Ashish Gupta, Kush Shah & Anurag Mantry
The government has announced a complete recapitalisation of PSU banks, to the tune of Rs 2.11 trillion (or $32.5 billion) over the next two years. This amount is significantly large (1.8 times the total capital infusion by the government between FY09 and FY17), given that our estimate of the capital requirement by FY19 was to the tune of $43 billion. We estimate this will add 20-100% to the total capital base and lead to an equity dilution of 20-200% at the PSU banks, assuming this Rs 2.11 trillion is allocated to the banks to ensure a 60% NPA cover and minimum 8% common equity tier (CET)-1 cover. The government has introduced recapitalisation bonds as a major component (64%) of the capital infusion plan. These bonds are essentially liquidity-neutral for a bank, as they lead to the same absolute increase in the quantum of the investment book and the equity base. The government, in a sense, will be borrowing from the banks to recapitalise the same banks. Such bonds are typically interest-bearing and non-marketable, at least for a specific period.
While details of the bank-wise planned infusion are not available, we have assumed capital infusion based on current capital levels and provisioning needs for the banks. Our distribution of capital assumes capital needed to provide for stressed loans, with 60% NPA cover, 50% on restructured loans and 30% on other stressed assets. We also assume CET-1 increases to 9% as of FY19E, factoring 10% risk-weighted asset (RWA) growth and 8% return on equity (RoE). PSU banks were facing the dual problem of rising provisioning needs, with 40-45% of NPAs likely to move to resolution under the Insolvency and Bankruptcy Code (IBC) and limited capital buffer vis-à-vis increasing minimum regulatory capital requirements (11.5% minimum total capital + CCB by FY19). This would have pushed the banks into a vicious cycle of low capital-low growth. While the current loan demand environment remains muted and an immediate acceleration in loan growth is unlikely, the move will enable banks to stem the contraction in their loan-book (10 banks had witnessed loan book de-growth in Q1FY18) and clean up their books while maintaining capital above required levels.
Capital levels remain low for the PSU banks, with CET-1 below FY19 regulatory requirements for a large number of banks. With total CET capital for the PSU banks at ~Rs 5 trillion, the Rs 2.11 trillion of planned capital infusion would be a significant increase (~40%), resulting in 20-100% increase in capital levels across banks. Given the current market cap of PSU banks is ~Rs 4.2 trillion, the planned infusion would lead to significant dilutions (20-200%) for most banks. PSU banks are under-provisioned, with provision cover falling over the past few years. Coverage is low across banks, at 30-50%. In order to provide for a 60% NPA cover, 50% of restructured loans and 30% on other stressed loans, banks would need to make provisions which are 30-80% of their current CET-1 capital. As PSU banks have been constrained for capital and under-provided, they have been forced to pull back on loan growth, with loan growth flat over the last few quarters. This has resulted in PSU banks losing significant market share to private banks. PSU bank market-share has declined from ~80% in Q1FY14 to 72% in Q1FY18.
While this move could lead to dilution of book-value given current market prices, it could also lead to a shift in valuation from multiples based on adjusted book to actual book. We estimate that there will be a 20-200% dilution from the recap (assuming dilution at 20% premium to current market price), which will push up the price-book ratio (P/B) of these banks to 0.6-1x, as dilution will be at a discount to book. The past few years, these banks have been valued on an adjusted book basis on account of the: (a) under-provisioning, and (b) under-capitalisation. We estimate the 20-200% dilution from the recap will push up the P/B of these banks to 0.6-1x (as dilution will be at a discount to book).
However, as the under-capitalisation and under-provisioning are largely addressed, the nominal P/B and P/adj book will converge. While the weakest PSBs that were being forced to shrink their loans are the largest beneficiaries, we prefer banks with better pre-provision profitability as these can, post recap, deliver ROEs at 8-11%. These ROEs and a better provided loan book can help these banks trade at 0.8-1x book relative to 0.5-0.8x book multiples. We upgrade State Bank of India, Punjab National Bank, Bank of Baroda to “outperform” for a 32-40% upside as we base TP on 1x FY19 P/B multiple. Given the PSU banks are trading at a significant discount to book-value, the large dilutions will result in the book value of equity per share (BVPS) falling for most PSU banks. With the fall in BVPS, P/B multiples for PSU banks will increase to 0.6-1x. With the capital infusion from the government, banks would increase provisioning on their stressed loans, which will result in book value and adjusted book value converging. Even building in the dilution, on market cap to pre-provision profits, these banks will be at an attractive 3-4x.
Gupta is MD, Shah is research analyst and Mantry is research associate, Credit Suisse Equity Research Views are personal