY) beating estimates by 9.3%.

"PSU and mid-cap banks saw higher earnings beat and within large private banks, Axis Bank and IndusInd Bank outperformed. NIM (net interest margin) uptick across banks would continue in Q3FY23 as the full transmission of yields is yet to materialise (repo hike of 190bps YTD)," said Prabhudas Lilladher.

Can banking stocks sustain gains?

Many analysts and brokerage firms are expecting the bullish run of banking stocks to continue as most fundamental factors are in pace.

Sheth observed that the retail and SMEs have driven credit growth, but now with improving capacity utilization, a reduction in the corporate tax rate, and government incentives under the production-linked incentives (PLI) scheme, the corporate segment outlook for continued credit demand is visible, at least in the medium term, and thus the banks are expected to enjoy this run and report higher profits.

Brokerage firm Kotak Securities believes that tier-2 banks such as public sector and regional banks have better upside than the frontline banks.

The brokerage firm has upgraded fair values for banks under its coverage "partly to reflect the greater confidence in earnings led by lower credit costs, better-than-expected loan growth and consequently higher operating profit growth."

The brokerage firm underscored that the increase in fair values is primarily for the second-tier banks (public banks and regional banks), which have traded below or closer to book value where we are witnessing most of the improvement in business performance.

"We have seen a very sharp increase in price performance in these banks over the past few years. Regional banks, public banks and non-frontline private banks have seen a sharp increase in prices and are outperforming the frontline private banks," said Kotak.

"The decline in credit costs implies that we are likely to see RoEs (return on equity) moving closer to the industry average fairly quickly from here and the dispersion of RoEs, which was quite high in recent years to converge for most banks. We capture some of this by marginally changing our cost of equity estimates as well," Kotak said.

Kotak believes that the sector is still in the very early stages of recovery post-Covid.

However, the brokerage firm also highlighted that the macro risks are still quite high and may warrant a change in view, it said.

"We are yet to see an asset bubble currently either in the corporate sector through a large CAPEX cycle or in the real estate sector. These are usually sectors that can potentially result in a sharp slowdown and consequently result in high loss rates. The loan book has more retail loans in the current cycle and hence, the probability of a higher credit cost appears to be lower," said Kotak.

Overall, the banking sector looks poised for growth even though some macro risks persist.

"Baking as a sector still has the potential to outperform as we are just in the initial phase of the growth cycle where credit growth is picking up gradually and also NPA situation is now behind us. So, banks have room to grow," said Narendra Solanki, Head of Fundamental Research and Investment Services, Anand Rathi Shares & Stock Brokers.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.