Indian banks in best shape in a decade, ripe for picking, says Nomura; check top stock picks, target prices

Indian banks in best shape in a decade, ripe for picking, says Nomura; check top stock picks, target prices

Indian banks are in the best shape in a decade, and the domestic bank stocks are ripe for picking for mid- to long-term with the investment thesis being ‘solid as ever’, said Nomura in a research note. The global brokerage is very bullish on Indian bank stocks, saying that banks are well capitalised; have lowest non-performing loans in a decade; and have high provision coverage levels, which are likely to sustain until FY25E. Further, the credit cycle is benign and profitability is at its highest level in a decade – which means banks are at the cusp of a multi-year credit cycle, the note said.Factors contributing to bullish sentiment in Indian banks

Among the factors that are driving growth in the banking sector, the improving capital adequacy, falling GNPA (gross non-performing assets) and a higher provision coverage ratio (PCR) contributed to improving the positioning of domestic banks.

Banking sector is now well capitalised with capital ratios near all-time high levels:

Healthy contingent provision buffers

Banks’ provision buffers have continued to improve, as lenders built up their contingent provisions during the COVID-19 era, with some banks further adding provisions in FY23. These buffers are likely to continue providing banks with a cushion against any potential asset quality issues in the future.

Rising credit growth, falling NPAs

Nomura said that the credit growth in the banking system is a stronger function in asset quality rather than interest rates. NPAs rose by 7% in FY15-18, leading to credit growth of ~9/10%. As NPAs moderate by 90 bps in FY22-23, credit growth has seen a 15% on-year pick-up in FY23. As a result of improving asset quality, strong risk management, and underwriting, banks are increasingly willing to lend.

NIMs improve

The net interest margin for banks has expanded over the past year, leading Nomura to believe that NIMs might be near their peak levels. However, Nomura projected that the moderated from peak levels will be gradual and find support from upward re-pricing of non-repo linked loans. Banks like ICICI Bank, Axis Bank, Kotak Mahindra Bank and SBI have seen a sharp spike of 50-100 bps in their reported NIMs, with a larger proportion of repo-rate linked loans. Private banks have between 40% to 60% of their loan book directly linked to external benchmarks, meaning that banks’ lending rates are increasingly sensitive to external environment interest rates.

Expect NIMs in FY24F to sustain above FY23 levels and then gradually moderate in FY25F:

If the interest rate hiking cycle from April 2010 to November 2011 were to be compared to the cycle from May 2022 to February 2023, the increase in NIMs was 20 bps compared to a 350 bps hike in the repo rate during the first cycle, whereas NIMs rose by 50 bps in the second cycle as the repo rate was hiked by 250 bps.

Outlook for domestic banksImpact on credit-growth

The credit-mix for the domestic banking system has shifted from corporate loans to retail segments over the past decade. Retail loans have grown by 16% CAGR compared to 3% CAGR in corporate loans over the same period. Companies were impacted by highly leveraged and weak balance sheets, the banks saw high NPL formation, and there was low demand for capex over the past decade. However, the picture seems set for a reversal, as corporate balance sheets have improved to their best form in a decade, the debt-to-equity has come down and are in a “sweet spot to ramp up investments”. As a result, Nomura expects the outlook for credit demand to be on a strong footing.

Shift from PSUs to private banks

Over the past two decades, the lion’s share of the market has moved away from PSBs to private lenders, and Nomura said the trend is likely to continue. On average, over the last five years, private banks have grown at 1.5-2x the credit growth of PSU banks. Private banks have gained significant market share in retail loans, with sharper gains in corporate loans. Loan growth for large private banks is expected to come in at 18-20% over FY24-FY25E, while for PSU banks, the pace is likely to be slower at 14%.

Bank stocks to watch; Check Nomura’s top picks

Nomura prefers banks that have a strong liability franchise and RoA outlook. Based on this, ICICI Bank and Axis Bank are the financial services provider’s top picks, while IndusInd Bank is their key alpha idea. Alternatively, AU Small Finance Bank has been downgraded to ‘Reduce’ from ‘Neutral’.

(The stock recommendations in this story are by the respective research analysts and brokerage firms. FinancialExpress.com does not bear any responsibility for their investment advice. Capital markets investments are subject to rules and regulations. Please consult your investment advisor before investing.)