Lower credit growth, higher margin pressure, and persisting asset quality concerns are structural risks for some PSU banks.
Banking has been one of the top performers of the current stock market rally, with the CNX banking index delivering a 50 per cent return in 2012. Private banks have led the gains with a 60 per cent return, outperforming the public sector (PSU) banks which delivered 34 per cent.
PSU bank stocks were weighed down by asset-quality concerns, accentuated by the economic slowdown. Now with an expectation of a rate cut by the RBI in January, a few PSU banks such as Bank of Baroda, Bank of India, Union Bank and Canara Bank, have outperformed the bank index over the last three months.
Their (forward) price-book ratios have moved up broadly from 0.5 times to 0.8 times. They still look inexpensive and trade below their historical valuations. However, we believe that investors should be selective in buying PSU banks as there are risks to some of them.
The Government’s recent reform drive and the expectation of a repo rate cut augurs well for the banking sector. But lower credit growth, higher margin pressure and persisting asset quality concerns, are structural risks for some PSU banks which may limit a significant turnaround.
While credit growth is expected to pick up in FY14, we believe it will be lower for PSU banks as they consolidate their loan book due to higher slippages. High cost retail deposits will continue to put pressure on Net Interest Margins (NIMs) even as lending rates fall. While asset quality will, at best, stabilise at current levels and tend to improve from the second half of FY14, the risk of slippages on the restructured books remains high. Also, as Basel III implementation looms ahead, capital adequacy norms remain a challenge for small and mid-sized PSU banks due to higher provisions, pressure on margins and muted growth.
Private banks appear better placed to take advantage of the recovery in retail cycle. Better loan mix, improving (current account savings account) CASA ratio and higher fee income drivers for private banks may yield a better return on assets (ROA).
Lower loan/deposit growth
At the back of a slowing economy, September-December 2012 was subdued for lending, with the latest data (fortnight ended December 28, 2012) showing a credit growth of 15.1 per cent over the last year. Deposit growth continues to be slower, with low inflows and banks consciously reducing high-cost bulk deposits. For the same fortnight, deposit growth stood at 11 per cent over last year. Credit-deposit ratio for the sector remains stretched at 77.6 per cent, a 274 bps increase over last year.
Within the loan book, the share of industrial borrowers has shown an uptrend from 2010, and now stands at 44.7 per cent (as on November 30, 2012). However the pace of growth in this segment has clearly come down from approximately 20 per cent in 2011 to 17 per cent in 2012. Retail loan growth, on the other hand, has shown resilience and banks have focussed on retail assets, growing 16 per cent over last year.
Private banks are better leveraged to the retail segment and are more likely to benefit from the cyclical recovery, with close to 35-50 per cent of exposure towards retail for larger banks. PSU banks have less than a 20 per cent retail exposure and have significant exposure to sensitive sectors such as infrastructure, metals and agriculture.
In this respect though, some PSU banks are better placed than their peers. SBI has a strong retail lending focus while Bank of Baroda has consistently witnessed above-industry loan growth due to strong presence in States such as Maharashtra, and Gujarat.
Pressure on NIMs
Private sector banks have been able to maintain margins due to a more stable (CASA) ratio, lower slippages and quicker asset re-pricing. Gaining market share in CASA has given private banks an inherent advantage over PSU banks. This will help private banks to sustain and even marginally improve NIMs over FY14. On the other hand, moderating CASA ratio and higher slippages will continue to weigh down on PSU bank margins. On an average, private banks command about 40-50 basis points (bps) better NIMs than PSU banks.
The RBI kept both repo and cash reserve ratio (CRR) rates unchanged in December. Expectations remain high for a rate cut in January. However, the repo rate cut will not result in lower deposit rates unless the central bank cuts CRR also to improve the liquidity situation. Hence with cut in lending rates, Net Interest Margins for banks are expected to be under pressure in the next few quarters, more so for the PSU banks.
Given the high cost retail deposit base, PSU banks are expected to witness more pressure on NIMs. In a falling interest rate scenario, PSU banks will be under more pressure to cut lending rates to drive their credit growth.
Asset quality concerns
Asset quality concerns have been on the rise at the back of economic slowdown and global financial crisis. Gross NPAs for the banking sector increased from 2.4 per cent in 2008 to 2.9 per cent in FY12. Restructured assets increased to 5 per cent in FY12 compared with 3.9 per cent in FY11. While the GNPA for most private banks is at 1 per cent, for PSU banks it stands at 3-5 per cent for the latest quarter.
Asset quality issues have been pronounced in case of PSU banks, indicative in the increasing restructured asset and expanding GNPAs. With increased focus on small-medium enterprise (SME)/agri loans, asset quality issues are expected to further intensify. Loan restructuring, on the other hand, is expected to continue with the risk of further slippages.
However, within the PSU space, Bank of Baroda is comparatively better placed than its peers. It has the lowest slippages at 2 per cent and GNPA at 1.9 per cent. PNB, at the other end of the spectrum, has witnessed steep slippages in the agri/SME segments. The NIMs also significantly fell from 4.1 per cent to 3.5 per cent over two years. The bank is now shedding high-cost bulk deposits and focusing on retail loan book. With low valuations (0.8 times one year forward price-to-book value), any turnaround in the form of better-than-expected asset quality, higher retail loan growth and NIM improvement, will be key triggers for the stock. While valuations suggest a buying opportunity in PSU bank stocks, structural risks within the space will not change dramatically, particularly for the smaller banks.
Key will be to watch out for factors such as fresh slippages, loan restructuring, CASA mobilisation and loan growth, which can signal a comeback for many of these stocks.