Among PSU Banks

PSU banks have shown some out-performance iSeveral of the publicn recent times. Yogesh Supekar and Tanay Loya find out whether PSU banks should be part of your portfolio and whether private banks are better long term investments despite being richly valued.

It has been a challenging market environment for equity investors in CY18 so far, in spite of the indices doing well and inching up by 11 per cent on a YTD basis. 

Now, when the markets are precariously placed at all-time highs, the broader question for the investors is - Will equities deliver from here on and which sectors or set of stocks will outperform? Indeed, identifying sectors that may outperform is the key to portfolio outperformance, along with timing and appropriate portfolio weightages. 

The recent performance of PSU banks has caught the attention of the investors anew. The PSU banks have always been on the radar of the investors, even though the sector has been plagued by the NPA problem and poor corporate governance and frauds, all at the same time.

Several of the public sector banks (PSBs) have outperformed the private banks on a QTD basis, and such outperformance in PSBs can be attributed to the sound recovery from the loan accounts in the first quarter (Q1) of the current financial year. This development has convinced investors that the banks consistent focus on containing nonperforming assets (NPAs) is yielding results. 

While the growth in cash recovery is a positive sign, investors must discount the fact that the recovery rate in India is way lower than the average global recovery rate. 

 Dedicated recovery teams, centralised follow-ups on bad loan accounts and resolutions via NCLT are driving the trend for the PSBs 

Private banks vs PSBs The perpetual debate that goes on among investors is whether to include more of private banks or the PSBs in the portfolio. While historically the private banks have outperformed the PSBs by a huge margin, the compelling valuations and the perception of "worst is over for PSBs" is prompting investors to flirt with the idea of investing in PSBs. Investors looking at investing opportunities will have to first define how much weightage they wish to give to the banking stocks in their portfolios and subsequently decide how much weightage should be given to the PSBs. Clearly, the focus should be only on those PSBs which are not in the PCA list and where the banks have a net worth much higher than the NPAs. 

Capital infusion along with likely recoveries from bankruptcy cases will help these lenders regain strength in the next couple of years, ICRA has predicted

When one considers the case of private banks versus the PSBs for long term investing, the private banks stand out as clear winners, despite their rich valuations. On all operating parameters, the private banks outperform the PSBs and hence should be preferred for long term investing. Private banks have outperformed PSBs when it comes to earnings. PSBs performance has deteriorated due to their asset quality. The asset quality for the PSBs worsened when the interest rates have fallen, while the same cannot be said about the private banks.

ATMs fraud risk: Nearly 74% PSU bank ATMs running on outdated software 

CRISIL expects approximately 60 per cent haircut in the top 50 NPL accounts.

Private banks have done well, irrespective of the rate cycle. For the PSBs, the margins declined from approximately 2.5 per cent to below 2 per cent in FY18. Private banks managed to escape the GNPL mess owing to a combination of higher retail focus and their ability to structure loan covenants better. Of course, ICICI Bank and Axis Bank were the exceptions. The focus on retail assets has allowed the managements of most of the private banks to focus on growth, rather than resolutions and this has been the key differentiator between the two. Clearly, the personal loans contribute most to the incremental growth story, while unsecured retail and credit cards are the two growth engines that the private banks are betting on. PSBs are unable to tap growth in both credit card segment and the unsecured personal loan segment. Both private banks and PSBs have seen challenging times in home loans and auto loans owing to RERA, GST, BS-IV etc. 

Why PSBs may underperform in the long run: | The PSBs have traditionally been trading at a discount to the private banks and may continue to do so. The PSBs have a higher share of corporate loans and, historically, this has impacted the NIMs of the PSBs. On a relative basis, the track record of PSBs suggest that PSBs have struggled to garner enough interest income and there is no reason to believe the situation is going to change. 

