Rate cut euphoria over done!
Banking stocks (and Bank NIFTY) stay resilient on rate cut hope and consequent ease in cost of funds and related Treasury gains from what is called, Profit on sale of investments. Is it good enough to sustain long term bullish undertone when there is significant pressure on core business (and revenues)?
Analysts and investor community evaluate Bank's productivity (and efficiency) from margin from financial intermediation and fee income from on & off balance sheet core business. Treasury income and NPA recovery is seen as one-off. Although income from non-core activities add to Book value and EPS, sustainability thereafter on sequential QoQ basis becomes tough as one-off does not occur every quarter!
The issues revolve around the following:
1. How Banks would gear up to handle margin pressure? While reduction in cost of funds is good, there are not many high yield bankable credit in the market. Banks have generous appetite for low risk - low yield Gilts and AAA/AA credit, thus squeezing the intermediation margin. The extended rally in 10Y bond below Repo rate of 8% is not because of rate cut hope; what to do with the money? Put it back with RBI at negative spread? There will be significant pressure on financial intermediation margin, called the NII/NIM going forward if the system continue to stay in risk-off credit-aversion mode! As the system has been in low interest rate regime for 3-6 months, benefit from interest cost advantage between outgoing deposit and incoming funds may not last long, hence Banks seen in a hurry to cut deposit rates contrary to rate guidance from RBI.
2. How Banks would maintain high fee income in the absence of opportunities? The fee income comes from extension of credit facilities (fund and non-fund), transaction banking products (handling payments and receipts), FX & Derivative products (through market intermediation), investment banking products (through advisory, arrangement and syndication of Debt & Equity capital markets) and Third Party distribution products (of MFs, AMCs and Life/non-life Insurance products), with most monies coming from credit related fund, non-fund and FX & Derivative products where maintaining sustainable high growth is tough.
3. How Banks would handle higher NPA provision and write-off when under revenue pressure? Analysts community include restructured assets to gross/net NPA for true valuation. The worry is from wholesale book where most borrowers have the intent to repay but not enough cash flows to honour repayment obligations; the number is growing! It will become more tough going forward.
Revenue growth falling short of elevated valuation!
All taken, net-off impact of revenue risk from core business and one-off treasury income (which itself may not be significant post adjustment of RBI concessions on mark-to-market provision for FY14) may at best cover couple of quarters, but not beyond unless credit demand emerge at attractive yields.
It is wise (and prudent) to dilute the euphoria on banking stocks till economic growth recovery shifts to higher gears generating bankable credit demand to divert funds from zero risk-low yield assets to high yield - acceptable risk productive assets. That's when the rally (and current elevated valuation) will stay sustained without fear of value-adjustment from hot-to-hold to fair-value or cheap-to-acquire price. Caution!
Moses Harding
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