The banking sector is definitely in for a rough time. The sector is facing multiple headwinds in the form of high cost of liquidity, rising bond yields and faltering credit growth. The sector is also likely to see higher provisioning for sectors such as real estate, telecom and infrastructure as these sectors have been hit the hardest due to rise in interest rates, corruption scams and inflation. The bank Nifty has returned a negative 6% calendar year to date reflecting the poor outlook for the sector. However, the Nifty itself has returned a negative 9.9% calendar year to date, thereby showing the Bank Nifty in a better light with relative outperformance on the downside. This is set to change.
The Bank Nifty will start significantly underperforming the broad market, both on the downside as well as on the upside. The first quarter 2011-12 results will not be rosy for the sector. On the investment book front, there is unlikely to be any good news. Bond yields have risen by around 50bps in the April-June quarter and banks will be making provisions for depreciation in yields in their AFS (Available for Sale) portfolios rather than showing any profits. There will be no consolation even if portfolio maturities are low, as bond yields have risen across the curve.
Credit growth has been anemic in the April-June quarter. RBI data as of 3rd June 2011 shows that total outstanding non food credit was Rs 39,06,439 crores. The outstanding non food credit as of 8th April 2011 was Rs 39,06,480 crores. Going by this data non food credit growth was actually negative this quarter. Hence credit growth on a quarter on quarter basis is likely to be negative. The first quarter is usually a quiet period for bank lending, as it is the beginning of the fiscal year and corporates usually firm up their borrowing plans in the first quarter. However, the absolute lack of credit growth is definitely a sign of worry.
Banks are losing risk appetite after the exposure of corruption scams. The telecom sector had borrowed around Rs 100,000 crores to fund the 3G spectrum licenses in June and July last year. Banks have been lenders to the telecom sector, but after the 2G scam surfaced late last year banks have become nervous on lending to the sector. The sharp fall in valuation of large telecom operators such as Reliance Communication (RCOM) and GTL and GTL infra that have lost 50% and 78% and 72% in market capitalization year on year respectively is exposing highly indebted telecom sector companies vulnerability.
The sharp rise in provisioning in the fourth quarter of 2010-11 made by the country’s largest lender the SBI, took down its profits by 99% for the quarter on a year on year basis. Banks are unlikely roll over debt for any company facing stress in servicing debt and it will most likely show up as provisions. If public sector banks follow SBI’s example of big bang accounting, this quarter could see more NPA (Non Performing Assets) surfacing.
Banks are also reducing credit growth targets for 2011-12 from 20% and above levels to 16% to 18% levels. SBI is looking at 16% to 18% credit growth while ICICI Bank is targeting 18% credit growth for this fiscal year.
Treasury income does not look promising either. RBI rate hikes have pushed up overnight borrowing costs while rise in yields in money market papers, where yields have risen by around 60bps to 100bps have negated arbitrage opportunities. Treasury fee income is also looking down with slowing sales in currency derivatives as well as a slowdown in bond placements and loan syndication. Rising yields have forced corporates to defer their issues. May 2011 has seen a decline of 43% in issuances year on year.
On a broad sector basis, the banking sector is seeing difficult times. Individual banks may have done well through better business practices and by drawing away customers from rival banks. However, one or two banks doing better than the rest cannot really push up the prospects of the sector.
Going down the down the line, banking stocks may look up, as inflation will have cooled off on the back of slowdown in the economy. Interest rates are likely to come off once RBI turns neutral on policy and liquidity will have improved with deposit growth trending higher than credit growth. Till such time, bank stocks will underperform the broad market.