For investors to create wealth, growth is important and growth in profits is the key. The biggest question facing the PSBs is: Where will the growth come from? The capital that is getting infused by the government is simply being utilised to clean the previous mess. The ‘growth capital' is unavailable for majority of the PSBs. While the current government has been proactive when it comes to resolving the issues faced by the banking industry, the steps taken so far do not seem to help in putting the PSBs on the growth trajectory. Investors ought to focus on ‘growth' in profits for PSU banks and not resolution of NPAs alone. Many would argue that the growth will be seen in 3 to 4 years once the banks are fully recapitalised and the NPA issue is resolved. Agreed. But where is the guarantee that similar problem will not resurface again in the banking industry, especially among the PSBs. Nothing substantial has changed in the way PSU banks are functioning. There are no major reforms, there is no advance audit system in place to detect frauds, no HR reforms are in place for the PSBs, no proper incentive structure comparable with the private banks has been designed for PSB employees at the managerial level. How will the PSB employees be motivated unless there are performance linked ESOPs distributed to reward the management? These are the basic questions that need to be answered while searching for growth in profits for the PSBs. 

The issue is simple – unless the entire gamut of functioning of the PSBs does not change, the PSBs will continue to lose market share to their private counterparts. This will continue to happen in spite of PSBs being recapitalised – again and again. 

The underwriting has to improve for PSBs, the focus needs to be more on retail clients to beef up interest income and the overall operating parameters need to improve for the PSBs to start challenging the private banks. 

As of now, the situation looks more like the PSBs may survive and clean up the mess only to reflect growth by 2020 or 2021. By this time, the private banks would have gained further ground and the market share of the PSBs would have shrunk further, thus leading to under performance by PSBs. 

 Aniruddha Chatterjee Head of Buy Business at Thomson Reuters South Asia "In 2018, only 13 out of the Nifty 50 stocks have outperformed the index. In other words only a handful of stock are driving the market performance. Even the earnings numbers are quite muted. The aggregate earnings of the 37 of the 50 Nifty companies (companies that have announced their earnings so far) is down 11.5% when compared with same period a year ago. It is imperative to get the equity mix right in such market conditions. Data and insights derived from a comprehensive analysis of fund and market performance can help investors identify Fund Managers who have consistently outperformed and generated higher risk adjusted returns relative to their peers"

Rahul Sharma Sr. Technical Research Analyst, Equity99. " We believe that we are in the reversal of the NPA cycle and we are quite bullish on Indian Corporate lenders. Most of the pain is over in the earnings' point of view but we are still quite cautious on SME lending front. But in general, yes, we believe value has started emerging in some of the counters especially private corporate lenders. We are not recommending any PSU banks yet; we would like to see sustainability of earnings before taking any call, for that we would like to see what kind of numbers they are providing in H2FY19. We believe the rally in the baking stocks has just begun."

Jayant Manglik President Religare Broking Ltd. "NPA provisioning will restrict PSU banks' ability to grow at a faster clip"

What is your outlook on PSU banks? We believe that the worse could be over for PSU banks in terms of NPA provisioning. The Q1 results of PSU banks have witnessed moderation in fresh slippage generation, which is a positive. However, the provisions over the past quarters have eroded the capital of PSU banks considerably, which we believe will restrict their ability to grow at a faster clip. Notably, banking credit growth has firmed up to over 12% in recent weeks. However, in the backdrop of a strengthening economy and the government's focus on financial inclusion and raising of farm incomes, we remain positive on certain large PSU banks considering their widespread branch distribution network and relatively stronger balance sheets compared to their peers. 

What are you advising your clients on investing in PSU banks? While we remain positive on certain large PSU banks, investment in these is advisable only for those with at least a 2-3 years investment horizon and realising the fact that the risk in the sector is relatively higher than the market in general. 

What are the risks of investing in PSU banks at this juncture? PSU banks are in urgent need of recapitalisation and any significant delay on this front owing to fiscal or political challenges would impede recovery of the sector. Moreover, any further major surprises on the NPA provisioning front will create a further dent in PSU banks' balance sheets, which consequently will impact stock market sentiments towards the sector.

