Macquarie recommends private banks; upgrades Kotak, City Union Bank, and 2 more; downgrades SBI and 3 others

Global brokerage house Macquarie, in a recent report, has advised investors that in the Indian financial space 'stick with private sector banks; avoid PSUs, NBFCs, insurance, fintechs.'

Consequently, it has upgraded four stocks within the banking and financial space and downgraded ratings on four others.

"Private sector banks are at attractive valuations and expected to report 16-18 percent ROE (return on equity) over the next few years. We would stay away from PSU banks, Insurance, and Fintechs owing to regulations, declining fundamentals, and/or unfavorable risk-reward," it said.

In the banking space, Macquarie has upgraded Kotak Mahindra Bank Ltd and City Union Bank from 'Neutral' to 'Outperform', citing their underperformance over the past 12-24 months, which has led to attractive valuations and favorable risk-reward profiles.

Conversely, it has downgraded State Bank of India (SBI) from 'Neutral' to 'Underperform' due to recent outperformance, impending ECL regulations, declining ROAs (return on assets) and ROEs (return on equity), and the potential need for an equity capital raise.

Among NBFCs, Macquarie has downgraded Bajaj Finance, Cholamandalam, and M&M Finance from 'Neutral' to 'Underperform' among NBFCs, citing expectations of lower growth, declining ROEs, and a delayed rate cut cycle.

In the insurance sector, while remaining cautious, the brokerage has upgraded SBI Life from 'Neutral' to 'Outperform', believing IRDA regulations less impact it. It expects SBI Life to achieve sector-leading VNB (value of new business) growth of 15 percent and considers its valuations reasonable in this context.

Private Banks

As per the brokerage, private sector banks are a steady power of compounding story. Despite a lower loan growth environment, it expects private sector banks to report healthy returns on assets (ROAs) and ROEs over the next three years and remain steady power of compounding stories.

"We expect healthy ROEs in the 16-18 percent range. They are less affected by ECL regulations and carry contingent buffers (most of them) and we do not see any adverse asset quality outlook. A delayed rate cut cycle further cushions NIMs for them in the near term. We make marginal changes to our earnings estimates for private sector banks after their full-year numbers, and raise TPs for most of them as we roll our valuation-based models forward to FY26E, from FY25E," it said.

Meanwhile, for PSU Banks, Macquarie believes that the public sector lenders will see falling ROEs driven by normalisation of credit costs. There is additional risk of ECL impact which we are yet to factor in earnings, it added.

Moreover, it expects life insurance companies to face lower VNB (value of new business) growth this cycle driven by falling margins.

It also noted that NBFCs no longer have the advantage coming from rate cuts in the near term and the full impact of RBI regulations (increase in RWA) will be felt in terms of lower loan growth, margins, and return ratios in FY26E. Risk-reward is also unfavorable for some of the larger NBFCs, it stated.

Macquarie's top picks and pair trades:

Banks: Axis Bank, IndusInd Bank, and HDFC Bank.

NBFCs: Shriram Housing Finance and LIC Housing Finance

Insurance: SBI Life.

Pair trades: 1) Long HDFCB, Short SBI; 2) Long SHFL, Short BAF; and 3) Long SBI Life, Short IPRU.