Cogencis, Tuesday, May 7

(Brokerages continue to chase high-profile and accessible management of private sector banks, but this model may well and truly be broken, as the recent developments at some of these banks show. It is time for a reset, not just for banks but also those analysts who track them.) 

By T. Bijoy Idicheriah

In a recent interaction with a mid-sized private bank, the chief executive was upset that analysts focus on what the bank wasn't in comparison to other private banks, than focus on the strong and consistent franchise that it was. This meant that the stock was priced at a premium substantially lower than peers, even though bar an odd quarter, the bank had met its guidance targets with zero divergences detected in regulatory audits.

The curious thing is that the brokerage darlings such as YES Bank, ICICI Bank, Axis Bank and others, are facing investor ire, with the banks coming clean on asset quality and undergoing management transition. In some cases, as serious questions were raised on corporate governance standards, the stocks of these banks have been under pressure, even as the aforementioned bank continues to be valued at a steady level.

The question raised by bank chiefs who have bucked this trend and chosen the consistent route is - what exactly are analysts looking for when they recommend buy or hold on a stock, even as they ignore peers that have more stable metrics. Sometimes, banks collect media estimates of profit forecast, and even report uncannily similar numbers leaving many wondering what the true picture really is.

Another bank chief pointed out, only half in jest, that now analysts like only two types of news from private banks -- all the bad loans on the books have been reported in one go, or that the old team is being replaced by a new team. The fact that most analysts and brokerages have consistently missed the quarterly profit estimations on these banks, and got their recommendations wrong is forgotten.

This raises serious questions on how brokerages issue recommendations, that are used by investors to gauge investment worthiness of a bank. A sample reading of legacy reports on YES Bank show loud praise of the bank's management, and business model that was corporate driven, as analysts recommended 'buy' consistently on the stock even when regulatory issues were apparent due to growth pains. The same brokerages are now recommending 'hold' or 'sell' and blame the legacy book and past management for the problems, which led to a large 15 bln rupee loss in Jan-Mar along with very muted guidance for 2019-20 (Apr-Mar). Pre-earnings, 12 brokerages announced expectations that YES Bank would report a profit in the range of 8.1-12.9 bln rupees in Jan-Mar, with not a single brokerage smelling a loss that exceeded the highest profit estimate!

In light of recent performance of private banks and management, there is need for introspection at brokerages. 1) Are you basing the earnings estimates purely on your interaction with lenders or public disclosures? 2) How often are you relying purely on excel spreadsheets and past multiples or growth to calculate future earnings, when clearly the current situation has changed 3) How often are you going beyond the bank, and cross checking numbers with other.

But, there is another element to this favourable recommendation bias for those banks that provide quick returns and provide cosy management access to analysts, and this may be the most important one - How often is the recommendation based on the fact that you or your institution helped sell the last debt or equity offering of the bank?

Whether institutions admit it or not, such a relationship does put pressure on the analyst or brokerage to maintain a 'buy' on a scrip that they themselves helped to sell to investors. Do they fear loss of access if they don't deliver a positive report after a cosy chat with management?

In turn, bank managements are often under pressure, to ensure that they meet their commitment to investors and brokerages, as this is indicated in analysts estimates, and thus run the risk of chasing transient but risky growth or to go off the stated business model that has worked for them.

Banking is a cyclical business, with lending lagging in Apr-Sep, and only taking off with retail and consumption sector push thanks to festivals that start September onwards, and then ending with a final rush for corporate loans at the end of the financial year, in Jan-Mar. Some industry stalwarts have long been critical of quarterly results for banks and lending institutions, that have long gestation businesses, but the merits of quarterly result declaration is a discussion for another day.

The quarterly results enable investors to sample the direction in which the bank is headed, especially on asset quality. But this is possible, only if the banks don't actually wait for the last day of the quarter or the last possible second available under regulatory norms, to declare what their actual status on loans is.

This is a virtuous cycle in good times, that can turn vicious in bad times, as some private banks are now realising. Bank managements realise that they can't 'manage' the brokerage estimates anymore, as they stand exposed like the emperor with no clothes, thanks to large scale defaults, details for which are freely available in the public domain.

Meanwhile, brokerages still have little patience for those banks that have shown steady and consistent performance, often because these banks don't need their help to sell the scrip to investors via equity offerings.

The brokerage model, at least for the banking system, is well and truly broken. It would be good if the brokerages and analysts woke up to this fact.  End

(When he's not breaking a leg on stage, he's breaking news and views on banks and regulatory issues. In Big Bank Theory, Assistant Editor (Money) T. Bijoy Idicheriah talks shop on matters that matter to the sector.)