Time to consider a few public sector banks

On the flip side, resolution process could entail banks to take a haircut in their exposure to loans

A lot of the opinion on public sector bank (PSB) stocks of late has been skewed towards why they don’t make sense for investors. But, recent data points suggest fund managers may have disregarded this opinion.

Data suggest they have been buyers of PSB stocks since September 2016. Fund managers have increased their holdings in State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BoB) and Canara Bank by 0.5-1.17 per cent in this period. This suggests fund managers may have seen early signs of asset quality stress peaking. The March performances (Q4) of Canara Bank, Union Bank and Indian Bank indicate the incremental stress is plateauing.

Dharmesh Kant, head-retail research, Motilal Oswal Securities, says banks should soon see a turnaround in metals, power and infrastructure (primarily road construction), which were the three primary areas of stress.

Nitin Aggarwal of Antique Stock Broking is among the few analysts to have a neutral to positive view on PSBs. According to him, FY17 could be the last year of earnings drain and the top five PSBs — SBI, PNB, BoB, Union Bank and Canara Bank — should comfortably post decent earnings growth in FY18.

Another head of research with a US-based foreign brokerage agrees with Aggarwal. “We have been monitoring the PSB space since Q3 and a lot of the bad news, especially for the top PSBs, seems priced-in.” Kant adds: “I expect provision write-backs to happen and this should boost the profitability for PSBs.” Some lenders such as PNB and Canara Bank have already recognised the reversal of earlier provisions in the December and March quarters, respectively. This trend is likely to continue as focus on loan recovery gets sharper, due to the recent measures taken by the Reserve Bank of India.

Christopher Wood of CLSA notes in his Greed & Fear report of May 11: “If the cynics are proved wrong and the bad debt issue starts to be resolved, it will be a positive for the major ‘value’ sector in the Indian stock market. That is, of course, the listed public sector banks.”

On the flip side, the resolution process could entail banks to take a haircut in their exposure to loans. CLSA estimates stressed loans in India may be about 17 per cent of total loans (of around $160 billion). “Nearly 30-40 per cent of write-off from this stressed pool is factored in,” says the head of the research quoted above.

However, fresh additions to stress such as Videocon Industries, recently classified as a non-performing asset (NPA), could increase the uncertainties of write-offs. This could also eat into the capital adequacy of PSBs. However, given that most PSBs have augmented their capital position by issuing additional tier-1 bonds (AT-1) bonds, the lenders may have some ammunition.

PSBs had raised about Rs 19,530 crore of AT-1 bonds from April 2016 to December 2016. But still, capital infusion by the government may be required for some PSBs, especially when big haircuts are undertaken during NPA resolution. For lenders such as PNB, SBI, Canara Bank and Union Bank, a stake sale in non-core businesses such as life insurance, housing finance and capital markets should also supplement capital, if not materially.

Valuations, which have remained soft despite a 20-60 per cent year-to-date gains, also supplement the investment rationale. The lenders may remain attractive as earnings catch up (see table). However, experts unanimously urge investors to stick with only the top names such as SBI, PNB, BoB, Canara Bank and Union Bank. Among the smaller banks, Indian Bank is the only preferred name. Mahesh Patil, co-chief investment officer, Birla Sun Life Insurance, says he prefers PSBs that are well capitalised and have cleaned their books pretty well and those where he is comfortable with the top management.

Sanjiv Bhasin, executive vice-president-market & corporate affairs, IIFL, suggests caution. “There seems to be a lot of froth in the market. While the worst of asset quality is priced in for PSBs, investors could use any market correction to buy these stocks,” he adds.