SBI: Buy

A prolonged slowdown in the economy has impacted public sector bank stocks in the last one year. Besides slowing loan growth, mounting asset quality pressure has eroded the earnings of state-owned banks. The tale has been no different for State Bank of India, the country’s largest bank.

The bank’s earnings have shrunk by 27 per cent year-on-year in the first nine months of 2013-14, primarily on account of increase in provisioning for bad loans.

While the bank’s asset quality is expected to remain under pressure in the near term, fresh slippages may start to ease as the macro environment improves. A pick-up in growth, policy reforms in key sectors, moderating inflation and a stable rupee are positives.

While SBI has one of the highest non-performing assets (NPAs) at 5.7 per cent of loans, efforts are on to contain additional slippages. The bank has set up committees at various levels to identify early signs of stress. Loans above ₹500 crore will be monitored by the Chairman, Arundhati Bhattacharya, herself.

The bank plans to sell its NPAs to asset reconstruction companies. This should enable better recovery of bad loans.

Also, SBI’s restructured assets, at 3.3 per cent of loans, are much lower compared with the 6-10 per cent for other public sector banks. So, an increase in provisioning requirement is less likely than its peers, as tighter provisioning norms come into force from April 2015, when the existing leeway on categorisation of restructured assets will be no longer available. Also, despite the asset quality troubles, SBI remains one of the best capitalised public sector banks with Tier-I ratio of 10.2 per cent after the recent capital raising by the bank.

In the last one month, the SBI stock has recouped its 25 per cent loss over the last year. But even after this rally, at the current price of ₹1,904, the stock trades at 1.3 times its standalone one-year forward adjusted book value (excluding value of its subsidiaries at ₹545 per share). This is lower than its historical five-year average of 1.6 times, but at similar multiples to its peers such as Punjab National Bank and Bank of Baroda.

A pick-up in core income, receding asset quality pressure and cost containment measures should see the bank’s earnings grow by 16 per cent annually in the next two years. Investors can buy into the stock with a horizon of two to three years.

Betting on recovery A large portion of SBI’s loan delinquencies emanates from the small and medium enterprises (SME), mid-corporate and agricultural segments, with gross non-performing assets in each of these segments high at 9 per cent, 11.4 per cent and 10.9 per cent as on December 2013.

Within the corporate segment, a major portion of the slippages is from stressed sectors, such as iron & steel, infrastructure and textiles.

With GDP expected to recoup from a four-year low, recovery in some of these sectors will reduce risks to asset quality. The Government has also been clearing many stalled projects in the last six months. Some recent reforms in the roads and power sectors are also expected to revive the investment activity. As the economy improves and there is more clarity after the upcoming elections, the asset quality pressure in these stressed sectors should start to ease.

To reduce bad loans in the SME segment, SBI has been growing its lending in this space at a modest pace. As of December 2013, the SME loan book grew by about 1 per cent year-on-year and its share in total lending has come down to 13 per cent from 16 per cent in the beginning of the year.

Strong retail portfolio SBI has the largest network of branches in the country. At 20 per cent, the bank’s share of high yielding retail loans is the highest among public sector banks. It has seen a steady growth in this segment on the back of market share gains in the home and auto loan segments. SBI’s large network of branches has helped it maintain a higher share of low-cost retail deposits vis-à-vis its peers. The bank’s CASA ratio stood at 41 per cent as of December 2013.SBI has also seen improvement in its core net interest income in the last two quarters. From just 3 per cent growth in the June quarter, net interest income growth has gone up to 13 per cent in the December quarter.

The hike in its base rates twice in the last six months, should help the bank stabilise its margins. Also, it has raised capital recently — ₹2,000 crore was infused by the Government and ₹8,032 was raised through a qualified institutional placement. This should help in reducing the cost of funds.

However, the NIM may come under pressure if the RBI increases rates. The bank’s headroom to increase its lending rates may be limited given the risk of loans going bad.

The RBI has delayed the transition timeline for Basel III capital adequacy norms from March 2018 to March 2019. While this will provide some breathing room for public sector banks, particularly those with low Tier I capital; SBI being one of the best capitalised PSU banks, will not benefit significantly from this headroom.

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