Amit Kachroo Aaneev Wealth "Private banks are definitely a good bet as they are better than public sector banks"

Are you advising your clients to invest in PSU banks at this juncture? Considering the fact that PSU banks have taken a beating, we are not exactly advising clients to invest in PSU bank stocks. The main reason is the rising non-performing assets (NPAs) and the negative news about Punjab National Bank. In fact, the clients are pretty much reluctant to buy PSU bank stocks. The only investors buying these stocks are those who already have made good money previously and want to add more stocks now as valuations are down. The other basis is that most of the PSU banks' NPAs have peaked out, and moreover, the next couple of quarters may see some recovery. At the same time, it should be noted that almost every public sector bank has reported loss due to NPA issues.

What is your outlook on the banking stocks? Overall, investors right now have a penchant for private bank stocks as some of the banks have shown good growth. Public sector banks have witnessed higher downturn in quality of assets as compared to private sector banks. My sense is that private banks will definitely be a good bet as they are better than public sector banks on many parameters, like private banks are more customer-friendly, provide better service and have good personal interaction. In the PSU banking space, we have seen that SBI happens to be a favourite bank among some investors.

As far as private banks are concerned, we are bullish on HDFC Bank which had shown a positive growth year on year, Yes Bank which has just got the AAA rating with stable outlook from CARE ratings. Also, their current account and savings account book and retail deposits book is increasing day-by-day. Both the banks have very less NPAs and their asset quality continues to grow. Federal Bank is another bank in private sector space which has reported a good quarter earnings. It might prove to be a great stock in the coming years.

Jimeet Modi Founder & CEO SAMCO Securities. "Buy on dips would be the ideal strategy"

Are you advising your clients to buy PSU banks? Currently, the markets are continuously touching new highs and all the sectors are showing robust growth on account of good quarterly numbers and the PSU banks are not far behind. 

Non-PCA PSU banks have been showing improvement in their asset quality with slightly lower NPAs, reduction in slippages and pick-up in interest incomes. They are neck-to-neck in capturing incremental loan demand by posting growth in line with their private banking peers. Therefore, we expect this quarter to be a turning point for the non-PCA banks and we would recommend them to our clients. We would advice our clients to buy non-PCA PSU banks and not make any fresh calls on private banks which seem to be trading at higher valuations at this point in time. But given the quick run-up in the PSU banks, buy on dips would be the ideal strategy. 

What percentage of portfolio should be invested in banking stocks? The financial services sector forms a significant portion of the basket of Nifty stocks and also contributes a sizeable chunk to our GDP, hence, it would be ideal to have 15% of the total corpus in PSU banks with 7% in insurance companies and 7% in housing finance companies. 

Private banks or PSU Banks – which set of stocks many outperform in coming 2-3 years? As some of the non-PCA PSU banks such as SBI, Indian Bank, Bank of Baroda and Vijaya Bank have been showing signs of improvement in their net interest income in-tune to their private peers we expect these banks to move higher on account of re-rating and private sector banks to head lower from the current levels on account of portfolios adjustments.

What is PCA? Amid increasing distress asset of banks, the RBI has revised its guidelines related to prompt corrective action (PCA). PCA is triggered when banks breach certain regulatory requirements in terms of three parameters, such as capital to risk-weighted assets ratio (CRAR), net non-performing assets (NNPAs) and return on assets (RoA). The PCA by the RBI will assess, monitor, control and take corrective actions on banks which are suffering from ailing assets. The PCA framework is applicable only to commercial banks and does not extend to cooperative banks, non-banking financial companies (NBFCs) and FMIs. Once in the PCA list, these banks will not be able to open new branches or lend money to borrowers or recruit new staff. 

