Stock Fundamentals

Here’s a DIY guide to choosing banking stocks

Keerthi Sanagasetti | | Updated on: Jan 18, 2022
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We shortlist lenders based on their NIMs, GNPA and other metrics

While the Nifty 50 has recouped much of its recent losses and is inching towards its previous peaks (in October 2021), the Bank Nifty index has corrected 8 per cent from its peak in late October 2021. Expected uptick in interest rates, risk of higher delinquencies due to the sporadic lockdowns and muted credit growth in the past are factors weighing on banking stocks. But does this correction pave the way for accumulating some long-term bets? We help you boil it down to a few resilient picks within the industry using a few key metrics in their recent quarterly results.

The criteria

While increasing interest rates could be a risk for banks’ margins, the difference in product mix (loan and deposits) helps maintain a non-linear relationship between the movement in market interest rates and margins. Thus, despite the policy rates being retained at status quo for the last couple of years (since March 2020), a few banks have seen improvements in margins owing to better product mix. Using the Capitaline database, we shortlisted banks that saw an improvement in their net interest margins, or at best maintained their NIMs in the recent September quarter (y-o-y).

In the next step, we filtered out banks with gross non-performing assets (GNPA) less than 5 per cent, to weed out names that would still be grappling with balance sheet clean ups, rather than focusing on growth.

The recent Financial Stability Report by the RBI, too, highlighted that, banks saw a slight uptick in Non-Performing Assets (NPAs) in the personal loans and agriculture segments, in the September 2021 quarter, while industry and services segments saw moderation. With December 2021 quarter numbers still reflecting the effects of restructuring 2.0, more stress in the retail book is likely in the further quarters only. Normal delinquencies can be heightened with a third wave inducing further lockdowns and economic slowdowns.

Hence, to further strengthen our view on the bank’s resilience we then eliminated banks that showed more than 1 percentage point increase in their GNPAs (y-o-y), in the recent September quarter results.

Finally, to pick banks that are well poised to play on the likely uptick in credit growth, we shortlisted banks with an existing Capital Risk-adjusted Adequacy Ratio (CRAR) of at least 15 per cent — such that we pick resilient names that not only are able to wither the economic impact of the pandemic but also have enough headroom for further growth. The RBI has mandated a minimum CRAR of 15 per cent for small finance banks (considering the riskier segments they operate in), while the minimum requirement for scheduled commercial banks is much lower at 9 per cent only.

The margins and the GNPAs alone may not be the right way to zero in on your investment choice within banks. However, this screener can sure be a starting point to undertake further research into the businesses we have highlighted below.

Who made the cut?

ICICI Bank has shown continuing improvements in its asset quality and margins in the last couple of quarters. In the September 2021 quarter with its GNPA down 35 basis points (bps) and NIMs up 43 bps to 4 per cent, ICICI Bank made the cut.

Following this were Kotak Mahindra Bank and HDFC Bank – with the highest NIMs within the large private banks (4.45 and 4.1 per cent, respectively) — that made the cut. This came in despite slight aberrations in their margins (HDFC bank reported flat margins) in the recent September quarter, owing to their cautious approach to credit growth. However, both these banks were able to contain their slippages to GNPA to less than one percentage point (y-o-y), in the recent September quarter, despite multiple waves of the pandemic. Their long-known superior underwriting skills speaks for such a resilience in asset quality. Besides the banks are also well capitalised with CRAR above 20 per cent.

Axis Bank that showed a 65 bps drop in its GNPA numbers also made the cut. However, the bank’s balance sheet clean-up process took a toll on its margins – that were down 19 bps yoy in the recent September quarter. Investors would need to watch out for developments in the bank’s margins going ahead.

IndusInd Bank, too, made the cut, given the contained expansion in its GNPA numbers (up 56 bps) and a mere 9 bps drop in its NIMs.

However as indicated earlier, the screener can at best be a starting point for zeroing in on your investment choice within the banking space. This is because the sector is now facing many macro events that could take a toll on bank financials, going ahead.

For instance, the RBI in its FSR report highlighted elevated risk in SME (Small and Medium Enterprises) and MFI (Micro Finance lending) portfolios, going ahead. Hence banks such as IndusInd Bank (13 per cent of its advances comprises of micro finance), SBI (13 per cent lent to SME), Bandhan bank (with over 60 per cent exposure to micro finance loans) and Ujjivan small finance bank (66 per cent comprises of Micro banking and another 10 per cent lent to SME), could see asset quality related stress in the upcoming quarters, given their heightened exposures to these risky segments.

Published on January 15, 2022

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