Friday, January 9, 2009

PSU Banking Sector Update; Tale of two times


PSU Banking

 Tale of two times 


The banking stocks, PSU bank stocks in particular have outperformed the broader markets by upto 30% over past two months, rightly driven by 280+bps dip in the G-Sec yields. While, one may get carried away by the robust treasury gains that the PSU banks may report, we believe that over next twelve months odds are more against the PSU banks than in favour. For one, a faster drop in the lending rates, (~150bps till date) and also differential interest rates vis-à-vis deposit rates (~50-100bps till date) would raise question marks on the NIMs. While the scene on the NIMs is similar to that witnessed in 2002-07, the key difference is the interest rates this time have been cut under panic rather than driven by the inflation. And for two, the issue of directed lending seems to emerging driven by stimulus packages by the central government. Directed lending during 1990s had helped only NPAs rise by 50%+ during the period. Third, while the treasury gains contributed 60% of the networth cumulatively over FY02-05, the treasury gains are likely to contributed just 3-13% to networth now. We believe that the banks with better CASA profile, wider branch network and strong asset quality would be better placed in such scenario. With that in mind we would prefer BoB, UBI and PNB. We would less prefer Allahabad Bank, Canara Bank, Corporation Bank and State Bank of India.

NIMs could come under pressure

The PSU banks have cut their prime lending rates by ~150bps over past two months reflecting partially, the dramatic cut in the policy rates and partially driven by push from the government. We believe that a similar fall in the cost of deposits is not likely to happen. The contraction in NIMs could be ranging from 9-19bps. While the scenario may look similar to 2002-07, there are some differences here. One, the rate cuts were spurred by search for growth and not liquidity. Two, the demand deposit contributed 25% of the deposit growth in 2003-06. They will be hard to come by now. Three, with lower industrial growth, the competition will be more for smaller pie of term deposits. Despite strong growth in demand deposits, the NIMs of PSU banks fell by 50bps over 2004-07 even as the bank nifty rose by 150% during the same period driven by economic and credit growth, treasury gains and low NPAs.

Asset quality may be camouflaged

We believe that the asset quality becomes all the more important factor now. In the stimulus packages announced till date, the banks have been made conduits of directed lending in sectors like housing. There are more such packages likely to come. As rightly, pointed out by the Narasimham Committee in 1998, the pursuit of growth objectives should use the fiscal system rather than the credit system. During 1990s, the NPAs of the PSU banks had risen by ~50% to Rs540bn. During the same period, SBI's stock price tumbled by ~60%.

Over, last quarter we have seen some lenient policies coming from the RBI on the asset quality front with more relief being asked by the banks. We believe that in such situation, there is a high likelihood that the NPAs may remain hidden under camouflage. We believe that now on, the restructured assets of the PSU banks would require investors' watchful eye.

Treasury gains may not last long

The G-Sec yields have again hardened back to 6.1% in January 2009 after touching a low of <5%. We believe that the magnitude of the monetary easing now is likely to be slower than earlier. Apart from the same, the government borrowings are likely to be higher by ~40% at Rs500bn from Q4FY09 than the earlier estimates. Hence, we believe that the gains on the bond portfolio may be capped from hereon. Also, quite unlike FY2002-05 when the treasury gains contributed nearly 60% to the networth, the contribution to net worth this time is likely to be limited to only 3-13%.

Faster growth and higher NPAs could entail early equity dilution

Most of the PSU banks are likely to face shortage of tier I capital in FY10E. Higher NPAs and faster balance sheet growth could entail equity dilution for the PSU banks even earlier than that. The announcement of Rs200bn recapitalization of PSU banks could be a precursor to such event. In case, the government comes out with a rights issue it may be book value dilutive since many PSU bank stocks are trading at sub-book value.

Valuation and view

The PSU bank stocks have outperformed the Sensex by upto 30% over last tow months in anticipation and in line with the drop in the bond yields. However, from hereon the performance of the PSU banks will have to reflect the movement of NIMs and asset quality. We believe that the banks with better CASA profile, wider branch network and strong asset quality would be better placed in such scenario. In such case, we would prefer BoB, UBI and PNB. We would less prefer Allahabad Bank, Canara Bank, Corporation Bank and State Bank of India

There is two change in our recommendation: Downgrading Canara Bank to REDUCE from ACCUMULATE and Allahabad Bank from BUY to HOLD

There are five changes in our price targets: Downgrading price target for Allahabad Bank to Rs75, Corporation Bank to Rs240 and State Bank of India to Rs1,500 and upgrading price target for BoB to Rs350 and for PNB to Rs580

 



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