Indian Banking Sector (PSU) is at a crossroads

Indian Banking Sector (PSU) is at a crossroads

On Friday 16th of March 2018, the finance ministry informed the Lok Sabha that for the past eight years bad loans in the banking sector have been rising steadily and state-run banks had crossed Rs7.77 trillion at December-end 2017. Under the ?Industry-Large? category for all banks Gross non-performing assets (NPAs) has soared to Rs 5.27 trillion as on December 2017 from Rs 1.23 trillion on 31 March, 2015. ?Corporate lending by banks have increased from Rs31.12 trillion in March 2013 to Rs40.66 trillion at December-end 2017.

In the Indian banking system Total Gross bad loans amounted to about Rs 8.5 lakh crore in December 2017. India?s banking sector have a negative ripple effect due to the recent PNB-Nirav Modi scam which has deepened public mistrust of India?s banking system and doubts about the political leadership?s probity. Both the Rotomac case and the PNB fraud underline how fund diversions were overlooked, and how no alarm bells were sounded, no red flags were raised is what?s distressing the most.

Public-sector banks have a higher share of nonperforming loans than their private-sector counterparts. Public sector institutions have deep networks and control approximately 70 percent of banking?s asset base. Capital infusions the tune of $15 billion has already been made by the government from 2009 to 2016. But over the years, share of the sector?s assets has steadily shifted towards private-sector institutions and has grown from 21 percent to 25 percent in the past decade. From 2006 to 2016, private banks have grown more rapidly and generated far more value for their shareholders, with their share of market cap increasing from about 40 percent to nearly 70 percent in the same period.

In fiscal year 2017 Loan growth has remained weak? in the past quarter the banks? credit books shrank by 4%. Major Indian companies balance sheets are continuing to be under stress, corporate loans volume fell by 3 percent from April to December 2016. Companies whose interest-coverage ratio is less than one, has roughly 40 percent of the outstanding debt making debt repayment difficult. Overall, in the medium term wholesale-banking loans recovery seems difficult.

Let’s look at the three cycles of the Indian economy. When we opened our economy in 1991, to when a local industry transformed to a global one in 1999, banks took a major hit. By 2000, NPA levels were at 15%, almost as high as today.

A new phase began from 2000. If their dues weren’t paid, Banks could take charge of an asset.? Corporate debt restructuring (CDR) was brought in and a big lender The Unit Trust of India was bifurcated. The toxic assets of IDBI created a Bad bank before its merger with IDBI Bank. In 2004-05, the land price and the commodity price increased highly. By 2007-08, the gross NPA levels were down to 2%.? That was a dramatic change.

2008 was a disastrous year. By 2010, UPA II was a disaster and industry wasn?t working. What went unnoticed were the increasing references (of companies) to CDR. In 2008, there were just six references and after 2009 the number just shot up, indicating the build-up of stress in the system.

From 2006 to 2008, power, steel, and mining companies were trying to increase their valuation by getting natural resource assets. This resulted in unrelated diversification. In the last five years, when almost all industries were underperforming, the profits earned by banks are getting wiped out now.

PSU 1

Source: RBI

PSU 2

Source: RBI

Source: RBI

As far as the business fundamentals for these banks is concerned nothing is looking healthy.? Banks have not been completely capitalised yet. Given the recent fraud/scam, banks will now be shy to give corporate loan, their key go-to product business-wise. The next one-year will be a challenging period for them. In case of any negative event going ahead, analysts expect the sentiments of banks to provide for NPAs to get hit further.

Certain banks such as, Punjab National Bank (PNB), Bank of India, Union Bank of India, Canara Bank, Andhra Bank and Allahabad Bank have been hit especially hard and have seen significant erosion in their market caps, does it make them a good investment at this point with a longer term horizon? This is a moot point; the value proposition is tempting however the recent spat of scams being unearthed every day can make an average investor very jittery in holding any of these banks in their equity portfolios.

From a long-term perspective, most experts remain bullish on the banking space, they suggest investors should buy only those banks whose non-performing assets are at a manageable level and there is credit growth/earnings visibility.

Investors in these stocks have various questions in mind for e.g. whether PSU banks have suddenly become attractive at these beaten down valuations. Are these stocks a good bet? ?Should one look to catch a falling knife or stick to other segments such as private banks or NBFCs?

Here are few recommendations in case you have an ongoing dilemma regarding investment in the PSU banking space.

  • Stick to private banks

Stick to private banks and stay away from PSU banks for now if one wants to invest in banking space. Indian private sector banks rank among the most highly valued globally. Four Indian banks find themselves in a list of 11 with market capitalisations of over $10 billion each and a price-to-book-value ratio (P/BV) of greater than 3, data sourced from Bloomberg showed. Private sector banks with retail focused are more likely to outperform their corporate lending peers.

  • Wait for next to 12-18 months

Investors should wait and watch the movement on PSU banks and it could probably be an option 12-18 months from now. In the long term, there may be opportunities but in the overall financial space, one has to be cautious on a sector such as NBFC on the valuation front.

  • Keep an eye on Bond moves

The recent uptick in bond yields is going to hurt banks negatively; net interest margins are going to come under pressure and the mark to market losses on the bond holdings are going to be on an uptrend. This is again a drain on the already hurting PSU banks.

PSU banking space in India ? Are you lured by the recent price correction!

The stocks haven’t been this cheap in years and it look temptingly cheap. ?But is the low valuation justified in view of the risks it is facing? Or are investors being too pessimistic and someone with a contrarian bent of mind can really make a fortune over the long term?

So, no matter how tempting the prospect of raking in big returns from PSU banks, it is one space you may do well to avoid for now. If you still want to take exposure, make sure it is not so large so as to run your portfolio into the ground.

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