Mr. Darpin Shah, Institutional Research Analyst, HDFC Securities.
Banking Sector Thematic Report: Down cycle stress testing
Even as the nationwide lockdown gradually lifts, there is more than enough evidence to suggest that the economic impact of COVID-19 is set to continue. Contextually, for banks, liability franchises and potential asset quality outcomes have come to be of paramount importance, and rightly so. In our earlier note, entitled 'Double whammy for some', we focussed on the liabilities' aspect.
While the moratorium will optically limit GNPAs till 1HFY21E, asset quality deterioration is inevitable. As the situation remains extremely fluid, we've analysed FY21 earnings under 4 scenarios (increasing segment wise NPA and PCR estimates) to evaluate the potential downside risks.
Under the most extreme scenario (IV), ABVs fall by 3-22% and ROAAs fall by 25-70bps. SBIN and KVB are the most vulnerable, as both report losses under scenario III and IV. Across parameters and scenarios, KMB performs the best (lowest dip in ABVs and healthy RoAAs).
Mid-tier private banks and SBIN, under our base case, trade at close to trough valuations and factor in scenario I/II to a certain extent. However, banks such as ICICIBC, AXSB, KMB and CUBK trade at a premium to their previous down cycle valuations.
We believe, that current valuations across our coverage do not adequately capture potential downside risks to earnings under scenario III & IV, especially after the recent run up. It is difficult to assign probabilities to individual scenarios. However, we believe, it is evident that across scenarios, banks with healthy B/S (CRAR, PCR and liability franchises) are well placed to absorb shocks.
Consequently, we continue to prefer large private banks such as ICICIBC (SoTP of Rs 442) and AXSB (SoTP of Rs 541). SBIN (SoTP of Rs 270), too, offers a favourable risk reward trade-off, despite its earnings vulnerability. Amongst the mid-tier banks we prefer CUBK (TP of Rs 164).
The results of our analysis are as follows:
Asset quality: Under various scenarios, we project a relatively greater increase in NPAs in the services/ SME and retail/ personal loan segments. Book mix is an important driver. Consequently, banks with a higher proportion of such loans see a greater increase in GNPAs. AUBANK, DCBB, FB and IIB report the greatest increase in GNPAs across scenarios, while KMB reports the lowest increase.
LPs: Our provision estimates under various scenarios have multiple drivers. Under the most extreme scenario (IV), we expect that majority of our coverage banks will see provisions rise by more than 45%. The base effect results in some anomalous trends- ICICIBC registers a 62.8% rise in FY21E LLPs and RBK sees a mere 22.9% rise, under scenario IV.
Earnings: Banks report the greatest variability on this parameter on a/c of high sensitivity to LLPs. SBIN, KVB and RBK report the greatest decline in earnings across scenarios, with SBIN and KVB reporting losses under scenario III and IV. KMB is the best placed on this front, as earnings dip 17.7% and RoAAs reach ~1.4%, even under scenario IV. AUBANK reports 1%+ RoAA, even under scenario IV.
CRAR: Even under scenario IV, our coverage banks see their CRAR fall between 31-69bps, with KMB reporting the lowest fall and SBIN reporting the highest. Almost all remain fairly well capitalised, even under scenario IV.