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The performance of banking sector, which is the backbone of the country and commands highest weightage in the benchmark index, has showed some signs of improvement sequentially in the quarter-ended June 2018.

Banking sector stocks rallied sharply in the past few weeks, especially after Canara Bank registered a robust Q1 performance.

In the past three consecutive weeks, Nifty Bank gained 4.6 percent while Nifty PSU Bank was the biggest gainer with 16 percent upside, which was far better than private bank index’s gain of 5 percent.

But same indices did not perform well between January 29 and July 20 with Nifty Bank, Nifty PSU Bank and Nifty private bank index falling 2.3 percent, 24.4 percent and 1.3 percent, respectively, due to global as well as domestic worries.

“In my view, NPA recognition has not played out in state-run banks. It’s only the recovery that has helped banks rally so far. There are high probabilities they (NPAs) may bottom out in second half FY19. But conservatively, I feel it might take 4-6 quarters for same,” Sumit Bilgaiyan, Founder of Equity99, told Moneycontrol.

Overall, banks reported net loss of Rs 1,761.85 crore (majorly led by PSU banks) for the quarter ended June 2018, which was narrowed from big loss of Rs 41,630.60 crore in March quarter. They had reported profit of Rs 12,487.79 crore in June quarter 2017.

Vineeta Sharma, Head of Research at Narnolia Financial Advisors, told Moneycontrol that corporate lenders have shown some sign of positive trend this quarter. “The pre-provisioning profit (PPP) for PSBs as well as private lenders have grown well.”

She said the growth in PPP has not yet translated into healthy profit after tax but the management commentary of most of the lenders with high corporate exposure has been rather encouraging. “Fresh slippages have been mostly from the watchlist and the high provision coverage ratio of companies gives confidence that by the end of FY19, banks will start reporting growth in net profit.”

Let’s look at few parameters that ignited spark in these banks which attracted lot of investors in the first earnings season of financial year 2018-19:

Non-Performing Assets

As we are fag end of the June quarter earnings season, 38 out of total 40 banks already announced their April-June quarter earnings data while rest two namely Allahabad Bank and IDBI Bank will announce their results on August 14.

As per RBI rule, non-performing asset (NPA) means loans or advances have not paid for more than 90 days.

Total gross NPA as a percentage of gross advances in April-June quarter improved to 10.77 percent (Rs 9,20,530 crore) against 10.95 percent (Rs 9,42,077.6 crore) in March quarter, but increased compared to 9.74 percent (Rs 7,58,524 crore) in June 2017.

Total net NPA as a percentage of net advances declined to 5.52 percent in June 2018, from 5.87 percent in previous quarter and 5.71 percent in year-ago period.

In absolute terms, net NPA for the quarter ended June 2018 stood at Rs 4,45,195 crore, which was lower compared to Rs 4,77,223 crore in March quarter but higher compared to Rs 4,24,861 crore reported in the quarter ended June 2017.

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The sequential fall in gross as well as net NPA indicated that the improvement started picking up the space and the worst may fully be under control in the second half of FY19 and first half of FY20, experts said.

“We believe stress in the Indian banking sector remains high but it may be close to bottoming out, as regulator (RBI) is conducting asset quality review and pushing banks to recognise stressed assets appropriately,” Prashanth Tapse, Associate VP, Mehta Group, told Moneycontrol.

The clean-up of bad loans began in late 2015. While public sector banks recognised bad loans in the first year of the clean-up, private sector banks lagged and did a bulk of the recognition only in fiscal years 2016-17 and 2017-18.

Tapse said the Financial Stability Reporting’s noted that the clean-up is now concluding but may not be completely done yet. “Stress tests conducted by the RBI as part of its financial stability review showed that the gross NPs ratio may increase further to 11.1 percent by September 2018 from 10 percent levels.”

Private as well as PSU banks’ gross NPAs fell sequentially 10 basis points and 5 bps but increased 42bps and 174bps YoY respectively.

Net NPA of private banks dropped sequentially (22 bps) as well as on-year (5 bps) while PSU banks’ NPA declined 31 bps QoQ but increased 5 bps YoY.

Astha Jain, Senior Research Analyst, Hem Securities, believes that it will take another 2-3 quarters for state owned bank to completely come out of asset quality concerns.

“However the main issue lies with the growth in PSU banks and our view is that in state owned bank category except SBI, other banks have to work really hard to match on growth parameters with private sector bank,” she said.

She further said also another important factor is that now NPL recognition has increased & therefore more provisioning is required. “Hence expecting strong financial performance from PSU banks except SBI is very early at this point of time.”

Provisions and Contingencies

The second important factor was provisions and contingencies which overall fell 47.89 percent sequentially to Rs 69,352.66 crore in June quarter, though increased 64.26 percent YoY.

On quarter-on-quarter basis, out of total 38 banks, 28 reported a decline in provisions while the rest showed increase.

Experts feel provisions may remain elevated for some more quarters as the RBI is coming out with new list of companies which banks have to make some provisions.

“Slippages and recovery & upgrades data surely suggests that PSU corporate lenders are finally getting rid of NPA issue. Also in an absolute sense, Q4FY18 was the worst in terms of NPA, but re-rating would take time as stress list remains high. NPA from SME and power loans remains to be factored in,” Shailendra Kumar, CIO, Narnolia Financial Advisors, told Moneycontrol.

Also, the RBI is expected to come with further provisioning norms on 125 fresh companies. Though it will not directly impact NPA numbers but will see higher provisioning, he said. “So, NPA the worst is behind, but provisioning will remain elevated for the next 1-2 quarters.”

Slippages and Recovery & Upgrades

PSU banks have come out with a decent set of quarterly numbers this time. Q4FY18 had seen very high slippage in terms of asset quality.

Shailendra Kumar said aggregate slippage of all the listed PSU banks in Q4FY18 was to the tune of Rs 1,96,000 crore and that was way ahead of average Rs 95,000 crore slippage during prior ten quarters.

For Q1FY19, major PSU lender that has come out with their numbers has slippage of Rs 25,346 crore in comparison to the corresponding slippage of Rs 62,531 crore in Q4FY18, he added.

He feels what is more encouraging is that recovery & upgrades have picked up speed. “In comparison to further slippage of Rs 25,346 crore, corresponding recovery & upgrade is Rs 21,753 crore this quarter.

SBI reported slippages for the quarter at Rs 14,349 crore (including fresh slippages of Rs 9,984 crore) against Rs 32,821 crore in March quarter while recovery & upgrades were at Rs 14,856 crore against Rs 85 crore in March quarter.

Should you trade in bank stocks after Q1 earnings?

Majority of experts are still favourable to private banks than PSU banks. The recent rally seems to have priced in almost all positives related to earnings, they feel.

“We are still positive on private sector banks from long term perspective & our top picks are HDFC Bank, IndusInd Bank, Bandhan Bank & Yes Bank,” Jain said.

Prashanth Tapse feels the recent rally in the banking space has limited upside left on table.

He expects that Bank Nifty will retrace from its highs as RSI is in over bought zone and a small divergence can be seen as well. Key support levels are 27,650 / 27,195 with resistance near 28,300 / 28,513 and on counter trading. “We like Bank of Baroda (CMP Rs 150, Target Rs 175, with Stoploss Rs 144).

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Sumit Bilgaiyan, Founder of Equity99, said he is still cautious regarding PSU banks. “Few more quarters of stable numbers are required for some positive outlook. So it’s still not the right time to invest as they have already rallied out.”

According to Shailendra Kumar, one can adopt a buy on dip strategy for select PSU banking stocks.

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