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Basel III: Highest equity dilution likely in BoI, Canara, Union banks

The lenders are struggling to balance their funding needs with profitable growth

Sheetal Agarwal  |  Mumbai 

The deferral of deadline for banks to comply with Basel-III guidelines to March 2019 (from March 2018 earlier) does not solve the capitalisation problem faced by most banks — especially public sector banks (PSBs). The focus for the PSBs will shift from Tier-I capital ratio to core

Tier-I ratio (which refers to core equity capital of the bank) given that the Reserve Bank of India (RBI) has prescribed a core Tier-I ratio of 8.9 per cent, higher than Basel-III requirement of 8.5 per cent.

Brokerages estimate that PSBs might have to raise anywhere between Rs 1,80,000 crore and Rs 2,00,000 crore by FY18 to comply with these guidelines. Estimates of equity dilution (arising from fund raising) vary, given assumptions of brokerages on return on equity, non-performing assets ratio and the price at which dilution takes place. However, most brokerages believe that among the top six PSBs, Bank of India (BoI), Union Bank (Union) and Canara Bank (Canara) are the weakest on the capital adequacy front and would witness highest equity dilution.

Current valuations seem to be ignoring fundamental challenges being faced by these banks, which might cap upsides. These stocks saw some gains over the past week.

“We believe BoB, PNB and SBI are relatively comfortable on capitalisation and will need to raise capital only in FY17 with relatively lower potential dilution (at current market prices) of 39 per cent, 60 per cent and 51 per cent, respectively. Among the worst hit are BoI, Canara Bank and Union Bank, as all three would have to bring in capital more frequently starting from FY15 with much higher dilution (219-278 per cent),” says Siddharth Teli, managing director and co-head, Institutional Research, Religare Capital

Manish Karwa, banking analyst at Deutsche Bank Research, echoes this. “We believe Union Bank and Bank of India will have to raise three times their present market cap over the next few years to be compatible on capital,” he says. Higher provisioning for mounting bad debts, aggressive loan growth and high dividend payout have severely hit PSB profitability. They are thus unable to generate enough profits to fund their growth. This, despite continuous fund infusions by the government. Among the government’s options are reducing dividend payout, increasing FII/private players’ stake in these banks and selling non-core investments made by these banks (in rating agencies, mutual funds, CIBIL, etc.). However, the only permanent solution to this problem seems to be that the banks pursue profitable growth and earn enough internal accruals to plough back into the business.

Bank of India trades at 0.5 times FY15 estimated book value, which is below its historical average one-year forward price/book value of about 1. The bank received Rs 1,000 crore equity capital infusion from the government in FY14, despite which its Tier-I ratio stood at 8.2 per cent, lower than its larger peers.

The bank though has lower gross non-performing assets (NPA) ratio of 2.8 per cent (versus 5-5.7 per cent of larger peers), its restructuring pipeline remains sizeable at Rs 1,700 crore. Its weaker return ratios could dilute further, as capital raising becomes more expensive. A key hurdle for the bank is its weak Casa ratio of 22.5 per cent.

Canara Bank trades at 0.4 times FY15-estimated book value, lower than its historical average of 1.1 times book value. The bank received Rs 500 crore from the government recently. The bank continues to face asset quality challenges and has a restructuring pipeline of Rs 3,300 crore. Its gross NPA ratio stood at 2.8 per cent in December 2013 quarter and analysts expect it to surge to 3.8 per cent in FY15. The bank’s Casa ratio is relatively weaker at 23.1 per cent, making it vulnerable to high interest rates. The bank’s strategy of aggressively growing loans with focus on small and medium enterprises and retail segment along with its low base rate is likely to put financials under pressure, believe analysts.

Union Bank of India trades at 0.4 times FY15 estimated book value versus its historical average of about one. The bank recently received Rs 500 crore from the government pushing its Tier-I ratio to 7.6 per cent. “Union Bank faces immediate dilution risks due to conversion of nearly Rs 111 crore of Perpetual Non-Cumulative Preference Shares and its failure to meet the minimum Tier-1 requirement for FY15 itself,” says Saikiran Pulavarthi, head of Research, Espirito Santo Securities. The bank’s asset quality continues to be under pressure given the high restructuring pipeline of Rs 2,000 crore and continuous inching up of the gross NPA ratio (up from 3.0 per cent in March 2013 to 3.9 per cent in December 2013).

First Published: Mon, March 31 2014. 22:48 IST