India's inflation has unexpectedly eased to 5.72% in December of 2022 from 5.88% in November.
Beating market forecasts of 5.9%, it is the lowest reading since December 2021. Moreover, it is also the second straight month that inflation has stayed below the Reserve Bank of India target of 2-6%.
This trend suggests that maybe the inflation in the country has peaked, indicating an end to the high interest rate regime.
Banking stocks generally welcome high-interest rates
A higher interest rate allows lenders to charge more money on their advances, keeping the rates on deposits almost the same.
So they make more money on the spread - the difference between the interest income earned on loans they issue and the interest expense paid out on deposits used to fund those loans.
So when interest rates fall, they first reduce the deposit rates and only later cut the lending rates. And so, again they generate higher margins until lending rates are also cut.
But this is only true of the strong lenders in the markets.
So how do you tell them apart?
Track record.
While most lenders will be affected under a low-interest rate regime, the efficient ones might escape without much damage.
This is thanks to their solid track record. Banks that have maintained their asset quality across business cycles are most likely to outshine their inefficient peers during testing times (i.e. under a low-interest rate regime).
So bearing this in mind, we highlight five such lenders that enjoy an immaculate track record. These are most likely to gain when the higher interest rate regime ends.
#1 SBI
At the top of our list is the country's largest banking institution: State Bank of India (SBI).
Despite the bank's troubled background, its financial situation has improved.
In the previous five years, SBI has increased its advances at a CAGR of 8.1%, and in the most recent year, its profit is up 15 times, recording a 3-year CAGR of 149%.
State Bank of India Financial snapshot (2018-2022)
But the robust growth has not affected the asset quality, as depicted by the net non-performing assets as a percentage of net advances (bad loans).
This ratio has improved dramatically, falling from 5.7% in the financial year ending 2018 to 1.02% in 2022. However, it's still below HDFC bank's which has never crossed 0.5%.
The bank is adequately capitalised, as depicted by the CAR, which has steadily been increasing. It stands at 13.9% in the financial year 2022, well above the regulatory norms.
All of this has led to strong return on equity (RoE), which is up from -2.6% in the financial year 2018 to 11.6% in 2022.
The banking giant is confident of growth going forward led by the government's capital outlay plans and an uptick in the credit demand across the country. Moreover, it's confident in generating sufficient capital organically to fund the growing business.
#2 HDFC Bank
Next on our list is the HDFC Bank.
The private lender's advances have grown over 2.4x in the last five years at a 5-year compounded annual growth rate (CAGR) of 19.2%.
Despite expanding its advances, the bank has maintained its asset quality thanks to its conservative attitude with its margins and provisioning policies. The CAR has been on a steady rise from 14.8% in the financial year 2018 to 18.9% in 2022.
The net non-performing assets (NPAs) of the bank have remained steady in the range of 0.3-0.4% from the financial year 2018, the lowest in the industry. This is admirable as it indicates the company hasn't taken any unnecessary risks to expand its business and has remained well capitalised.
It also speaks volumes of how efficient the management has been because maintaining asset quality while growing the business is of utmost importance.
The company has also increased its profitability. The 5-year CAGR net profits stands at 20.1% propelling the lender's return on equity (RoE) which stands at 15.4% in the financial year 2022.
HDFC Bank Financial Snapshot (2018-2022)
The company is optimistic about robust growth. It's focussing on deposit mobilisation and branch expansion to drive growth and is well-placed to capitalise on the pickup in the corporate credit cycle.
It's also confident of long-term synergies from the merger with HDFC Ltd.
However the investors are not. Hence the stock price has been volatile in the past year but closed at the same price towards the end of the year. It is now trading at Rs 1,600, a P/BV of 3.4 times.
#3 Kotak Mahindra Bank
Third on our list is Kotak Mahindra Bank.
Kotak has always remained well capitalised with strong buffers that protect it from any asset quality shocks.
While the advances have grown at a 5-year CAGR of 12.7%, the NPAs have remained in check. The 5-year NPAs average stands at 0.4% and the CAR in the financial year 2022 is at 22.7%. This will allow the bank to outperform its weaker players when interest rates start to taper off.
Strong asset quality in tandem with robust growth has allowed the lender to double its profits in the past five years. This has pushed up the RoE, which stands at 15.4% in the financial year 2022.
Kotak is expected to perform well going forward mainly due to the value unlocking of the multiple subsidiaries the lender holds.
The stock price hasn't moved much since the beginning of 2022 and is trading at Rs 1,780, 3.5 times P/BV.
#4 IDFC First Bank
Fourth on our list is IDFC First Bank.
In the last five years, IDFC First Bank has increased its advances at a CAGR of 19.1%. Its asset quality has been good with a NPA of 1.52% in the financial year ending 2022.
However, the bank has reported a loss in the past due to the mergers and acquisitions it has undergone. It has reported a loss twice in the past 5 years, once due to the merger with Capital First and the in 2020 due to a one-time provision cover towards stressed accounts.
The company sports a relatively clean balance sheet and is gearing its focus towards high margins business. It's confident of maintaining high margins in the future.
Moreover, news of a demerger with its parent will set the banking stock free to grow and possibly reward shareholders with outsized gains.
IDFC First Bank Financial snapshot (2018-2022)
#5 HDFC Ltd
Last on our list is HDFC Ltd, the country's largest mortgage lender.
In a sector which is so closely linked to the macro environment, HDFC's ability to manoeuvre through market cycles with exceptional capital allocation has been fantastic. This Is what sets it apart from other lenders in the sector, positioning it to perform well even when interest rates are falling.
The leading lender enjoys an immaculate track record. While the net income has grown at a 5-year CAGR of 17.4%, the asset quality remains intact. The NPAs have stayed around 0.8-1% over the same period.
While the stock was a victim of the FII selling in 2022, the company's performance remained intact. A dividend paymaster, the company has been rewarding its shareholders well, registering a dividend yield of 1.1% in the past five years.
The stock price has moved in tandem with its peers, reporting a total return of 20% since the beginning of 2022. It is trading a P/BV of 1.7 times.
In conclusion
As the country reports lower inflation sequentially, there is a good chance the RBI may lower the interest rates. Banking stocks are highly sensitive to changes in interest rates. So tracking the interest rate cycle can go a long way in investing in banking stocks.
However, not all lenders are worth analysing. So, conduct your research before allocating your hard-earned money.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com
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