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Limited investment opportunities among PSU bank stocks

While leading private sector banks will continue to do well, few PSU banks show promise. Investors may opt for select lenders with low net NPAs.

, ET Bureau|
Updated: Feb 05, 2018, 12.31 PM IST
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Investors may opt for select lenders with low net NPAs such as Bank of Baroda and Vijaya Bank.

The banking sector has been leading the market bull run for quite some time: The Nifty Bank Index has outperformed the Nifty 50 Index over a 3-year period. And largecap private sector lenders such as HDFC Bank, Axis Bank, ICICI Banks, among others, have led the charge. Not surprisingly, the Nifty Private Bank Index has beaten the Nifty 50 and Nifty Bank comfortably over a 3-year period.

PSU banks, however, have not only underperformed the broader banking index, they have actually lost money. The Nifty PSU Bank Index has made an absolute loss of 14% over the past three years, even as the Nifty Private Bank Index made an absolute gain of 43%. Without the 30% jump in the Nifty PSU Bank Index on 25 October 2017, triggered by the government’s announcement of infusing capital in PSU banks, the loss would have been even greater. Given the general state of PSU banks, does the segment offer select investing opportunities?

Recapitalisation blues
A closer look at the Nifty PSU Bank Index reveals that it did not make further gains after the 30% spike on 25 October 2017. The government’s list of PSU banks receiving the first tranche of money under its bank recapitalisation plan not being in line with the Street expectations was the key reason for this. Initially, the government had stressed that the focus of their recapitalisation plan will be growth, and the Street expected that the bigger and healthier banks would receive a higher share of new capital. However, Rs 52,300 crore of recapitalisation bonds—around 65% of the first tranche of Rs 80,000 crore—went to banks classified by the Reserve Bank of India (RBI) under its prompt corrective action (PCA) category. For example, Uco Bank, with gross nonperforming asset (NPA) ratio of 19.7%, received the second highest sum of Rs 6,507 crore 112% of the bank’s current market cap. “While the announcement of the first tranche of recapitalisation is an overall positive for the banking sector, it was not in tune with Street expectations,” says a report by Jefferies, an investment bank.

However, the government’s move to recapitalise banks has improved the overall financial situation of PSU banks and they are now in a much better position compared to a few quarter earlier. “After recapitalisation, some of these banks will be able to raise capital from the market, improve their capital adequacy ratios, and can start looking at business growth,” says Siddharth Purohit, Research Analyst, SMC Institutional equities.

PSU banks languish at the bottom
Nifty PSU Bank has made an absolute loss of 14% over the past three years

NPA worries
PSU banks’ recapitalisation aside, investors are still worried about the NPA issues faced by these banks. “The stock market performance of PSU banks will be subdued for the next few quarters because the positive news (capital infusion) has been discounted. However, the negative news (NPA write offs) will come in the next 1-2 quarters,” says Asutosh Kumar Mishra, Senior Research Analyst, Banking, Reliance Securities. Several banks such as Indian Overseas Bank, Uco Bank, United Bank of India and Bank of Maharashtra with gross NPAs of 22.7%, 19.7%, 18.8% and 18.5% respectively have to make huge provisions. And because of these provisions the banks will report huge losses in the next few quarters. However, there is no need to panic, as most of these NPAs have already been reported under National Company Law Tribunal (NCLT) and are not a major surprise. Due to PSU banks’ NPA issues, the market continues to prefer private sector banks despite the rally in private sector banks’ stocks. “Private sectors banks will continue to grow and, therefore, my preference is still for the well-managed private sector banks such as HDFC Bank. Among PSU banks, Bank of Baroda and Vijaya Bank are fine,” says Purohit. Please note that among the PSU banks that were recapitalised, Vijaya Bank and Bank of Baroda, with net NPAs of 4% and 5.1% respectively, have the least asset quality-related issues.

Bond yield issues
The recent jump in bond yields is another factor that is troubling PSU banks. Long duration government bonds have crashed in recent months—yield on bonds maturing in 2027 have already crossed 7.6%—and all banks holding long-duration bonds have had to write down their holdings, widening their losses. If we go by absolute numbers, SBI will take the maximum hit due to rising bond yields. But one needs to look at the extent of losses based on what percent of banks’ overall holdings comprise long-duration government bonds. “Smaller PSU banks under PCA will take the maximum loss hit in percentage terms because most of their new deposits were invested in treasuries,” says Mishra. The reason why smaller banks classified under PCA are facing the maximum heat is because while the RBI put restrictions on these banks giving new loans, there was no restriction on accepting deposits, and these banks had no option but to park these new deposits in government securities.
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