India's Economic Outlook Through Its Banks' Results - Part I

| About: HDFC Bank (HDB)


Deteriorating asset quality of India’s banks has been the biggest hurdle for India's economic growth in recent times.

In this backdrop, the June quarter results of the country’s banks are being keenly watched by investors to assess if the scenario is turning for the better or for worse.

We take a look at the latest asset quality metrics of three of India's largest banks and try to understand the implications for the outlook of country's economy.

Deteriorating asset quality of India's banks has been a serious concern for more than a year now, as we have written in the past. It is undoubtedly the biggest hurdle for growth of India's economy, which, although growing at high-single digits, can grow much faster. In this backdrop, the June quarter results of the country's banks are hugely important. Investors and analysts alike will keenly watch the performance of bad loans in these banks to assess if the scenario is turning for the better or for worse.

Three of India's largest banks, HDFC (NYSE: HDB), Axis and Kotak, reported their first quarter FY17 earnings last week. We take a look at their latest asset quality metrics and try to understand what it means for the outlook of India's economy.

The latest earnings for these banks suggest there is no sign of a turnaround as far as bad loans are concerned. HDFC's bad loans increased 12% sequentially from the previous quarter, while net of provisions, the increase was more than 13%. For Axis Bank, the number was a lot worse - a whopping 57% increase compared to the previous quarter and 59% net of provisions. Kotak Bank on the other hand fared much better with gross and net bad loans growing 8% and 16%, respectively.

Is there a trend in the numbers?

To understand the bad loans scenario better, we also need to look at fresh delinquencies, i.e. performing loans that turn bad in a given quarter. Note that the bad loans discussed above represent the total stock of non-performing loans at the end of any quarter and fresh delinquencies are additions to that stock in a given quarter. Therefore, the former is a stock estimate while the latter is a flow estimate. Fresh delinquencies edged higher in the last quarter for all three banks. For HDFC, the figure moved up to 2.1% of total advances from 1.4% in the preceding quarter, while for Axis it was more than 10%, the highest ever in the bank's history. Kotak once again outperformed its peers, with fresh delinquencies of around 1%.

Although Axis's delinquencies are expected to come down as a percentage of assets, it needs to be noted that the bank has consistently surprised on the downside over the last several quarters. An important fact is that 8% of loans that went bad in the quarter were from outside the bank's watch list. A majority of Axis's advances are to large businesses in the power and steel sectors, so continued negative surprises on the asset quality front tell us there are no signs of a turnaround in the core sectors of the economy. This is especially true because Axis's management remains convinced that 60% of its advances under a watch list of INR 226 billion will turn bad in the next two years.

Similarly, it is important to put HDFC's numbers in the right context. It is one of the best run banks in India with a stellar record of controlling asset quality over many years. Therefore, a 12% growth in bad loans (35% year on year) when advances grew 1.8% (23% year on year) is not an indictment of the bank's asset quality management. Rather, it points to continued stress in the economy. This is especially true when one considers that HDFC has no major exposure to the typically stressed sectors, such as steel, power, infrastructure or textiles.

While the corporate sector accounted for most of Axis's fresh delinquencies, in the case of Kotak, these came from small- and medium-sized enterprises (SMEs). A prolonged period of stress in the core industrials sectors now seem to be trickling down to small- and medium-sized businesses. Thus, weakness in the SME sector may well be another cause for worry as far as India's economy is concerned.

Subdued credit growth

Both HDFC and Axis reported year-on-year credit growth of over 20 percent. Although prima facie these numbers look healthy, on a sequential basis, i.e. compared to the fourth quarter of FY16, credit growth seems to have slowed. HDFC clocked credit growth of 1.3% sequentially in the first quarter of FY17, while Axis clocked 1.8%. For the fourth quarter of FY16, the corresponding numbers were 6.3% and 7.4%, respectively. Therefore, are we in the midst of a trend of weaker credit growth? It is early to conclude, but the numbers reported by two of India's largest private sector banks does conform to the Reserve Bank of India's analysis.

In conclusion, even though reported GDP growth is accelerating, the ground realities still do not make a case for optimism about India's economy. In the latest earnings of two of India's major banks, there is nothing to suggest that things are turning around for the better. In subsequent posts, we will look at earnings of other major Indian banks, starting with ICICI Bank (NYSE: IBN), to see if a clearer picture emerges.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.