Bad loan recognition likely to weigh on stocks of public sector banks

Earnings improvement over two quarters was without proportionate lending growth

Public sector banks (PSBs), such as State Bank of India, and Punjab National Bank, have been among the top performers on the bourses over the past three months. The Nifty PSU Bank index is up nearly 23 per cent since the beginning of the current calendar year, outperforming the benchmark index Nifty50 by a big margin. For comparison, the Nifty50 is up 4.1 per cent during the period, while Nifty Bank index that is dominated by private sector banks is up 6.5 per cent. 

Analysts attribute this to change in investors sentiment around PSBs. “The recent rally in PSBs is more of an expectation trade than market reaction to actual earnings growth. Investors expect a bounce ba­ck in corporate and commercial credit growth in FY22 that will benefit PSBs. The markets now also expect PSBs to report lower bad loans in the next two quarters, sooner than earlier expectations,” says Shailendra Kumar, CIO Narnolia Securities.

PSBs, however, remain a laggard over the long term. The PSB index is up 62.5 per cent since the end of March 2020, against a 70 per cent rally in the Nifty50. The PSB index is down 25 per cent in the past three years, against a 44 per cent rise in the Nifty50.

On Monday, the Supreme Court refused to grant additional relief on the extension of the moratorium period and vacated the earlier order of standstill on asset classification. Now, banks will have to start recognising delinquencies as bad loans and this may hit PSBs’ balance sheet and earnings over the next two quarters. Investors, however, expect PSBs to report much less bad loans and provisioning than estimated during the peak of the lockdown.

The apex court ruling may also force banks to write-back or refund the compounding interest on loans under moratorium. This can also hit the earnings of PSBs in the fourth quarter. The loan moratorium was a blessing in disguise for PSBs and most of them reported a sharp positive swing in profits in the past two quarters due to a decline in provisioning for bad loans.

The 13 listed PSBs together reported net profit of nearly Rs 21,000 crore during the trailing 12-months ended Decem­ber 2020, a sharp turnaround from the combined net loss of Rs 15,500 crore in FY20 and net loss of Rs 70,000 crore in FY19.

This fuelled the recent rally in PSBs. “The third quarter results lead to a change in the investors perception, and that leads to valuation rerating of many top PSBs. Earlier, PSBs were trading at a big discount to their adjusted book value; the discount is now down sharply,” says G Chokkalingam founder & MD Equinomics Research & Advisory Services.

PSBs together currently trade at 0.8x their book value, a sharp improvement from the P/B ratio of 0.5x at the end of March last year. The current valuations are still lower than PSBs historical average P/B ratio of 1x in the last 10 years, indicating a further upside in their stock price.

Analysts worry that the sharp improvement in PSBs earnings over the last two quarters occurred without a proportionate growth in their lending business. Most PSBs reported low single digit growth in loan book and gross interest income during the first nine months of FY21.

This, coupled with slow growth in industrial credit, puts question mark on PSBs’ ability to grow top-line and bottom-line growth.