PSU Banks likely to gain the most due to power reforms

In the near-term, the reforms will impact power financiers such as PFC and REC negatively, believe analysts

The government’s plans to turnaround state electricity boards (SEBs) under the UDAY scheme has received thumbs up from analysts as they believe this plan will help the SEBs improve their operations and profitability on a sustainable basis and consequently aid prospects of independent power producers (IPPs), if implemented in true spirit. The impact on banks and non-banking financing companies (NBFC), though, will differ. 

The reforms will impact these companies in multiple ways. One, reduced borrowings and repayment of loans from SEBs could shrink their loan books in the interim. Second, banks may reverse standard provisions (5% of loans) made on restructured SEB loans improving profitability. Third, conversion of SEB loans into state-owned loans will compress the yields on these loans from 12-15% prevailing to about 8-9% and hence lead to NIM pressure, estimate analysts. This could also impact the return ratios of banks and NBFCs.

For banks though this impact will be partly mitigated by provision reversals. Analysts estimate that provision reversals could lead to an increase of 0.2-3.5% points in the gross NPA provision coverage ratio across public sector banks besides improving their balance sheets. Since state government bonds are safer, banks will also be required to provide less risk weight to such loans, so the impact on their NIMs may be moderate.

“If cash flow in the power eco-system improves, bad loans from non-SEBs will reduce. This will also help CET1 ratios by 20-40 basis points for banks with large SEB exposures such as OBC, Union Bank, Canara Bank, Punjab National Bank as risk weights reduce,” believe analysts at Morgan Stanley.

Analysts at Edelweiss Securities estimate that banks’ return on equity ratios could be hit by 80-100 bps over the next few years. But for infra financiers (PFC/REC), the return on equity impact will be relatively higher at 3-5% points as working capital loans to discoms gets re-priced downwards.

Most analysts agree that power financiers PFC and REC will see more hit post implementation of this scheme. These companies’ NIMs will witness multiple pressure points such as lower yield on these loans and lower loan growth to this segment in the wake of intensified competition from banks. Consequently, their earnings are estimated to fall by 15-20% over the next couple of years, believe analysts at Kotak Institutional Equities. They estimate that REC has 32% exposure to distribution companies while that of PFC stands at 22%.

But, as the initial adjustments take place, the power financiers could again see loan demand pick up. Banks will also be cagey to take higher exposure given sectoral limits as well as the bad experience of the last many years. 

Analysts though have mixed investment views on these companies. CLSA, for instance, is more positive due to inexpensive valuations of about 1 times FY17 estimated book value. On the other hand, Ambit Capital has a very cautious view. “Yields of 8-9% from state government bonds hardly cover PFC and REC’s funding costs of 8.5-9% and puts a big question mark on their intermediation role in funding SEBs and hence on their business model,” they believe. Not surprisingly, both these stocks nosedived 8-11% in Friday’s trade vis-à-vis a flattish Sensex.

Private banks stand to be indirect beneficiaries of this scheme. Banks such as ICICI Bank, Axis Bank as well as IDFC which have a relatively higher exposure to the power sector could benefit from higher credit demand from IPPs. Some analysts are turning more positive on select PSBs on account of reforms such as Indradhanush and UDAY.

HOW THEY STACK UP
Bank	Total Loans (Rs bn)	Power (% of loans)		Restructured loans
		SEB	Non-SEB	SEB (% of loans)
Andhra Bank	1,258	3.7	7.4	3
Allahabad Bank	1,510	3.4	5.8	2.1
BOB (B)	4,084	1.6	3.1	0.7
BOI	3,840	3.9	4.8	1
Canara Bank	3,241	8.3	5.6	2
Central Bank (B)	1,931	9.5	4.5	7.4
Corporation Bank	1,403	2.8	7.2	1.7
Dena Bank	780	9.3	3.5	4.8
IDBI Bank	2,043	-	12.2	-
Indian Bank (B)	1,250	3.5	6.8	3.1
IOB (A)	1,750	5.6	5.8	1.1
OBC	1,465	4.8	8.8	3.7
PNB	3,809	2.8	7	1.5
SBI (B)	13,137	0.9	7.3	0.3
Union Bank (A)	2,556	4.7	4.2	2.2
Vijaya Bank	848	8.7	9.9	2.9
Syndicate bank	2,029	5.7	2.7	2.1
Total	46,935	3.4	6.2	1.6
Notes:
(A) Exposure to power extrapolated proportionate to increase in infrastructure book
(B) Assumed infrastructure exposures and SEB restructured loans same as previous quarter
(C) We have assumed exposure to be equal to last quarter where data is not available
(D) SEB exposure relates to exposure to Govt. power sector entites. Do not have details of SEB restructured book
Source: Company, Kotak Institutional Equities