Why the Centre needs to review its recap plan

After the PNB scam broke about two weeks back, there has been an erosion of about ₹32,000 crore in the Centre’s holding in 21 PSBs. In the scam-hit PNB alone, the Centre has lost around ₹8,700 crore.

Reports now suggest that the Centre will wait for further assessment of the fraud at PNB before infusing the earmarked ₹5,473 crore into the bank.

While this is welcome, the Centre also needs to review the massive capital infusion at other PSBs, given the erosion in book value due to the abysmal valuation at which the infusion takes place. In the first tranche of the bank recap plan, ₹88,139 crore of capital was allocated to 20 PSU banks. In many of these banks such as UCO Bank, Oriental Bank of Commerce, Dena Bank, Bank of Maharashtra and United Bank of India, the proposed capital infusion is higher than the current market cap of the bank. In such banks, the erosion in book value is bound to be higher. The recent sharp fall in stock prices would only make matters worse.

Why the erosion happens?

In the past, the government’s tacit backing has only left minority shareholders short-changed. Most of the PSBs have been trading well below their book value in the last couple of years. Capital infused by the government at such abysmal valuations has been eroding the book value significantly.

Let us assume that the book value of a share is ₹100 and it is trading at ₹50 in the market. Now the government pumps in additional capital and is issued one share at the prevailing market price of ₹50. If the book value for two shares (one each for the government and other shareholders) was ₹200, by issuing an additional share for ₹50, the book value for three shares comes to ₹250 – ₹83 for each share.

This fall in book value is reflected in the market price. Recently, PNB has convened an extraordinary general meeting of shareholders on March 16 to seek approval for issue of 33.49 crore shares of ₹2 each at a premium of ₹161.38 per share, garnering an amount of ₹5,473 crore through preferential issue to the government. If this goes through, then given that shares would have been issued at 20 per cent discount to the bank’s book value (as of December 2017), it would have led to an immediate erosion of about 2-3 per cent in book value. The reference date in this case (to decide the pricing) was set at February 14, when the scam came to light.

Had it been set to a much later date, the erosion would have been much higher, given the sharp fall in price of the stock over the past two weeks. A back-of-the-envelop calculation suggests that at the current market price, the erosion could have been as much as 7-10 per cent.

Hence, the recent fall in PSU bank stock prices can hurt investors even more, going ahead.

Low market cap can hurt

Indian Overseas Bank, which has been allocated ₹4,694 crore of capital, has also convened an extraordinary general meeting of shareholders on March 28 to seek approval for issue of shares to the government.

While the details of the pricing are not available in the stock exchange filing, given that the reference date for determining the issue price has been fixed at February 26, the price could be around ₹20 per share. The bank, already having an outstanding share base of about 285 crore shares, would have to issue about 234 crore shares to the government to garner the earmarked capital amount of ₹4,694 crore.

This would imply a sharp 24 per cent erosion in book value straight away. The market cap of IOB stock at around ₹5,619 crore (as of February 27) is only a tad higher than the recap amount.

There are many other banks where the market cap is way below the amount earmarked by the Centre for capital infusion. For instance, in UCO Bank, the Centre has proposed to infuse ₹6,507 crore; the market cap of the bank is just ₹4,891 crore. The bank has proposed to issue shares to the government at ₹31 a piece, a steep 50 per cent discount to its book value of ₹63 (as of December 2017).

Post-infusion, there could be a steep 27 per cent erosion in book value. Dena Bank and Bank of Maharashtra, which have market cap of about ₹2,200-2,300 crore, would also receive a higher capital of ₹3,000-3,100 crore. In these banks, the erosion could be significant.

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