Banking woes could further aggravate slowdown in FY24

Caution among BFS firms in developed markets, following recent developments around bankruptcy of Silver gate, SVB and Signature Bank in the US and UBS-CS merger in Europe will likely lead to further curtailing of discretionary tech spends in the near term. This will likely impact growth for Indian IT in H1, and bring down overall growth for FY24, says a Kotak report.

Spending on cost take-outs will pick up, but will yield benefits in 2HFY24 or later. TCS and Infosys are better positioned, whereas Wipro and CTSH are vulnerable. Expect further polarization of growth between winners and losers in FY24.

Talking to Bizz Buzz, Amol Athawale, Technical Analyst (DVP), Kotak Securities, says, “What we are seeing is a relief rally backed by strong positive global cues as there are expectations that the US Fed may not take aggressive rate hike steps to tame inflation.” Some of the concerns over the falling financial health of the US banking industry have also subsided, which further boosted the market sentiment. Falling crude oil prices and recovery in the metal space on hopes of revival in the Chinese economy is also providing some support to the struggling markets, he said.

Expect more focus on ‘current survival’ rather than investing for ‘future survival’. Experts believe there can be a pause or slowdown in pace of digital/cloud programs due to cut in discretionary spending in the near term. BFS firms have been spending aggressively on cloud migration and tech upgrades to become cloud-first and data-driven organizations to improve customer experience, reduce inefficiencies, increase productivity and better compete with digital natives. Tech budgets and outlook on tech spending for CY23 were reasonable for most large US banks. However, the current predicament for the BFS sector in developed markets throws a spanner in the works. Surviving the current crisis, and ensuring adequate liquidity and capital adequacy will emerge as the top focus, leading to prudence on spending. Tech budgets outlined at the start of the calendar year can be toned down to align with increased risks faced by the sector.

Experts expect impact on growth in 1HFY24 for Indian IT. “We expected a growth slowdown in FY24 to play out in the form of a weak March 2023 quarter, followed by a moderate uptick in Q1 and normalization in Q2. Current woes in the banking sector can impact sequential growth by 1-2 per cent in Q1. This assumes quick resolution to the global banking crisis and problems remaining localized to BFS. Our current growth forecast for leaders, viz., for FY24E, stands at 8 per cent, which may get impacted by 1-2 per cent due to the current crisis. Exhibits 1-3 detail out exposure on multiple dimensions for Indian IT. A full-blown recession will have a bigger impact,” says Kanwaljeet Saluja of Kotak Institutional Securities.

Infosys and TCS are better positioned; CTSH and Wipro are vulnerable. Cut in discretionary spending will impact all companies. Lower exposure to BFS will reduce impact on HCLT and TM. Higher focus on cost take-outs will generate opportunities in the form of application rationalization, higher offshoring, captive carve-outs, enabling automation and vendor consolidation. In addition, if spending on risk and compliance, and M&A integration increases, it lowers the available budget for discretionary programs. The benefit from this counter cyclical spending will be back-ended. Companies that can capture both discretionary spending and cost take-outs will ultimately benefit and gain share. TCS and Infosys are better positioned among Tier 1 IT.

LTIM and Mphasis can benefit among mid-tier; the latter, however, will face near-term headwinds due to outsized exposure to BFS and significant exposure to the impacted mortgages sub-vertical. CTSH and Wipro are vulnerable among Tier 1, higher consulting exposure increases vulnerability for the latter.

Outlook on tech spending for CY23 was reasonable prior to banking crisis. Commentary by banks of all categories - large US banks, regional and mid-tier US BFS firms, cards and payment service providers, and European banks indicated a moderate but reasonable growth outlook for tech spending during 2023. The spending growth varied across banks depending on several factors, including exposure to impacted segments, investment priorities and urgency for transformation. Growth for a few was higher than 2022; for a few, tech budgets were to decline as well. Among large US banks, Citi and BofA budgeted for a decent increase in tech spending. The outlook was positive for Morgan Stanley and Wells Fargo, neutral for JPM, and negative for Goldman Sachs.

Among mid-tier BFS firms, the overall outlook on tech spending was positive. For example, Fifth Third intended for 10 per cent increase in tech budgets similar to previous years, whereas Julius Baer increased tech spending by a significant amount for the next three years. The current crisis can lead to the toning down of earlier announced tech budgets.

Analysts await commentary from BFS firms, the latest can be in earnings call commentary during the March quarter update in the next couple of months to better understand the evolution of tech spends during the current crisis.

Quick numbers on exposure to BFS and vulnerable sub-segments. In analysts’ view, BFS exposure (excluding insurance) for TCS stands at 29 per cent CTSH at 19 per cent, Infosys at 26 per cent, Wipro at 27 per cent, HCLT at 14 per cent and TM 2 per cent. Europe BFSI exposure for Infosys, Wipro and CTSH stood at 4.9 per cent, 11.7 per cent and 6.2 per cent, respectively. We estimate TCS Europe exposure at 13 per cent.

Exposure to regional banks in the US is the highest for CTSH, followed by Infosys/TCS. TechM and HCLT have low exposure to regional banks.

Recent developments, including the merger of banks having weaker balance sheet positions with those that are relatively stable and larger GSIBs infusing cash into precariously positioned regional banks, will have implications on tech spends for the sector. However, these events will be followed by a focus on rationalizing costs and provide opportunity for global SIs to play a significant role in the integration of tech stack. Service providers with prior experience of effectively executing projects of such scale will benefit.

Analysts note that post-GFC, Indian IT players benefited from captive takeover deals - TCS and Wipro acquired Citi’s India captive arms, TCS and Infosys signed large deals with ABN AMRO, and Cognizant acquired Indian captives of UBS during 2008-09.

Analysts believe similar opportunities might come up in 2HFY24, benefiting service providers, with strong capabilities across services and mandates - from helping clients lower costs initially to repurposing spends to enable continued transformation over the medium term. UBS-CS, on pro forma basis, spend $7 billion on technology, and would look for upfront cost saves by eliminating redundancies in tech stack as part of their plan to rationalize the over CHF8 billion annual cost run-rate by CY27. The company indicated CHF2 billion cost savings would be from the integration of IT systems. M&A of such scale provide significant opportunities for service providers to sign deals with long-term annuity revenue streams, while also consolidating out the long tail of vendors.

Overall, we expect quality companies such as TCS and Infosys, with strong understanding of the domain, breadth of capabilities, and scaled practices, to benefit from such cost take-out programs. This would lead to divergent revenue growth across players as compared with secular growth seen over the past two years.