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The truth behind Indian PSU banks

Saturday , 13 February 2016

True value of banks are unknown, therefore investors are advised to exercise due caution before they jump in

A very astute investor was once questioned on why he does not invest in banks. To which his curt response was, “I think a bank’s annual reports belong to the fiction section of the library and cannot be relied upon”. Unfortunately, investors have also reached similar conclusions, when it comes to Indian PSU banks.

Bank PSU Nifty has not only shed 50%+ in the last 15 months when it was at an all-time high, it has severely underperformed in Sensex. In fact, India now has a market cap to assets of 2.7 per cent vs. China’s 5.8 per cent – a country which is under similar, if not more stress than India.

As a result of this fall, the sum total market cap of all PSUs listed is slightly more than that of HDFC Bank, even though their assets are 15 times greater than those of HDFC.

Most PSU banks suffered a considerable decline, mainly due to stress on asset quality and loss of faith within the investor community on reported numbers. To make matters worse, no one believes that the restructured assets are likely to go back to a sense of normalcy, no matter how they are resolved. As a result, there is increased fear and distrust around the restructuring process. Banks are also not making it easy on themselves, by not sharing any information with regard to the process or results, in a transparent manner. In addition, investors are concerned about anecdotal evidence that the RBI is forcing stringent recognition of NPLs and capital requirements. For an outsider, the process seems to be haphazard, lacking transparency and potentially more stringent with time.

Further, banks did not benefit from over 125 bps rate cuts, as bond yields hardly changed during the last year.

All this is likely to result in weaker loan book growth, higher NPLs, weak profits and stressed capital. This in turn is likely to lead to a lower return on capital and puts further pressure on valuation. In fact, market experts now expect Indian PSU banks to trade lower than 0.1-0.4x price-book value, such as multiples that were seen in the late 1990s-early 2000s. Given such a scenario, the only plausible way to overcome the current situation is by a large influx of capital.

Is there a bottom fishing opportunity in PSU banks?

With most banks trading at PBV multiples of below 0.5x, there is a natural tendency to view it as a long-term buying opportunity. A few market experts are of the view that now may be a good time to slowly start buying into a few of these banks. However we advise caution as true book value (BV) is not known. With that being said, we can guesstimate true BV, by making few high level assumptions about potential NPLs and arrive at an adjusted BV.

We can safely presume that reality lies somewhere in between the following three scenarios. Scenario 1: wherein books reflect true value of NPLs but banks provide for 80% of it. Scenario 2 & 3: where books do not reflect true value of NPLs, specifically, scenario 2 assumes true NPLs at 2.0x current NPL and provisioning up to 80% of stated NPLs. While scenario 3 assumes true NPLs at 3.0x current NPL and provisioning up to 80% of stated NPLs.

As you can see, 8 out of 24 PSU banks listed will have negative BVs in case scenario 2 assumptions play out, while almost all banks barring two banks will have negative BVs under scenario 3.  Given such wide discrepancy, it would not be wise to make a guess. Instead, we hope that the sooner banks disclose the true state of their balance sheet, the sooner the price fall is likely to stop.

All in all, PSU banks while available at seemingly attractive levels are a risky bet to take, given that their true book values are unknown. While one may try to guess, we would hesitate to do so. In fact, we prefer to advise our readers to wait and let the RBI, as well as banks announce the true extent of problems and BV before we can consider buying into any banking shares. In other words, buy only when you are sure and base your decision around facts.