Bond losses to hurt Q3 earnings of banks; NBFCs may sail through

The December quarter earnings season may hold little cheer for banks, as the steep drop in bond prices is expected to add to the existing bad loan problem.

During the quarter, bond yields on the 10-year benchmark government bond surged 67 basis points or 0.67 percentage points, as market players anticipate the government to overshoot its fiscal deficit target. When yields rise, bond prices fall as the two always move in opposite directions.

In addition to interest and fee-based income, banks also make money by buying and selling bonds. The lower value of the bond portfolio will dent profits for the quarter, analysts say.

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Kotak Institutional Equities in its report last week, said, "We expect banks to report weak earnings growth due to lower treasury contribution and elevated loan-loss provisions. Marginally higher loan growth should support NII (net interest income) growth. We expect slippages to moderate further but any divergence would warrant monitoring."

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Rating agency ICRA estimates that the MTM loss for the entire banking sector will be around Rs 15,500 crore during the quarter, 80 percent of which is to be borne by public sector banks. Such losses will erode capital ratios for the lenders.

A slight growth in loan book is expected due to a favourable base effect and an uptick in retail portfolios, majority under home loans and the unsecured personal loans and credit card segments.

Kotak report estimates banks overall to report a 31 percent year-on-year (YoY) decline in earnings, with private banks reporting a 2 percent YoY decline.

Further public sector banks are likely to make initial provisions for the next wage settlement cycle beginning November 2017.

Retail asset heavy lenders like HDFC Bank, IndusInd Bank, City Union Bank and Federal Bank are likely to report stable/better performance, while other banks are likely to report weak performance.

Treasury profits were the saving grace for lenders in the last couple of years as they grappled with rising NPA provisions. In the past six quarters (Q4FY2016-Q2FY2018), banks made treasury gains of around Rs 1 lakh crore, much higher than the total profit before tax (PBT) of Rs 51,105 crore for the entire banking sector during this period, the ICRA report pointed out.

Provisions towards NPAs

While the large corporate cases undergo insolvency proceedings at various courts, banks will have to make incremental provisions as mandated by the Reserve Bank of India and also make write-offs where the banks will have to take haircuts on account of the sale of the assets.

Analysts expect haircuts of over 50 percent in most cases.

RBI has asked banks to make 50 percent provisions toward secured debt and 100 percent provisions towards all unsecured portion of debt falling under the Insolvency and Bankruptcy Code (IBC) and also all cases that fail to get resolved under IBC and are forced into liquidation.

Most private banks shall report their earnings before the end of January while public sector banks are largely announcing their results toward end-January or early February.

NBFCs to grow higher

Upbeat on NBFCs or non-banking finance companies, Kotak report expects then to deliver 30-50 percent earnings growth on a low base (post-demonetization), liability-side benefits and steady improvement in demand.

"We expect most NBFCs to deliver 30-50 percent earnings growth on the back of improving underlying performance and the low post-demonetization base. High loan growth will be a key driver for PNBHF (PNB housing finance) (PAT up 54 percent) and Bajaj Finance (PAT up 39 percent).

NIM (net interest margins) and control over expenses will drive higher earnings for L&T Finance, Cholamandalam while lower credit costs will drive earnings for Shriram City Union Finance (SCUF) and Shriram Transport Finance.

HDFC’s strong earnings growth is largely driven by capital gains from a stake sale in HDFC Life; its underlying performance will likely be stable as well.

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