Another quarter of muted performance: Q2FY16 performance was broadly no different from that of the previous few quarters. Earnings declined 3% y-o-y led by weak revenue growth and high provisions. Fresh impairments have declined but slippages are still high. SBI, HDFC Bank, IndusInd and Yes Bank reported another quarter of strong performance while Axis, BoB, BoI disappointed. As for NBFCs, NIM expansion supported earnings while loan growth was weak. Bajaj Finance, SKS, Chola and LIC HF reported strong performance while HDFC, MMFS, Magma and Muthoot were weak in Q2.

Trends unchanged; revenue growth sluggish due to weak NII performance: As in the past few quarters, earnings are still sluggish with Q2 reporting a decline of 3% y-o-y while we expected it to move to the positive zone. Revenues grew 11% y-o-y with NII (net interest income) growth struggling at 9% y-o-y and non-interest income growth at 16% y-o-y. NII growth for private banks was stronger at 17% y-o-y and weak for public  banks at 9% y-o-y, reflecting the weak trends in loan growth. Overall provisions increased 31% y-o-y but loan-loss provisions increased 41% y-o-y with a large share of provisions for impaired loans. SBI among public banks and HDFC Bank, IndusInd and Yes Bank among private banks reported strong results.

Loan growth recovery still not visible; revenue growth sees support from treasury: Loan growth (under coverage) is still weak at 10% y-o-y, the slowest in recent years as we are not seeing any recovery in demand from the corporate segment and alternate channels have opened up meaningfully. Divergence continued between public (6% y-o-y) and private (19% y-o-y) banks primarily due to the nature of the loan portfolio and private banks looking to rebuild growth in the corporate segment. We see loan growth—and consequently revenue growth—as the key challenge that is likely to continue in FY2016-17 as we see little evidence of corporate demand (~45% of loans) as banks have negligible sanction pipelines. Revenue growth and earnings growth should sustain/improve largely as the treasury book shows positive contribution.

Fresh impairments slow, reflecting change in guidelines; stress levels remain high: Fresh impairments declined marginally to 3.7% from ~3.9% of loans in Q2 but slippages increased 30 bps q-o-q to 3.2% while fresh restructuring was at 0.5% of loans with the decline representing the closure of the restructuring window. Gross NPLs increased 7% q-o-q (10 bps of loans) to 4.3% (5.3% for public and 2.1% for private banks). Outstanding impaired loans declined after six consecutive quarters of increase by 33 bps q-o-q to 9% of loans. Weakness in trends on recovery/upgrade and high write-offs still indicate that the stress levels remain high in the system. Outstanding restructured loans declined 50 bps q-o-q to 4.8% of loans. Most banks have now started using the 5/25 window to change the cash flows of long-term projects, raising fresh concerns on these exposures.

NBFCs: NIM supports earnings; business momentum weak: NIM expansion supported earnings of most NBFCs on the back of lower interest reversals and decline in borrowing costs. While lower interest reversal (on the back of lower slippages) is an encouraging trend, muted disbursements make it challenging to predict the timing and pace of recovery. Bajaj Finance, SKS, Chola and LIC HF reported strong performance while HDFC, MMFS, Magma and Muthoot were weak during Q2FY16. Decline in bank base rates will benefit most NBFCs in Q3 and will be the key earnings driver in the second half of 2016.

Outstanding impaired loans decline after six consecutive quarters of increase; recovery/upgradation stable but low: The broad trends on outstanding impairment ratios showed an improvement with a decline of 33 bps q-o-q to 9% of loans. This is the first quarter where we have seen a decline after FY2014. Gross NPLs increased 20 bps q-o-q to 4.3% while restructured loans declined 40 bps to 4.8% of loans.

Q2 also saw further improvement in the underlying fresh impairment ratios although the improvement was negligible on a sequential basis. Fresh impairments declined 20 bps q-o-q to 3.7% of loans but slippages were higher by 30 bps at 3.1% and fresh restructuring declined sharply to 0.5% of loans. The qualitative assessment of the slippages for the quarter continues to appear that a large share of slippages for banks is coming from the increasing rate of failures of previous restructured loans, especially from the iron and steel sector.

SBI, PNB, Canara Bank and OBC among public banks while HDFC Bank, IndusInd Bank and Yes Bank among private banks reported better performance on fresh impairment ratios. Axis Bank, BoB and BoI had a disappointing quarter.

Overall gross NPLs increased 7% q-o-q at 4.3% of loans (30 bps increase to 5.3% of loans for public banks and flat q-o-q to 2.1% of loans for private banks). Large private banks have now started indicating that the stress levels in the balance sheet is gradually easing and believe that FY2014-15 was probably the weakest period from an impairment perspective. However, public sector banks continue to be impacted by the restructured portfolio where they are currently witnessing a higher share of slippages. A few banks continued to resort to sale of loans, both standard, NPL and written-off loans to ARCs at a steep discount.

Recovery/upgradation was broadly similar to the previous quarter at 1% while the write-offs were flat q-o-q at ~1.1% of loans. Typically the second half of the year is stronger on recovery and upgrades. It could be seasonal and probably not cyclical and we would need to see the trends to establish the trend on impairment ratios.

Managements, especially for public banks, continue to highlight that a disproportionate bandwidth is towards impairment management but the efforts can pay off only when there is recovery in the economy, which at this stage appears to be promising. The earliest sign that we would need to read to gain confidence on the impairment cycle would be the reduction in slippages, which at this stage is not visible although one would argue that it has probably stabilised. We should, after a few quarters, notice stronger trends on recovery/upgrades.

Provision coverage showed some improvement, albeit nothing substantial, especially among public banks. SBI reported one of the best improvements in provision coverage ratios while ICICI Bank reported a sharp decline q-o-q.
Restructured loans show a decline of 50 bps q-o-q; net NPL and restructured loans decline 40 bps at ~7% of loans: The overall restructured loans declined by 50 bps q-o-q at 5% of loans. Public banks reported a decline of 50 bps q-o-q to 6% of loans while the share of restructured loans for private banks increased by ~40 bps to 1.9% of loans.

The decline on a sequential basis was broadly on expected lines given that the window for fresh restructuring has come to a close. Loans restructured in the SEB segment were stable q-o-q at 46% from 50% in the past few quarters.

There would be no further fresh disbursements from FY2016 to SEBs as a part of the financial restructuring package.

This is expected to decline with the implementation of the recently announced package on discom reform.

Overall stress (net NPL and restructured loans) stands at 3.0% of loans (20 bps q-o-q decline) for private banks and 8.8% of loans (40 bps decline q-o-q) for public banks. We do note that there are high slippages into NPL from the restructured loan portfolio as the restructuring package implemented in these corporate portfolios has not been successful.