Optimism on PSU banks justified, but selectively

Brokerages bullish on SBI, PNB & BoB, though some feel rally may subside as earnings take centre stage

In an extended Diwali party for public sector banks (PSBs), the mega-bailout announced by the government on Tuesday pushed their stocks to record the biggest single-day gain on Wednesday. 

Big or small, the entire pack was buzzing with gains ranging between 18 per cent and 41 per cent. While giants such as the State Bank of India (SBI), Punjab National Bank (PNB) and Bank of Baroda (BoB) spiralled 27-41 per cent, smaller peers such as Canara Bank, Bank of India, Union Bank, Indian Bank, Allahabad Bank and IDBI Bank jumped 20-35 per cent. In all, 22 PSU banks saw their combined market value increase 27.7 per cent, or by Rs 1,19,000 crore, in a day.

However, brokerages warn that the focus should be more on established and larger players, even as they remain bullish on PSBs.

Analysts unanimously concur that Wednesday’s jubilance is justified as the major roadblock — lack of capital — has been adequately addressed now. And this is despite the huge sum of Rs 2.11 lakh crore, most of it front-loaded, planned to be infused into PSBs for recapitalisation.

First, taxpayers’ or deposit holders’ money will not be compromised to fund the bailout as much of it is expected to be raised through non-cash modes, mainly from the bond market. Although banks may subscribe to the bond issuance by the government, they will earn a decent return close to the yield on government securities, experts said. 

Second, the budgetary allocation may not alter significantly as the government plans to stick to its recapitalisation plan under the ‘Indradhanush’ scheme announced in 2015. Any capital requirement beyond the allocated Rs 18,000-crore limit may be met by the government reducing its stake in PSBs to 52 per cent; an exercise which may fetch Rs 52,000 crore. 

Thus, analysts at Edelweiss sum up that the move would enable the government to infuse capital sans budgetary implications, as well as allow it to earn dividends and participate in equity returns as the recovery cycle plays out.

Also, the PSB stocks for long have been undervalued due to concerns over thin capitalisation. 

“With this (capitalisation) being addressed, the beaten-down PSB pack will continue to rally. Under-ownership in these stocks would also fuel the rally,” says a confident Amar Ambani, who heads the research team at IIFL.

The move has prompted analysts to reinforce their confidence on select PSBs, mainly the SBI, PNB and BoB. Some have majorly reversed their stance. For instance, a huge leap was taken by Morgan Stanley, which hasn’t favoured the PSB space since 2011. The foreign brokerage has upgraded its rating on the SBI and PNB by a couple of notches to ‘overweight’, from ‘underweight’, while changing the stand on BoB to ‘equal weight’, from ‘underweight’. 

As a rub-off effect, even Axis Bank and ICICI Bank, which have significant corporate loan exposure, saw a jump in rating and share price gains.

“PSBs were unable to take proper hits on their bad loans. This, in turn, was making them push out recognition and provision, hurting chances of earning a reasonable return in equity (ROE). Proper recapitalisation has the ability to break this vicious cycle. Now banks can take required hits, make proper provisions, and move ahead,” said analysts at Morgan Stanley. 

They believe that the adjusted book value of the SBI will grow at 12 per cent a year for the next two years, while that of PNB and BoB will grow at 10 per cent each. For smaller PSBs, the brokerage said while the stocks should do well in the near term, it might take a long time to see double-digit growth in ROE. 

Credit Suisse has also upgraded its rating on the SBI, PNB and BoB to ‘outperform’.

However, some analysts also expect the euphoria to fizzle out over time, even as they reckon capital infusion as a medium- to long-term positive. 

For one, much of the capital infusion would be used to clean-up the books, leaving little room (capital) for growing the lending activities. “Therefore, the rally will become sane as the focus turns back to earnings and fundamentals. In the next 6-12 months, PSBs would be busy restructuring the loan book, leaving little room to focus on lending activities and improve core profitability,” an analyst said. 

While capital infusion is crucial, structural reforms to strengthen PSBs is also the need of the hour to improve operational efficiencies and lending practices. 

UBS analysts led by Gautam Chhaochharia, head of India Research, UBS Securities India, said in a report, “This one-time bailout would be wasted if it is not followed up with structural changes at state-owned banks (in terms of HR practices, incentive structures and independent boards).

Hence, after Wednesday’s price appreciation, analysts believe that the PSB stocks — the SBI, PNB and BoB — are a ‘buy on dips’ opportunity.

In a report, analysts at Kotak Institutional Equities led by M B Mahesh, said, “We are lot more comfortable to own frontline large public banks like the SBI and private lenders like ICICI Bank or even Axis Bank, after the recent correction. We would avoid most small public banks, given the risk of book-value dilution.”

PSBs gain, NBFCs lose?

• PSU bank recapitalisation viewed as overhang for non-banking finance companies (NBFCs)
• Frontline NBFC stocks — Bajaj Finance, L&T Finance, Edelweiss, Repco, Can Fin Homes — decline 5-8%
• NBFCs gaining market share at the cost of PSBs may shrink as PSBs capital adequacy increases
• Lending to SMEs a core growth opportunity for NBFCs
• Interest rates of PSBs historically attractive vis-à-vis NBFCs
• Competition from well-capitalised PSBs may reduce NBFCs’ attractiveness
• NBFCs may hence see margin compression as PSBs catch up on SME lending
• Morgan Stanley says retail lenders, including banks, could struggle in near term as PSBs start competing for loans 
• This concern and strong outperformance could cause stocks of retail lenders to lag