Axis Bank: On the watchlist

Even six to seven quarters after the RBI’s asset quality review, the festering issue of bad loans appears far from over. While the pace of slippages of loans into non-performing assets has slowed, they remain elevated for many banks. Private sector banks that had managed to keep bad loans under check up until the 2016 fiscal, have seen a spurt in NPAs over the past year, led by banks such as ICICI and Axis Bank that have relatively higher exposure to stressed sectors. While these banks are better capitalised to absorb the incremental stress than public sector banks, subdued core performance and uncertainty over asset quality, can weigh on earnings.

In the June quarter, while Axis Bank reported lower slippages, continued stress from outside its watchlist is a cause for concern, indicating more in the coming quarters for the private lender. A relatively lower pace of credit offtake when compared to other private sector banks and pressure on net interest margin (NIM) can continue to keep the bank’s earnings subdued. While the bank is well-placed to benefit from a pick up in investment activity and has a strong retail portfolio, a meaningful turnaround in earnings may be some quarters away.

Investors can exit the stock now, and re-enter when the bank’s asset quality concerns recede and growth starts to pick up. Banks with better earnings visibility over the next year, would be a better bet, to tide over the growth challenges in the overall economy as well as volatile markets.

Since the beginning of 2016, the stock has been volatile, rising and falling sharply owing to uncertainty over its asset quality performance. The stock now trades at 1.9 times its one-year-forward book, in line with its five-year historical average. Risks to earnings can keep the stock under pressure over the next year.

Axis Bank, like other lenders such as ICICI Bank and SBI — that have a higher exposure to stressed sectors — had created watchlist (key source of future stress in the corporate loan book) towards the end of the 2016 fiscal. With around 60 per cent of accounts under watchlist slipping into NPAs, the outstanding loans under the watchlist of around ₹22,600 crore as of March 2016 are down to ₹7941 crore as of June 2017. While slippages from the watchlist was expected, the incremental stress every quarter from outside the watchlist remains worrisome.

In the June quarter of last year, 92 per cent of the corporate slippages came from the watchlist. By March 2017, the bank reported a lower 83 per cent of corporate slippages from the watchlist (or 17 per cent from outside the watchlist).

In the latest June quarter, of the ₹2,300-odd crore corporate slippages, a significant 60 per cent and above came from outside the watchlist accounts.

To be fair, with the watchlist itself shrinking sizeably over the past year, incremental slippages could come from outside the watchlist. However, the size of such slippages remain a concern and will need watching in the coming quarters.

Write-offs too have been inching up in recent quarters. From ₹1,194 crore in the March quarter, write-offs stood at ₹2,462 crore in the June quarter.

Aside from worsening asset quality weighing on earnings, Axis Bank’s core performance has also been subdued over the past year. The bank had managed just a 10 per cent growth in loans in 2016-17. While this has inched up to 12 per cent in the latest June quarter, it lags some of its other private peers. While some mid-sized players have managed to report upwards of 20 per cent growth, on a lower base, the largest private lender — HDFC Bank — too delivered a loan growth of 23 per cent in the June quarter, despite its size. With corporate book consisting of predominantly working capital financing, HDFC Bank has been fairly insulated from the investment slowdown.

While growth in Axis Bank’s corporate book in the June quarter was driven by strong growth in working capital loans, the overall growth in corporate lending remained subdued at 2.6 per cent (as against 25 per cent for HDFC Bank).

Retail loans for Axis Bank, though, remained on a strong footing, reporting a growth of 22 per cent.

However, on the margin front, a substantial part of the variable loans moving from base rate to MCLR has impacted Axis Bank’s net interest margin. From 29 per cent in March quarter, MCLR-linked loans now constitute 36 per cent of loans. The sharp fall in MCLR over the past year has impacted yields and hence margins. Axis Bank’s fixed rate loans is just 16 per cent of its portfolio. For HDFC Bank that has managed to maintain stable margins, fixed rate loans constitute the chunk — 70 per cent of its loans.

Axis Bank saw a muted 2 per cent y-o-y growth in core net interest income and a 16 per cent decline in net profit in the latest June quarter. Earnings had shrunk by 55 per cent in the 2017 fiscal, owing to sharp increase in the bank’s bad loans.

After falling to single-digits (7.2 per cent) in FY-17, Axis Bank’s return on equity (ROE) has inched up slightly to 10.2 per cent in the June quarter.

This is, however, way below the robust 17-18 per cent ROE that it sported in the past. A substantial pick up in credit offtake and stability in asset quality is required for a meaningful turnaround in earnings.

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