What’s killing bank stocks?
BANK stocks rose in the past two trading sessions. Is it the so-called dead cat bounce or a short-lived rally in a declining trend? Nobody seems to have the answer. The Reserve Bank of India (RBI), in its February monetary policy review, kept the policy rate unchanged. Even if it cuts the rate after the government commits itself to fiscal consolidation in the Union budget, it could be the last of the rate cuts for many months to come. Theoretically, a rate cut could have encouraged the banks to lend more and boost their interest income as well as bolstered the borrowers' capability to pay back.
The worst is certainly not over for many banks in terms of the quality of assets. However, the finance ministry's reassurance that the government is fully aware of the extent of the problem of bad assets of public sector banks and that it will infuse capital in them has probably soothed the frayed nerves of investors. RBI governor Raghuram Rajan has also clarified that there are other ways of pushing up the capital base of banks, including revaluing their assets.
Yet another contributing factor to the twoday rally could be finance minister Arun Jaitley's announcement at an investment summit in New Delhi that the bankruptcy and insolvency Bill could be passed in the forthcoming budget session of Parliament. The joint committee that is examining the details of the Bill is expected to submit its report by the first week of March. Before this two-day rally, on 4 February, 12 of the 39 listed bank stocks-including State Bank of India, the nation's largest lender, and ICICI Bank Ltd, the largest private bank-hit their 12-month low. A day before, on 3 February, five other banks, including Bank of Baroda, tested their lowest level in a year. Of these 17 banks, 13 are government-owned, and for two-United Bank of India and Punjab and Sind Bank-the stock prices dropped to their historic low.
Two-thirds of the listed banks, or 26 out of 39, traded at least at half the prices of their historic highs last week. One of them, Dhanlaxmi Bank Ltd, has shed at least 91% value from its peak, recorded in October 2010. For five other banks, all in the public sector (Indian Overseas Bank, United Bank of India, Bank of India, Oriental Bank of Commerce and Allahabad Bank), the value destruction is between 81% and 90% from their peak in 2010 (barring Indian Overseas Bank, which recorded its historic high in 2008). Similarly, Canara Bank, UCO Bank, Punjab and Sind Bank, Dena Bank and Corporation Bank have seen between 75% and 80% value erosion, from their 2010 price level.
Only three private banks-Dhanlaxmi Bank, Jammu and Kashmir Bank Ltd and Karnataka Bank Ltd-feature in the list of 26 that have seen at least 60% value erosion from their peak. The State Bank of India's value erosion, from its peak, has been close to 53%, and that of ICICI Bank, a little over 48%. The stock of HDFC Bank Ltd has seen the least erosion of value from its historic high, at around 7.5%, and IndusInd Bank Ltd, 8.3%. Kotak Mahindra Bank Ltd has shed 10.5% and Yes Bank Ltd 14.5% from their historic highs.
So, where do these bank stocks stand now in terms of valuation? Going by the price-tobook ratio, a popular valuation metric, Kotak Mahindra Bank is trading at 4.8 times its book and HDFC Bank, around 4.2 times. Both feature in the list of most expensive bank stocks, globally. The only other bank stock that is trading above three times its book is IndusInd Bank. Yes Bank and Axis Bank Ltd are trading more than two times their books, and ICICI Bank, around 1.5 times. All public sector banks are trading less than one time their book value, led by State Bank of India at 0.72 time. Bank of Baroda is the next most valued bank in this pack, trading at 0.67 time its book. At least five state-run banks' market value is less than a quarter per cent of their book value. They are Indian Overseas Bank, Bank of India, Oriental Bank of Commerce, Allahabad Bank and Punjab and Sind Bank.
The biggest concern of the investing community is the quality of assets of Indian banks. Many of them feel that the declared non-performing assets or the NPAs on which the banks do not earn any interest and for which they need to set aside money are an iceberg with a large part of it under water and not visible. Till now, most public sector banks have been revealing their NPAs at their convenience. For instance, higher treasury income in a particular quarter encourages a bank to reveal certain accounts that have turned into NPAs as it has the cushion to post a modest net profit even after providing for it. However, in the next quarter, the same bank may not reveal more-even if the NPAs have grown by this time-if it does not have enough income to provide for it. Most banks do not want to disappoint investors by announcing a loss or even a sharp drop in net profit, but now they will be compelled to do so as the RBI wants them to clean up their books by March 2017. For quite a few of them, the money required to make a full provision for NPAs may wipe out a large portion of their equity and reserves.