Large private banks are entering a “golden age,” says Morgan Stanley

Morgan Stanley raised its outlook and pricing targets for banks as it expects a sustained recovery for the industry, particularly large private lenders, in 2021 on the back of higher revenues and lower credit costs.

Large private banks have emerged stronger from the Covid-19 crisis as they have strengthened their capital, built excess provisions and strengthened their liquidity positions, Morgan Stanley said in its forecast note for 2021 entitled ‘Large Private Banks : entry into the golden age ‘. “A combination of these factors will help them quickly gain market share and substantially lower cost-to-income ratios over the next few years.”

Most estimates predicted that the quality of the banking sector’s assets would be under pressure again after the six-month moratorium on lending in August. The sector, particularly private lenders, did not see bad loans increase as much as feared. In addition, these lenders have raised funds to increase capital reserves.

Morgan Stanley expects a potential upside of 25-40% for large private banks from current levels, with ICICI Bank Ltd. and HDFC Bank Ltd. among the top picks.

The brokerage firm, however, downgraded Kotak Mahindra Bank Ltd. to “equal weight” from “overweight” despite similar favorable winds and a 22% earnings CAGR estimate on FY21-23. “At 26x FY23E earnings, this is largely discounted,” the note said, adding that it awaits a better entry point for the lender.

Morgan Stanley also expects a further rise in earnings for banks. A caveat here is that the macro recovery must be buoyant, as reflected in the high-frequency indicators, and rates should remain benign.

For midsize banks, Morgan Stanley expects a cyclical rise in earnings going forward. Midsize banks faced an additional challenge following the bailout of Yes Bank Ltd. and a decline in deposits in the fourth quarter of fiscal 2020. However, according to the note, there has been a sharp improvement in growth in last two quarters.

“The extension of the government’s credit guarantee scheme will further help reduce the stress on asset quality,” he wrote in the note. Morgan Stanley expects credit costs at these banks to normalize over the H2FY22-FY23 period. “We expect these banks to further narrow the gap with large private banks over the next year.”

Key risks highlighted by Morgan Stanley

  • Non-performing loans higher than expected for the PMI / BBB segments and with a lower rating.
  • Resumption of slower than expected growth.
  • Clear resurgence in Covid-19 cases.
  • Competitive intensity higher than expected, with an impact on margins.