Valuation or funds? Key question for pvt banks in a tug of war for capital

Replicating success in terms of investor demand and premium pricing may be tough as lenders prepare for mega fundraising

Rarely in Axis Bank’s history has it sought to raise equity capital in two consecutive years. After raising Rs 12,500 crore in September 2019, its board approved of another Rs 15,000 crore of equity capital raise for FY21. News reports suggest peers, such as HDFC Bank and ICICI Bank, too, may be readying for a similar exercise.
 

Plans to garner equity succeeds the recent decision to raise debt funds of Rs 25,000 - 50,000 crore by the three banks. The rush to raise money comes at a time when most banks — both private and government-owned — have done well in terms of preserving their capital in FY20 which, in theory, doesn’t necessitate shoring up of the capital adequacy ratio (CAR). In fact, as against regulatory need to maintain a CAR of 9 per cent, the FY20 figure ranges from 15 per cent to 19 per cent for most private banks.

Yet, in the current scenario of heightened uncertainties presented by the Covid-19 pandemic, the need for capital also makes a compelling case. However, the moot question ahead is whether banks can garner the kind of interest they did in the past and at premium valuations/low coupon rates, especially in the context of the uncertain environment.

A note by UBS Securities points out most banking stocks trade at below their five-year average price-to-book value. The discount is as wide as 30–70 per cent even within the top six private banks. In this context, Ashvin Parekh, an independent banking expert, feels if private banks do manage to raise adequate capital this financial year, their growth is secure for the next decade. “But they may not get the best of valuations at this time; that would be the challenge,” he points out.

Marred by the twin problems of unpredictable asset quality and multi-decadal low credit growth, judicious demonstration of capital may be a big challenge. “FY21 would be the first year in over a decade that private banks may be raising money to clean up their books (or in anticipation of stress) and restart their business on a clean slate,” said an analyst from a domestic brokerage. Considering that 5-35 per cent of banks’ loan book is under moratorium (50-70 per cent, in case of smaller banks), Siddharth Purohit of SMC Capital feels it may only be in the second half of FY21 that banks (private and public) get an exact sense of the asset quality pain facing them. What’s worrisome is that without much support from loan growth and pressure on fee income, the asset quality pain may get amplified. FY20 is an example of how stress builds up if banks prioritise capital conservation over growth.

An analysis of private and public sector banks by ICICI Securities indicates a sharp pullback in loan growth led to a sequential increase of 80 basis points (bps) in the gross non-performing assets (NPA) ratio in the March 2020 quarter and 30 bps increase year-on-year (YoY), thereby putting brakes on the industry's improving NPA trend seen for seven straight quarters.

“In such a scenario, even if banks manage a wee bit higher valuation from current levels, if not historic highs, that would be a big deal,” says Purohit. The scepticism is not without a reason, given discounts of over 5 per cent offered during recent share sales by private banks.

For public sector banks (PSBs), they may once again be forced to knock at the government’s door for capital, thereby deferring the latter’s ambitious plan to make PSBs self-sufficient to go to the market. What's worse, trading at less than half their book value, fund infusion will be more value depletive for their shareholders.

Raising debt may not be easy, too. The ghosts of YES Bank’s additional tier-1 capital write off is still fresh in the minds of bondholders. “If investors feel bonds issued by banks offer potential, there may be demand but at a higher coupon,” iterates Parekh, while emphasising that pricing will hold the key.

The silver lining, as Purohit points out, is the flush of liquidity in the global money market. “Coupon rates in the West are still in low single digits. Comparatively, Indian banks will definitely make for a compelling case,” he adds. Yet, the recent rounds of rating downgrades may make bond money a tad more expensive for banks.

Whether debt or equity, experts say it would be a tug of war for capital. Seen against the backdrop of over 27 per cent gains posted by Nifty Bank index in the last three months, waiting out for clarity on the key risks — asset quality and subsequent equity dilution — may be wise for investors in today’s conditions.