Axis Bank: Weak asset quality, margins disappoint

Amid rising bad loans and dip in profitability, stock price could witness some pressure

Elevated bad loans, high provisioning, and a surge in operating expenses impacted Axis Bank's results for the June 2016 quarter (Q1). Consequently, its Q1 net profit fell 21.4 per cent year-on-year to ~1,556 crore and was way below Bloomberg consensus estimate of ~1,998 crore.

Bad loans increased sharply. Nearly 92 per cent of this came from the watch list, which now stands at ~20,295 crore, down 10 per cent sequentially. The bank had created this watch list in the March 2016 quarter, which comprised the loans with potential to turn bad (default). Notably, the management had indicated after the March quarter results that about 60 per cent of the loans in the watch list could slip into non-performing assets (NPAs) over the next two years and that most of these could be front-loaded. This means the asset quality stress will remain high for a few quarters at least. Additionally, the management expects another ~200 crore loans to be under pressure as four or five of its clients would come out of the moratorium period. About half the bank’s corporate book has also witnessed a fall in credit ratings in Q1, say analysts. While the management believes ratings is a lag indicator on the asset quality, this is a key monitorable going ahead.

Despite these pressures, the management has maintained its full-year credit costs guidance at 125-150 basis points, but analysts are not convinced.

Suresh Ganapathy, financials analyst at Macquarie Capital, says: “We believe Axis Bank’s credit costs will be higher than management guidance in FY17 given that this metric stood at an elevated level (at 190 basis points) in Q1 itself.”

Surge in operating expenses towards branch expansions as well as higher employee costs was another factor impacting earnings in the quarter. The management believes operating expenses in FY17 will be higher than that in FY16. Higher costs also led to a slight dip in net interest margin (a profitability indicator) to 3.79 per cent in Q1. In fact, the management expects this metric to come off to 3.6 per cent in FY17 as it migrates to the new mechanism of calculating lending rate, which takes into account deposit rates (cost of funds). The new mechanism is called MCLR (marginal cost of fundsbased lending rates) and is mandated by the Reserve Bank of India.

Given the negative surprises, analysts are likely to trim their earnings estimate for the bank, which could weigh on the stock next week. Positively, the bank witnessed healthy loan growth of 21 per cent with both retail and corporate segments growing at 24 per cent and 21 per cent, respectively. The management expects to post 20 per cent loan growth in FY17.