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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 PSU Banks.The implementation of Basel III guidelines will lead to significant capital requirements for most public sector banks (PSBs) and bring some challenges for them. First the focus will shift from Tier I capital ratio to core Tier I ratio (which refers to core equity capital of the bank) and second, RBI has prescribed a core Tier I ratio of 9.5% - higher than Basel III requirement of 8.5%. Brokerages estimate that PSBs may have to raise anywhere between Rs 1,80,000 crore to Rs 2,00,000 crore by FY18 to comply with these guidelines. Estimates of equity dilution (arising from fund raising) differ with the assumptions taken by brokerages on return on equity, non-performing assets ratio and the price at which dilution takes place.
However, most brokerages believe that amongst the top six PSBs, Bank of India (BoI), Union Bank (Union) and Canara Bank (Canara) are weakest on the capital adequacy front and would witnessed highest equity dilution . Consequently, valuations of these banks may not appear as attractive as they are today and may remain depressed going forward.
"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%, 60% and 51% respectively. Amongst the worst hit are BoI, Canara Bank and Union Bank, as all three would have to bring in capital more frequently starting from FY15 onwards with much higher dilution (219-278%)", says Siddharth Teli, MD and Co-Head, Institutional Research, Religare Capital Markets.
Manish Karwa, Banking research analyst at Deutsche Bank Markets Research, echoes this. "We believe Union Bank and Bank of India will have to raise 3 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 has severely hit PSB's profitability. This means that they are unable to generate enough profits to boost their capital requirements. This, despite continuous fund infusions by the government (which increases government's stake in these banks).
Government has options such as reducing dividend payout, increasing FII/private players' stake in these banks and selling non-core investments made by these banks (in rating agengies, mutual funds, CIBIL, etc.). However, the only permanent solution to this problem seems to be that the banks chase profitable growth and earn enough internal accruals to fund their growth plans.
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 times. The bank received Rs 1,000 crore equity capital infusion from the government in 2014, despite which its Tier I ratio stood at 8.2% which is lower than its larger peers. Tha bank though has lesser gross non performing assets (NPA) ratio of 2.8% (versus 5-5.7% of larger peers), its restructuring pipeline remains sizeable at Rs 1,700 crore. Its weaker return ratios and could dilute further as capital raising becomes more expensive. Its low CASA ratio (22.5%) can provide limited cushion to margins.
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 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% in December 2013 quarter and analysts expect it to inch up to 3.8% in FY15. The bank has CASA ratio is relatively weaker at 23.1%, 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 alongwith 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 1.0 times. The bank recently received Rs 5oo crore from the government pushing its Tier I ratio to 7.6%. " Union Bank faces immediate dilution risks due to conversion of nearly Rs 111 crore of Perpetual Non-Cumulative Preference Shares (PNCPS) 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 continous inching up of the gross NPA ratio (up from 3.0% in March 2013 to 3.9% in December 2013)
