Running out of turn

Are you someone who believes private sector banks are always better than public sector ones — on every count? If yes, the reaction of the market in the past few weeks must have been baffling. Banking stocks have been rising for over a month now, encouraged by improving liquidity conditions and the introduction of the Banking Amendment Bill in Parliament. Since November 20, 2012, the Bank Nifty has moved up 9.7%. But here’s the shocker: against the Bank Nifty in which public sector banks (PSU) comprise only 24.1% of the index, the CNX PSU Bank index has gained 15.51%. For once, it seems as if public sector banks are outperforming their private sector counterparts.

But is this optimism for real? “The market had been rallying on expectations of a rate cut by the Reserve Bank of India and the Banking Bill,” says Nitin Kumar, an analyst with Quant. Perhaps the good news ends here. Now that the central bank has refrained from cutting rates, analysts believe it is premature to get excited about the sector, particularly because the non-performing assets pain is still lingering over PSU banks. “The current non-performing loan cycle is different from earlier cycles in terms of the extent of asset quality destruction that has already taken place,” points out Krishnan ASV, research analyst, Ambit Capital. The proportion of impaired loans, including restructured advances, is in excess of 7% of the total advances for the banking sector in June this year, the highest since the Lehman crisis of 2008. “Three-fourths of these impaired loans belong to PSU banks and it is not showing any scenes of abating,” says Krishnan. “Such asset quality destruction entails a significantly higher loss, given default, especially in mid-sized corporate entities,” he adds. 

Despite the rally in PSU stocks, currently, several leading public sector banks such as SBI (1.6x), BOI (1.1x) and PNB (1.3x) are trading cheaper than HDFC (4.7x), ICICI (2.1x), Axis Bank (2.2x) and Yes Bank (2.9x), raising hopes that prices could rise further. But that may not be the case. “In spite of potentially stronger balance sheets from migration towards Basel 3 [the latest global regulatory standard on bank capital adequacy ratio], PSU banks’ lower return on equity implies a ceiling on the valuation multiples that investors should be willing to pay for these stocks,” explains Krishnan.

Indeed, this uptick may not be the real thing, warns Kumar. “The clear picture will come out only after the third quarter of this fiscal year.” Therefore, even if current price trends point to positives for PSU banks, it may be premature to switch loyalties.