PSU banks rating: Hold – SBI, BoI and Union Bank; Reduce – BoB, PNB, Central Bank
Steep correction looks justified: Since Dec-14, our covered PSU banks’ valuation (ex-SBI) has declined to 0.8x P/AB (price-to-adjusted book value), correcting over 30% below their five-year average. We believe the correction was warranted, given these stocks were trading at five-year average valuations, while their RoA (returns on asset) corrected 42% below the five-year average, driven by continuing asset quality stress, leading to higher credit costs and weaker margins. SBI is the only exception, which saw 17% correction in valuations, in sync with its RoA decline.
H1 crucial, more correction could be in store: With regulatory forbearance ending on restructuring loans, asset quality trends in H1 will be crucial. While 5/25 refinance has taken off and could provide relief to operational infrastructure and core sector project loans, stress formation outside these sectors remains elevated. In addition, with monsoons still in early days, uncertainty remains, which coupled with rural slowdown, agri-NPLs (non-performing loans) could rise. Similarly, bond yields have shot up the past fortnight and are likely to incur losses to PSU banks in Q1. We suspect most PSU banks might have shifted meaningful quantum of SLR (statutory liquidity ratio) securities from HTM (held-to-maturity) to AFS (available for sale) as well as parked incremental purchases in the AFS category, which could result in higher MTM (mark-to-market) losses. This is crucial as in Q4, excluding treasury gains, most PSU banks’ PBT (profit before tax) dropped sharply.
Remain cautious: We continue to remain cautious on PSU banks as macro outlook stays subdued along with weak capital adequacy for most banks. We cut earnings estimates between 4% (SBI) and 13% (BoB) as we reduce treasury gains and margins and increase credit costs for most banks. Against consensus, our estimates are lower by 10-20% on most stocks. We maintain a Hold on BoI and UNBK (union Bank) as they continue to trade at 0.5-0.6x P/AB, while we remain Reduce on BoB, PNB and CBK (Central Bank), where valuations are still out of sync with RoA. We remain Hold on SBI, given its better top management, good capitalisation levels and relatively better profitability.
Dichotomy between price performance, valuations and RoA: PSU banks’ share prices have corrected sharply since Jan-15. Barring SBI, which corrected by 18%, our covered PSU universe corrected by 38%. Despite this, since Feb-14, when the current rally started, our covered PSU bank stocks are still up by 28%, while SBI is up by 72%. In contrast, ex-SBI, RoA of PSU banks have declined over the past four quarters, mainly driven by higher credit cost as asset quality continued to worsen. This is despite most PSU Banks booking significant treasury gains during FY15. In fact, in Q4FY15, excluding treasury gains, PSU banks’ PBT as % of assets declined to 30-50 basis points. This implies there is a clear dichotomy between the price performance and RoAs of these banks.
Scope for more correction: In terms of valuation, these stocks have corrected over 30% from their five-year average and have partially caught up with the profitability of these banks. Valuations are still 20% higher than Feb-14 levels and 30% higher than the bottom of Sept-13. However, given that RoAs have declined sharply over the past six quarters, and FY16 is likely to be another weak year for most of these banks, there is more scope for
valuations to correct in the next couple of quarters.
Asset quality risks remain: Q4FY15 saw higher restructuring by many PSU Banks, though slippages showed a mixed trend. However, overall gross stressed assets continued to climb. As of FY15, PNB has the highest level of stress with total gross stressed assets at over 16%, while SBI and BoB has lower stress, though still above 10%. With the regulatory forbearance on restructuring already passé, most of the incremental stress will become NPL immediately.
However, there will be some relief, as operational projects under infrastructure and core sectors that are generating cash flows are likely to get refinanced under the 5/25 refinance scheme announced by the RBI last year. However, those projects that are still under-construction with uncertainty around their future cash flows as well as all sectors other than infra and core sectors are likely to pose significant problems for banks. Besides, deterioration within NPL buckets is quite evident from the rising credit costs for most banks in FY15 and this deterioration will continue in FY16 as well, putting more stress on PSU Banks’ profitability. We hope that banks have recognised most of the stress upfront and have restructured in Q4 itself, though given the uncertain environment, we are not confident that incremental stress formation will reduce significantly.
Monsoon-led agri-sector risks looming: It’s still early days for monsoons in India, though most global forecasters are predicting a strong El Nino this year. The Indian Meteorological department is also predicting a 12% rain deficient, which could negatively impact the agri sector. This is in addition to the already slowing momentum of the rural economy. Most PSU banks have aggressively grown their agri-loan books over the past couple of years, which could lead to higher slippages in the next few quarters.
Adverse bond yield movement: The 10-year benchmark G-sec had corrected over 125 bps in FY15, which PSU banks capitalised on to book significant trading gains, which helped them to partially offset their elevated credit costs.
Given the broad expectation of rates declining over the next few quarters, we suspect that most PSU banks would have shifted a significant quantum of G-secs from HTM to AFS category, which would have increased the duration of the AFS book, in the hope of continuing to book treasury gains. However, the yields have spiked sharply in the last fortnight with the benchmark moving up by 25bps to 7.89%. As a result, we expect treasury gains to decline significantly as well as potentially higher MTM losses. A weak treasury performance could significantly impact RoA of PSU banks, especially given their elevated credit costs.