August has not been a kind month for banks globally. The uncertainty around the subprime portfolios of global banks has made bank stocks very unpopular with investors.
After years of record value creation and over-performance, bank stocks have been hit hard. For the moment, it seems like the rally has ended?at least for banks. Bank stocks have lost almost all their value creation since the start of the year. The banking sector, for the first time in years, is the worst performing industry sector. The smart guys with the pinstriped suits in investment banks have been hit especially hard by the crisis. The subprime portfolios of many of their hedge funds have had to be capitalised. The collateralised debt obligations (purchases of tranches of subprime deck certified by rating agencies as investment grade) with high leverage find no buyers in the market place. What is worse is that no one really knows how big the hole is and who really has been left holding the can.
As a group, investment bank stocks? indexed performance is 10 points below all banks. As a result, Chinese banks have entered the value stakes in a big way last month. ICBC became the world?s most valuable bank, displacing Citi. Accompanying Citi, Bank of America and HSBC in the top six slots are three Chinese banks?China Construction Bank and Bank of China being the other two.
In India, our property market has also overheated?The Economist recently called Mumbai highly overpriced. But the big question is?will prices fall, and if they do, what will be the impact on the economy? Till now, despite the significant slowdown in bank lending to real estate, builders are being able to hold out on account of profits made in the past. People believe that speculator demand has now cooled off and the market is primarily genuine. Sales have slowed down, but prices have not yet fallen. Informed opinion on property in India is always rare, but people suggest the property market will reflect how interest rates and the Sensex behave, and by Diwali, whatever has to happen should happen.
Indian banks have not suffered the fate of their global peers, though of course, no Indian bank is in the top 30 by market capitalisation. Currently, the Indian Bankex is still outperforming the Sensex. Indian banks are not much dependent on their modest mortgage portfolios, anyway. Systemic risk is also low, as most banks hold their own mortgages and know how much it is. Very little has been securitised, and the size of the securitisation market in India is only about $7 billion.
How will Indian banks perform going forward? Different ownership forms face different problems. The P/E ratio for new private banks is about 27, while it is about 8 for public sector banks. They both need increasing sums of capital to provide for their growth, but the capital problem is becoming more severe for new private banks, as is evident from all the discussions about holding companies these days. My sense is that bank valuation currently will have little to do with property. A few players that have been aggressive in mortgages without getting their systems in place may see a rise in their NPAs. They will see a dip in their profitability, but overall, the banking sector is not much exposed. In the longer term, despite the recent cooling of interest in the retail sector in India, it is a segment which has much lower penetration than global levels, and will be critical to bank portfolios.
Banks seeking a high valuation in India will require a strong retail asset portfolio. They will need to develop robust operating systems for managing the retail lending business. If they don?t do that, they will miss out on a very large opportunity, and the market will be watching.
?The author is managing director, Boston Consulting Group India. These are his personal views