Earnings review: Three takeaways from banks’ Q2 results

Bank Nifty’s struggle to keep up with broader market gains has left many investors resigned, adopting a fatalistic Que sera, sera (whatever will be, will be) approach to equities. Nowhere is this sentiment more palpable than with HDFC Bank, Bank Nifty’s largest constituent, which has delivered a mere 2% return year-to-date—a figure that has frustrated the shareholders of the country’s largest private lender.

However, as September quarter (Q2) results reveal, the entire banking sector faces headwinds that may continue to challenge the pack in the near term.

Deposit growth offers relief

First, the good news: banks are seeing strong traction in deposit growth. For several quarters, deposit growth lagging behind credit expansion has been a primary concern, with the Reserve Bank of India (RBI) highlighting risks to banks’ liquidity profiles. The September quarter results, however, indicate some relief.

Read this | Deposits outpace loans in relief for private banks

Four of the top five private sector banks reported deposit growth outpacing credit growth in Q2. HDFC Bank’s deposits rose 15.1% year-on-year, surpassing loan growth of 7%, while ICICI Bank recorded a 15.7% increase in deposits against a 15% rise in advances. The exception among the top five was IDBI Bank, where deposits grew 11%—below the industry average—even as loans expanded by 19%.

..but comes at a price

Yet, the increase in deposits brings a downside: lenders are now offering higher interest rates to lure depositors away from the booming equity markets, driving up their cost of funds.

Banks have faced rising funding costs both sequentially and year-on-year. ICICI Bank’s cost of funds increased to 5.09% in Q2 from 5.05% in Q1 FY25 and 4.78% a year ago, while Axis Bank saw its cost rise to 5.45% from 5.44% in Q1 and 5.17% in the same quarter last year.

This uptick in funding costs has pressured a critical profitability metric—net interest margin (NIM), which measures the difference between the interest earned on loans and that paid on deposits. Again, four of the top five banks saw margin compression in Q2, with HDFC Bank’s NIM slipping to 3.46% from 3.47% in Q1, ICICI Bank’s dropping to 4.27% from 4.36%, and Kotak Mahindra Bank’s declining to 4.9% from 5%

Although most bank management teams expressed confidence that margins would normalize in H2 FY25, many analysts expect softer NIMs to persist for at least a few more quarters.

However, the most concerning Q2 trend, from both sectoral and macroeconomic perspectives, is the rise in bad loans among leading banks.

Among the top five lenders, HDFC Bank and Kotak Mahindra Bank reported slight increases in their gross non-performing assets (GNPA) ratios. Furthermore, five of the eight largest private sector banks saw their GNPA ratios inch up, including IndusInd Bank, RBL Bank, and IDFC First Bank. Several lenders, such as Axis Bank and Kotak Mahindra Bank, flagged stress in the retail segment, especially in unsecured retail loans.

More here | Banks go slow on microloans as asset quality stress weighs

While analysts aren’t yet sounding alarm bells for the sector, banks’ credit quality will likely face closer scrutiny from investors going forward.

Rock star performer

Which bank has outshone the rest? A quick look at the top five lenders’ stock performance over the past month and year-to-date reveals the Street’s clear favourite—ICICI Bank, whose stock has soared 30% in 2024, far outpacing its peers.

The bank’s Q2 results only cemented its lead, with a 15% jump in profit after tax (PAT), strong growth in both credit and deposits, pristine asset quality, and a healthy return on assets (RoA) of 2.4%, easily surpassing analyst expectations.

“We believe ICICI Bank's 2QFY25 performance in light of systemic concerns in unsecured loans as well as deposit growth challenges sets it up in a league of its own in the sector. These outcomes should further widen valuation premium for the stock over other private banks in our view,” JM Financial said in a note.

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While most of the sector struggles, ICICI Bank’s standout performance brings a sense of carpe diem for its shareholders—quite the contrast to the weary resignation of Que sera, sera.