Banks’ non-core shift worries analysts

Private sector HDFC Bank and Axis Bank both declared profits riding on income that didn’t come from their core business of lending, prompting analysts to raise the red flag on the bank stocks.

Axis Bank made a Rs 330 crore net profit in the April-June period riding on Rs 326 crore of trading profits, of which Rs 155 crore came from trading gains in government securities, Rs 70 crore from corporate bonds, Rs 77 crore from equities and Rs 25 crore from forex trading.

HDFC Bank made a Rs 606 crore net profit in the same period, largely due to a 76% rise in other income to Rs 1,044 crore from Rs 593 crore last year.

More than half of HDFC Bank’s other income came from fees and commissions of Rs 650 crore, besides foreign exchange revenues of Rs 138 crore and profit on revaluation or sale of investments of Rs 256 crore.

A strong performance on the other income side actually saved these banks the blushes in an otherwise lacklustre quarter with regard to their core business of gathering deposits and giving out loans.

Axis Bank registered a 28% loan growth in April-June compared to an average 63% growth in the last two years while

HDFC Bank could only manage a 8.8% growth compared to an average 30% the bank has seen since 2002-03. Brian Hunsaker, Hong Kong-based analyst at American brokerage Fox-Pitt Kelton, observed that the “decline in business seems a function of both risk aversion on the part of Axis but also limited demand for credit.”

Other analysts were more critical. Deutsche Bank analysts Dipankar Chaudhury and Suresh Ganapathy pointed out that Axis Bank may go through more pains because of slower fee income growth, higher non-performing loans and credit charges emanating from a relatively unseasoned loan book.

“Early signs are already visible with a surge in restructured assets. Coupled with a likely overhang due to the SUUTI stake sale and demanding valuations, we reiterate our ‘sell call’ on the bank,” the analysts wrote in a note post the results. Deutsche Bank pointed out that restructured assets at triple the current gross non-performing assets are worrisome.

Deutsche Bank’s fears were also reflected in a note by Bank of America-Merrill Lynch analysts Rajeev Varma and Veekesh Gandhi. They estimate that non-performing loans could be 10% higher than their Rs 1,600 crore prediction.

HDFC Bank’s results have also not impressed some analysts. The bank’s profit rose 30.5% compared to last year but Anand Rathi analysts Clyton Fernandes and Kaitav Shah called for selling the bank stock due to weak core earnings, slow business growth and deteriorating asset quality.

“HDFC Bank’s loan book saw modest growth (8.8% year on year) even as the deposit base grew faster (11.3% year on year). The loan book growth has plummeted below 30% for the first time since FY03. Net interest margins declined around 30 basis points to 4.2%, leading to the net interest income growing 7.7% year on year. Aggressive provisioning is being supported by treasury gains, rather than core earnings,” Fernandes and Shah wrote in a note.

However, analysts say that though these banks have deviated from their low cost-high margin, solid banking business, it will be unfair to read much into their dependence on non-core business.

Vaibhav Agarwal, vice president, research, banking at Angel Broking, said the change in both banks’ businesses was due to the changed scenario in the quarter.

“Public sector banks’ interest rates were so low that they just didn’t want to compete. But once loan demand comes back, I am sure private banks with their increasing network will be back to core-businesses. This is not a strategic but a rather tactical one looking at the market situation,” he said.

Another analyst from a private brokerage said the fact that equity markets improved and bond prices were volatile gave these banks an opportunity to make some money from their non core functions.