Why some brokerages have turned positive on Punjab National Bank

Ability to demonstrate better bad loan recovery, price correction key positives

A week after Nomura turned positive on Bank of Baroda (BoB), it is the turn of Punjab National Bank (PNB) to enjoy a rating upgrade from the foreign brokerage. Nomura upped its rating on PNB from “neutral” to “buy”. With a price target of Rs 180, the potential upside was about 26 per cent, even after factoring in for Thursday’s 4.6 per cent rally. 

In a report dated July 5, analysts said after the 24 per cent correction in the past two months, incremental risk-reward was turning favourable for PNB. “Our adjusted book valuation of 0.55x FY19 book factors in Rs 79,000 crore of total stress vs gross non-performing assets (NPAs) of Rs 55,400 crore in FY17 and adequately captures any asset quality risks,” the analysts said. In fact, analysts at Prabhudas Lilladher and Motilal Oswal also had the same opinion on PNB’s asset quality issues. 

“Significant stress is being recognised over last several quarters, and now resolution in key sectors like steel, power, construction and roads remains a key for upgrades and recoveries,” analysts at Motilal Oswal said. With the overall provision coverage ratio at 40 per cent in FY17, they did not expect the bank to take a significant hit on its net worth in case of bad loan resolution or haircuts. While PNB’s overall provision coverage ratio was the lowest among public sector banks (PSBs), the provision for the top 50 bad loan accounts was at over 58 per cent. Prabhudas Lilladher said PNB had been able to display strong loan upgrades and recoveries much better than corporate bank peers, thus helping asset quality. Even in the March quarter, PNB was among the few banks which sold loans to asset reconstruction companies at a profit (Rs 3,220 crore). 

On the loan growth front, PNB has an uphill target of 12 per cent in FY18, with retail assets set to grow at 20 per cent year-on-year. The recent change in strategy to focus on small-ticket loans and loans to rural and micro, small and medium enterprises may help achieve this target. 

However, the sore point is its paltry return profile. After having lost its No. 2 position among PSBs to BoB a few years ago, PNB’s return profile looks far less attractive compared to the latter. While return on equity and return on assets of BoB was expected at 9.3 per cent and 0.5 per cent, respectively, in FY18, analysts estimate PNB’s at 3.4 per cent and 0.2 per cent, respectively. PNB being saddled with ageing bad loans was the key reason for this divergence. Iron and steel, infrastructure and cement accounted for over 40 per cent of gross NPAs. Therefore, the lack of a speedy resolution would be a setback for the bank. Low capital adequacy (8.9 per cent Tier-1 capital) ratio suggested the bank was unlikely to command any premium should it raise funds from secondary markets, unlike the case with State Bank of India.