 Aasif Hirani Director Tradebulls Securities "Investors have to be stock-specific within the PSU bank space"

On a QTD basis, are the PSU banks outperforming private banks? Do you think the outperformance in PSU banks will continue? One of the reasons for PSU banks outperforming private banks on QTD basis was the stark difference in valuation between them. Many of the PSU banks were trading near to their book value, which made the investment attractive. The government's announcement of capital infusion also helped in PSU banks outperforming private banks, but we don't think outperformance will continue. There are lot of headwinds for PSU banks in the form of PCA, losing market share to private banks, poor financials, NPAs, weak core capital compared to private peers, etc. which will prevent them to outperform private banks in the future. 

Should investors prefer investing in PSU banks right now? Have PSU banks bottomed out? Investors can continue to invest in PSU banks, but they have to be very stock-specific even within that space, because the RBI is intervening and there are lot of banks under prompt corrective action (PCA). Under the PCA, there will be virtually no growth for those banks, and so there is no reason for investors to invest in those banks. The NPA worries seem to be getting over, but I might refrain from saying PSU banks have bottomed out. The market is already trading at life highs, so any correction would also drag PSU banks lower and we may even see new bottom getting made.

In a portfolio context, what is the right weightage that needs to be given to the PSU bank stocks? As mentioned, investors have to be stock-specific even within the PSU bank space. We feel 75:25 ratio works well for private/ PSU banks. If an investor has allocated 15% weightage for banks in their portfolio, then 3.75% should be allocated for PSU banks. 25% out of total percentage of weightage in banking sector should be given to PSU banks. In hindsight, we feel 20% would be the right weightage for banking sector (so 5% would be for PSU, while 15% would be for private banks). 

For the long term, would you recommend buying private bank stocks or PSU banks? History has shown that private banks have rewarded shareholders more than PSU banks and with reasons. My question is how many urban people open bank account in SBI or BOB? Private sector continues to take the market share away from PSU banks. Private banks' market share is around 30 per cent which is expected to increase by 38 per cent in the foreseeable future. Even if we set aside the NPA issue, we need to look at growth as well. Unless the banks have strong capital, they cannot grow. 

Currently, majority of PSU banks are at the mercy of the government for capital infusion. So, in the long term, we continue to prefer private bank stocks against PSU banks. As we have stated earlier, we can be stock-specific in PSU banks, but cannot paint the whole PSU sector with the same brush. 

Conclusion Banking stocks should be a part of any equity diversified portfolio, but the weightage to be given to the banking sector is a different question altogether. We believe not more than 20 per cent of an investor's portfolio should comprise of banking stocks. The prospects of private banks outperforming the PSBs definitely look brighter on a long term basis even though the current momentum in the PSBs may lead to out performance for the PSBs in the short term. 

The valuations are expensive for many of the private banks and where the valuations are cheap, corporate governance has been an issue. It is a tricky call on identifying appropriate banking stocks for inclusion in the portfolio. However, investors can surely ignore including those PSBs that are in the PCA list. Their focus should be on those banks that are showing superior operational performance and are relatively well-capitalised. 

Just because valuations are cheaper does not mean that PSBs are ripe for long term investment. PSBs having the highest probability of reporting superior growth in earnings should be included in the portfolio. It is tempting to buy stocks of PSBs whose prices have fallen by more than 50 per cent in the last one year or so and have shown improvement in cleaning up the NPL mess. 

However, in the long run, only those banks that are well capitalised and have superior operational parameters with the ability to deliver on earnings growth should be included in the portfolio, be it a private bank or a PSB. 

Even today almost 67 per cent of the market share is with the PSU banks. This market share will eventually be grabbed by the aggressive private banks. For the long term, money will grow better and faster by placing bets on the private banks rather than the inefficient PSBs. 

Also, private banks have so far done NPA management much better than the PSBs. The success for the banks will also depend on how well they manage the NPAs. Hence while identifying a stock in the banking space, it will be useful to focus on the NPA management strategy adopted by the bank. 

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