Morgan Stanley Says ‘Load Financials’; Suggests Top Picks And What To Avoid

Morgan Stanley expects financials to outperform in 2022, aided by a combination of rising short rates, lower credit costs, and higher credit growth.

“We are in the midst of a big bull market, and financials have not done well. The RBI has stayed dovish longer than the market expected. It has held on to its dovish position to facilitate higher growth, and as a consequence, financials have struggled,” Equity Strategist Ridham Desai, and a team of equity analysts and an economist, at Morgan Stanley, said in a Jan. 19 report. “Financials need higher short-term yields to make more money, and so, relative to other sectors, the market has expressed its view that financials are going to lag.”

That, the investment banking company said, may change in 2022.

Morgan Stanley doubled its ‘overweight’ position on financials to 600 basis points at the expense of materials, which it downgraded to ‘underweight’. “We are overweight on financials and domestic cyclicals (both consumer and industrials) and underweight on external-facing sectors.”

The research house, in the report titled ‘Back Up The Truck and Load Financials’, said it expects banks to enter an “earnings acceleration cycle”. Balance sheets and profitability are much better than they have been over the past decade. “Coverage ratios have improved sharply, interest rates have likely bottomed, and pre-provision operating profit growth is well placed to accelerate.”

Morgan Stanley listed two key drivers—loan growth acceleration and higher margin—that will be led by a turn in the interest rate cycle for growth. The best-placed banks amid higher rates would be ones that have higher current account-savings account ratios, retail deposits and floating rate loans.

Its preferred picks among banks are ICICI Bank Ltd., Axis Bank Ltd. and State Bank of India, having the maximum positive leverage to a higher rate cycle.

The most negatively affected, according to the report, would be wholesale-funded banks such as RBL Bank Ltd. and IDFC First Bank Ltd. It also advised to avoid non-bank lenders with weak balance sheets and return ratios and/or funding constraints.

Top Preferred Segments In 2022

Both life and non-life insurance companies, Morgan Stanley said, have registered resilient performance through the pandemic. “This has been done with no government or regulatory support, unlike at lenders and other segments. New business profit CAGR at life insurers through the pandemic period is likely to finish in the 15-25% band, a robust performance considering the backdrop.”

The medium-term outlook for the segment is strong, supported by an improving economy, assuming a likely pandemic-free operating environment and a likely structural fillip to demand for life and health insurance following the pandemic.

Also, the interest rate sensitivity of the segment, it said, is relatively low, with ability to alter positioning as the rate cycle plays out. “Thus, insurers are positioned well for any outcome on rates.”

Morgan Stanley’s top picks among insurers are SBI Life Insurance Co. and ICICI Lombard General Insurance Co., given their relatively discounted valuations and favourable product mixes.

The research house is also positive on consumer financiers.

“This is structurally the most profitable and highest-growth segment within Indian lenders,” it said. “The segment has strong balance sheets, pricing power amid competitive intensity and is the fastest to see business growth pick up as the economy improves.”

Its top pick is SBI Cards & Payments Services Ltd.

Credit cards, it said, are one of the most profitable credit businesses and offer the highest secular growth. “SBI Cards’ positioning is even stronger because of strong parentage, State Bank of India, which means that funding is unlikely ever to be an issue for the company. The balance sheet is also robust with strong provisioning coverage and capital for the upcoming growth.”

Key Risks For Financials

• Severity of Covid waves.

• Slower pace of loan growth acceleration.

• Delaying pace of rate hikes and whether they turn disruptive (led by local or global factors).

• Disruptive tightening by the U.S. Fed.

• Upsetting macro stability and/or global growth.