We are in uncertain territory – stocks have moved, and timing/mode of keyevents is unknown. Large corporate lenders are up 20-30% since news of SOEbanks recapitalization. See India Financials: Finally the Indian TARP. However,recap details are awaited. Moreover, earnings at these banks will be tough, asimpaired loans start getting cleared and a new Accounting Standard (IND-AS) isimplemented. Stocks will be volatile, but if things pan out, upside could be verymeaningful. We look at three scenarios for the banking business.    Scenario 1 (recapitalization fizzles out, and banks remain entrenched in bad loancycle) – This is the scenario that existed prior to recapitalization news. Bad loanflows and actual losses will remain elevated. Multiples will also be at prerecapitalizationlows. In this scenario, we see 15-25% downside.    Scenario 2 (normalization from F2020-21) – Bad loans are cleared at a ~60%haircut, and ROE normalization starts. We do not assume an aggressive recovery(muted revenue, still-high credit costs). In this scenario, stocks could see 15-20%upside. This is our new base case (changes in our PTs reflect this).    Scenario 3 (a clean break) – As banks get out of an NPL cycle, recovery is usuallyunderestimated, as credit costs tend to move below normalized levels andrevenues pick up. We do not assume the recoveries seen in the last cycle, butupside could still be large at 60-90%.    We assign 20-25% probabilities each to Scenario 1 and Scenario 3 (with upside in3 being much higher than the downside in 1). These probabilities will keepchanging as events unfold – our instinct would be that if recapitalisation goesthrough as planned, the market would keep increasing the probability ofScenario 3.    How should we position among corporate lenders? We would own the threelarge corporate lenders (ICICI, Axis and SBI). As per our analysis, the risk-rewardof owning these banks is favourable. As NPLs are cleared, we would not besurprised if investors start ascribing top-of-the-cycle multiples to these banks.    This, coupled with the underownership (especially at SBI), should help thesestocks do well. We recently added SBI to our regional model portfolio for thefirst time since 2011. We have adjusted our price targets in line with Scenario 2.Indian corporate lenders have done very well, since the announcement ofrecapitalization by the government. (See our note, India Financials: Finally the IndianTARP (24 Oct 2017) for details.)

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