Public sector banks might be a good trade

They will be investment-worthy only if they are allowed autonomy to function commercially

Pledging shares is one of the ways in which promoters can raise unsecured debt. If there’s a problem with debt-servicing, the creditors can sell the shares.  But in practice, if there is a default, the shares promptly lose value and creditors have problems selling. The Zee-Essel case is one of several prominent cases, where pledging has hurt creditors and shareholders.

Consider the reverse situation. The promoters can increase their shareholding in a company, by buying shares from the market. This can be done through an open offer, or through creeping acquisitions in small quantities, or by a rights issue.

A buyback is usually a vote of confidence by the entities that know the business most intimately. If it’s a private concern, it usually indicates that the promoters believe that they can obtain superior returns by investing in their company. The underlying rationale could be more nuanced if it’s a public sector unit (PSU). Ever since 1991, the government has been trying to raise cash by selling stakes in PSUs. Different governments have been more, or less, successful at disinvestment. There’s also been plenty of specious logic around the subject, with cross-holdings where one PSU has been forced to buy another, being described as “disinvestment”.

When the government directly increases stakes in the companies that it controls, it is contrary to the concept of disinvestment. But there is one sector, where the government is actually being forced to raise its already high stakes. It is the public sector banks (PSBs). The massive ongoing non-performing asset crisis in PSBs has led to steady depletion of reserves. At the same time, the BASEL norms for capital adequacy have been raised. It means that PSBs require more equity to continue their operations. So do private banks but they have much better financials and higher valuations.

Raising equity by selling off stakes in PSBs is difficult as most of them trade at low discounts. The government would have to sell massive chunks at low prices. Hence, recapitalisation by the government is required.

That needs specific permissions from SEBI since PSBs are closely held anyhow and Sebi regulations demand that any listed company have a 25 per cent public shareholding. However, since the government is the owner, getting an exemption isn’t a problem.

Looking at shareholdings across December 2018 and March 2019, it’s clear that recapitalisation has got off the ground. The government has enhanced its holdings in Oriental Bank of Commerce, Syndicate Bank, Union Bank, Corporation Bank, Allahabad Bank, Andhra Bank, Punjab National Bank, Central Bank and United Bank of India. The Q4 results also seem to indicate some improvement in financials, though there’s a long way to go.

The recapitalisation buys some time for these banks to fix their balance sheets. Does this make the PSBs worthwhile investments? Not necessarily. These institutions have run into trouble due to massive political interference in decision-making processes over a period of decades.

A higher government stake may just mean kicking NPA problems into the future unless the banks are given more in the way of functional autonomy and allowed to do due diligence and lending on strictly commercial lines.

The higher government holdings also inevitably mean a larger equity base. That means lower earnings per share and lower return on net worth, as and when these institutions turn profitable. It also means that eventually, the government will have to sell a larger number of shares in each of these banks.

That could mean depressed initial public offer prices. Larger public shareholdings would mean more trading liquidity — that can cut both ways. It could lead to share prices being pushed up if there’s a lot of investor interest. It could also mean huge selling pressure if there’s bad news.

One other negative is the slowdown, or derailment, of the Insolvency and Bankruptcy Code process as more cases have ended up in legal tangles. While this is disappointing, it is still faster than the earlier interminable process. What we’ve seen so far, tells us that there will be major haircuts involved as well, even where resolutions occur. However, recognition and resolution of NPAs is probably the only way to go.

Ultimately, the PSU bank sector will be investment-worthy only if it’s allowed autonomy to function commercially. But it might just be a good trade while sentiment continues to ride high.