The banking sector has been the talk of the town after it posted better-than-expected results in Q2FY23 amid the Reserve Bank of India’s rate hikes and increasing inflation. While the rate hikes have been a cause of worry for most companies as they increase finance costs, and affect consumer demand, banks are not complaining. Bank stocks are up as higher rates improve their net interest margins and earnings.

Top private banks like Axis Bank, HDFC Bank, Kotak Mahindra Bank and ICICI Bank have had an especially festive earnings season. The banks performed well on almost all metrics like net profit growth, interest income growth, loan growth and asset quality.

In the past 90 days, the banking and finance sector rose by more than 5.2%, while the Nifty Bank index rose 8% on good Q2 results. The second quarter is generally much-awaited in Indian markets as festival celebrations ramp up demand and sales. Investors also look for ‘auspicious’ muhurat periods to trade. This year, analysts were gung-ho about bank stocks during Diwali muhurat trading. Reports suggest that during muhurat trading, seven bank stocks hit their 52-week highs as they reported their Q2 results. Some of them include big banks like Axis Bank, Federal Bank and Karnataka Bank.

According to Trendlyne’s DVM scores, ICICI Bank’s durability score was the highest among the top four private banks. A durable stock on the Trendlyne scale means that the stock has stable revenues, profits, cash flows and low debt. However, HDFC Bank beat the others in momentum score. A good momentum score indicates the bullishness of the stock.

Provisions inch up QoQ without impacting net profit growth

When Covid struck, the banks had to provide additional buffers over their loans to maintain their asset quality. Now that the economy is back to normal, the need for additional provisions has reduced. Even so, the banks figured that caution is the better part of valor and increased their provisions slightly, as some loan segments like agriculture had not picked up pace in Q2FY23.

Another reason for banks to increase their provisions bucket is to prepare in case of changing macroeconomic dynamics. Rising interest rates will affect the demand for loans. Given that the banks only started to recover from the shocks of Covid in Q1FY23, increasing inflation and interest rates are likely to affect loan demand, even if it’s for a shorter term.

However, this did not impact the rise in net profit. Axis Bank reported the highest net profit growth on both QoQ and YoY basis. Axis Bank’s net profit rose 29% QoQ and 70% YoY to Rs 5,329.8 crore in Q2FY23. This was followed by ICICI Bank, whose net profit grew 37% YoY to Rs 7,557.8 crore. Although provisions fell 17% for the bank, its net profit growth came in because of a strong net interest income increase of 26.5% YoY.

Banks earn high net interest income, reflecting high margins

With healthy growth in loans, all four banks saw a rise in net interest income. Axis Bank again topped the charts by reporting a 31% YoY rise in net interest income to Rs 10,360 crore in Q2FY23. However, in terms of the corpus, HDFC Bank had the highest interest income of Rs 21,021 crore.

Net interest margins (NIM) also increased this quarter on account of higher interest income and a decreased effect of interest reversal. Interest reversal is a term which indicates if the monetary policy supports lending or a savings environment. In the banking space, HDFC Bank’s NIM rose 10 bps QoQ to 4.1% in Q2FY23. Kotak Mahindra Bank’s NIMs rose the highest this quarter by 72 bps YoY to 5.2% with domestic NIM at 4.08%. The management attributed this to improved investments in technology to push loan growth.

ICICI Bank’s NIMs also rose as margins expanded on both the deposit and loan front. Axis Bank’s NIM rose on an increase in spreads (difference between interest paid and interest received).

An increase in NIM is a sign of high demand for loans, with banks likely to earn more, given they receive more interest than they pay out. However, monetary policies and rate hikes play an important role here. If the rate hikes continue, borrowing will get costlier, shifting customer preference from loans to savings, reducing NIMs. Axis Bank’s Managing Director and CEO Amitabh Chaudhary says, “If we can keep our NIMs intact, there are deposits out there which can be raised. This will allow us to manage that growth.”

Loan books swell as the share of retail loans increases for all banks in Q2FY23

With domestic demand improving and the second quarter overlapping with the festive season, the banking sector performed decently. ICICI Bank, HDFC Bank and Axis Bank outperformed the Nifty 50 in the past six months.

