PSBS shine on bumper FY21

Low valuations, expected improvement in financials drive interest among analysts

For about 13 years, foreign brokerages had halted sectoral coverage of stocks of public sector banks (PSBS). That has undergone a sea change, with Morgan Stanley’s March 3 report listing their analysts’ order of preference for PSB stocks.

The reason for this change is three back-to-back quarters of good results in financial year 2020-21 (FY21).

“State-owned banks’ balance sheets have improved, and bad loan formation should moderate going forward,” the analysts note, and this is the key reason for reviewing their stance on PSBS.

While State Bank of India (SBI) remains their preferred pick, Bank of Baroda (BOB) and Punjab National Bank (PNB) have been upgraded from ‘underweight’ to ‘equal-weight’. The brokerage maintains its ‘underweight’ recommendation on Bank of India and Canara Bank.

In recent times, other market experts, too, have recommended PSBS because of the improvement in their business.

For investors, the question is whether this signals a strong comeback in sentiments for PSB stocks or if it is just a one-time revisit of stance.

Among PSBS, SBI’S share price has gained over 40 per cent over the past year, and returns are comfortably in the green even on a 2-3-year horizon. However, this isn’t the case for its smaller peers. In other words, unlike for private banks, it’s tough to draw a secular trend for PSB stocks as far as rerating is concerned.

Though PSB stocks have appreciated by 30-40 per cent in the past three months, Sridhar Sivaram, investment director of Enam Holdings, says sustainability of the rally is tough to predict at this juncture. “While there is a broad case made out for the PSBS, it’s not a structural narrative yet; it’s more a case of recovery,” he explains.

The average credit cost of PSBS in FY18 peaked at about 400 basis points (bps).

In the December quarter (Q3) of FY21, the number lowered to about 220 bps and Morgan Stanley expects a further 20 bps easing by the end of FY21 to 198 bps. By FY23, the expectation is that the average credit cost for PSBS will reduce to 127 bps, a level last seen in FY12. Analysts say a 1 per cent (100 bps) reduction in provisioning cost could boost net profit by 3-4 per cent.

In addition to the potential improvement in earnings, PSBS are trading at less than 0.7x book value,

If PSBS prove their ability to raise capital independent of the government’s infusion, that would give a big boost to sentiment

which makes a strong case for considering them as tactical buys. According to Sivaram, with every bank having massively provided for its legacy issues, “there isn’t much trouble left, except for those that could crop up because of Covid”.

The Covid-related pressure could be higher on agri loans, small and medium business loans, and possibly mortgages. Slippages from corporate book, which accounts for over half of PSBS’ loan assets, is seen as quite negligible.

Yet, despite the optimistic outlook on earnings, if the Street lacks strong conviction on PSBS, it is for the want of structural reforms such as a marked improvement in underwriting practices or corporate governance standards.

Analysts at Morgan Stanley note that the margin of safety or the potential bad loan absorption capability, given the availability of capital or provisioning buffer, is softer for PSBS than for their private peers. “Margin of safety at PSBS (excluding SBI) is lower at -1 to 5 per cent; 6 per cent for SBI and over 10 per cent at private banks,” the analysts note.

So far, barring Canara Bank, other PSBS haven’t had much success while shopping for equity. If PSBS prove their ability to raise capital independent of the government’s infusion, it would give a big boost to sentiment.

The Street will closely monitor the success of BOB and Indian Bank’s fundraising this month, given both enjoy reasonable preference among domestic brokerages, to gauge if investors are indeed willing to put their money on the PSB turnaround story.