Global research firm Goldman Sachs on Friday downgraded its rating on State Bank of India, ICICI Bank and YES Bank citing the end of the “Goldilocks period” for financial sector entities.

It downgraded SBI and ICICI Bank from ‘buy’ to ‘neutral’ basis a 4 per cent downside and 3 per cent upside, respectively. Further, it downgraded YES Bank from ‘neutral’ to ‘sell’ attributing the call to a 37 per cent downside on the stock, but reiterated the ‘buy’ rating on HDFC Bank.

“We believe the proverbial Goldilocks period (strong growth and strong/visible profitability) is over for the financial sector in the near-term as headwinds are increasing,” it said in a report.

These headwinds include rising pressure on cost of funds due to structural challenges in the funding environment especially pertaining to unsecured lending, growing concerns on rising consumer leverage posing asset quality challenges, pressure on operating costs due to elevated wage inflation, and the need to expand the distribution network for future deposit growth.

The firm cut earnings estimates by 1-9 per cent over FY25, and an average of 2 per cent over FY26. It also cut the 12-month price targets for select companies by 2-8 per cent, on the back of expected 250 bps cut in FY25 loan growth, 15-17 bps increase in cost of funds over FY25 and FY26, and a 4 bps increase in credit costs.

Return ratios peaked

While Indian banks witnessed sharp RoA (return on assets) expansion in FY20-Q3 FY24, these returns are expected to start moderating due to continued pressure on margins, which is expected to extend into FY25, and slower loan growth resulting from stretched loan-deposit ratios.

“The sector will have to repair its balance-sheet mix and this, coupled with the need of building capacity, should keep cost-to-income levels elevated. We believe all players face the dilemma of maintaining market share or compromising margins amidst the backdrop of stronger balance sheets across the system,” the report said.

Even so, sector valuations have been at a comfortable level with aggregate PB (price to book) for private banks at 1.8x (12-month forward PB on FY25E), 1-5x range (FY25E) for NBFCs and 1.1x for SBI on standalone BVPS (book value per share) basis.

PSU vs private banks

While investors are tilting towards SOEs (state-owned enterprise) banks given their relatively-comfortable loan-deposit ratio, such banks will continue to witness pressure on margins given the focus on low-yielding loans such as mortgages or large-ticket corporate loans, and elevated funding costs (SBI raised deposit rates at end-Dec despite having a comfortable CD ratio), Goldman Sachs said.

“Asset quality is likely to stay healthy, but we note that ROAs may have peaked for the SOEs. We downgrade SBI to ‘neutral’. However, given the government’s intention to reform the sector such as bringing down the ownership level to below 50 per cent (link), this could be viewed as positive and could also potentially attract passive fund-flows.

On the other hand, given that most large and mid-sized private banks are trading in a close valuation band, visibility on loan growth, PPOP-ROA and credit quality will play an important role.

“Asset quality worsened for many private banks on account of normalization of the credit cycle. However, given that select banks have aggressively grown their unsecured loans and witnessed an expansion of margins, as consumer lending goes through a slowdown, unit economics and growth could be a challenge,” it added, reiterating its ‘buy’ rating on HDFC Bank, Kotak Bank, Axis Bank, lnduslnd Bank and Bandhan Bank.

Headwinds to growth

Deposit growth will continue to pose challenges as deposits become less attractive for investors due to strained financial savings, rise of alternatives such as stock market investments, and strong growth in alternate government savings schemes (PPF and Small Savings).

Alternate government schemes have grown to 21 per cent of total deposits, with the increase being equivalent to 34 per cent of the increase in deposits over FY21-FY23. “We believe the system would need to offer attractive rates to make bank deposits attractive’‘.

Further, consumer lending is seen nearing the consolidation phase driven by large volumes of unsecured lending, rising household financial leverage and a sharp reduction in net financial assets, elevated bounce rates (on 1 year lagged book), and deteriorating performance of portfolio on boarded over the last 12 months, it said.

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