Even though Kotak Mahindra Bank underperformed the Nifty 50 index in the past six months, its growth in advances is encouraging as it clocked a 25% YoY growth in corpus to Rs 2.9 lakh crore. Loan growth was led by improvement in retail loans, with the highest growth coming from tractor finance, credit cards and consumer durables segments.

Tractor finance grew 119.9% YoY. Jaimin Bhatt, Kotak Mahindra’s Group President and CFO, says, “The tractor industry has seen an uptick in demand owing to better cash flows of last harvest and pickup of commercial deployment. We have grown our disbursement strongly across tractor financing and improved our market share in the segment.”

In Q2FY23, HDFC Bank reduced retail loans to 38% from 40% in Q2FY22. However, retail loans dominated the loan mix across major banks. According to data, HDFC Bank was better placed in terms of loan mix because of its nearly even distribution in the past quarter. But its management has hinted that the share of retail loans might increase again in H2FY23.

Axis Bank’s SME loan mix improved to 10.7% in Q2FY23 from 9.8% in Q2FY22. The management will continue to focus on retail and SME segments as it expects the growth momentum to continue for these. KR Choksey’s report suggests that Axis Bank’s advances are likely to grow by 16.7% CAGR over FY22-24E.

Asset quality improves sharply across banks

This quarter, banks saw improved recoveries and upgrades from their NPA (non-performing assets) accounts. HDFC Bank’s NPA numbers were the lowest in the industry, according to the gross and net NPA data. This was helped by a reduction in NPAs across corporate, retail, commercial and rural banking loan segments. Given that recoveries have improved and slippages have reduced for the bank, KR Choksey expects GNPA and NNPA to remain at 1% and 0.3% respectively in FY24E.

Axis Bank and ICICI Bank’s NPAs improved due to restructuring of loans and decline in stressed loans. Axis Bank’s stressed loans fell to 1.89% in Q2FY23, as compared to 2.17% in Q1FY23. Although ICICI Bank’s NPA ratios have improved, the bank has kept an additional provision of Rs 1,500 crore for contingencies. Sandeep Bakshi, CEO of ICICI Bank said that the provision was made “by looking at risk markers across a broad range of portfolios and continuing uncertainties in both geopolitical and macroeconomic environment.”

Growth for banks to continue as credit growth remains positive

Uday Kotak, CEO of Kotak Mahindra Bank,  offered an interesting perspective on the ongoing credit cycle in the bank’s Q2 earnings call. According to him, we live in “Cinderella” times and do not know when the clock will strike “midnight” for this growth. “We can figure out when it is Cinderella time, and then take a call on how long this positive credit cycle remains, which is closely linked to the terminal rates of interest and the external account situation of the country,” he added.

Recessionary trends have already hit companies like Facebook, Apple and Amazon, which are laying off people or freezing new hires. In the Indian context, although we may be relatively insulated from a slowdown thanks to the large domestic market, spillover effects will be seen, especially in the IT sector.

According to reports, only the banking sector performed well in Q2, while other sectors like metals and FMCG faced cost inflation and slow demand post the festive season. Srinivasan Vaidyanathan, Chief Financial Officer of HDFC Bank, said, “Given the entire inflationary impact which we are seeing, some export-oriented industries might also be affected because of a global recession.”

However, big banks will be relatively immune to this as the Centre’s capex boost will keep the economy growing. Certain sectors might slow down but the banks remain positive on growth. Trendlyne’s dashboard shows that the banking industry overall is up nearly 28% in the past six months. Reports also suggest that the BFSI sector reported a 38.5% YoY growth in net profit in Q2FY23 and it is likely to sustain because of a steady improvement in asset quality.

Trendlyne’s Forecaster dashboard shows high bullishness on HDFC Bank, ICICI Bank, Kotak Mahindra Bank and Axis Bank. IDBI Capital expects market share for private banks to improve as public sector banks finish their consolidation process. It also expects private banks to outperform PSUs in terms of credit growth and asset quality in FY23.

This analysis by Trendlyne is meant for investor education - to help understand companies and make informed investment decisions on their own. It should not be considered an investment recommendation.