While banks have traditionally been seen as safe avenues to store money, the past few months have shown that banking scrips could also be safe investments. In the past three months, the Banking Index has lost only 30% compared with a loss of 41% in the Nifty. The difference in returns is starker when we look at the PSU banking space. During the same period, the PSU Banking Index lost only 18%.
Individual PSU bank stocks also performed better than their private sector counterparts. In the past six months, the HDFC Bank lost 32%, while the ICICI Bank fell 56%. Compare this with the 7-10% positive returns generated by PSU banks like the Bank of India and the Union Bank of India.
Investors seem to prefer banks that are not aggressive in their operations. “Clearly, the fact that PSU banks are more conservative in their operations has played on the investors’ confidence,” says Anita Gandhi, head of institutional business, Arihant Capital Markets. After the sub-prime crisis, a lot of people think that private banks are risky investments because they deal in exotic derivatives. This risk perception has also resulted in a flight of deposits from private banks to PSU entities, adds Gandhi.
This is, however, a recent phenomenon. Till a couple of years ago, private banks were the darlings of investors because they were seen as aggressive go-getters. But during a downturn, the trend reverses. “Due to their aggression, which could have led them to take riskier bets, these banks are now facing major concerns about NPAs,” says Gandhi. The ICICI Bank’s NPAs have risen 48% in this quarter. Compared with this, the NPAs of PSU banks declined by an average 60 basis points over the past year.
Analysts say that PSU banks are in a better position today because stricter controls are imposed on them. But, says Abhishek Agarwal, Research Analyst, Religare Capital Markets: “The regulations governing investments or exposure limits are the same for all scheduled commercial banks.” What PSU banks face is an increased amount of government intervention, including participation in schemes like the farm loan waiver, which are likely to lower their flexibility and put pressure on growth. But this has also helped cushion their fall in the sell-off by the FIIs. “When the FIIs pulled out money from the markets, the private banks were the worst hit as the FII holding was higher in these banks,” says Gandhi. According to current regulations, foreign holding in private banks can be up to 74% against the 20% in PSU banks. The government holding in PSU banks ranges from 51% to 80%, leaving limited room for FII participation. This has paid off now, but things may change when the government offloads its stake in PSU banks.
PSU banks are also strong on various financial parameters. Their capital adequacy ratio is 12-13%, against the minimum stipulated 9%. The average return on equity for 2009-10 is pegged at 20% for PSU banks and 15% for private banks.
All these factors make PSU bank stocks very attractive. Yet, most of them are available at a price to book value of less than 1 compared with a range of 1.2-1.8 for private banks. If you consider their PEs, the HDFC Bank and the Axis Bank are trading at 13 and 7.5 times the 2009-10 earnings, compared with 3-5 times for PSU banks. Given the fierce competition in the banking sector, it is likely that private banks will gain marketshare at the cost of PSUs. But large PSU banks will be unperturbed by this, given their strong balance sheets and huge customer bases. The possible increase in FDI limit for insurance firms and increasing business from public sector enterprises will add to their attractiveness.
And after the silver lining, the cloud. The next quarter may not be easy for banks. The sector moves in tandem with the economy, and though most of the negative is priced in, a further downfall cannot be ruled out considering that the economy is slowing down. However, given the strong fundamentals of some PSU stocks and their attractive valuations, Gandhi expects these to generate good returns over the next two years and recommends buying at every dip. For those who do not wish to track each stock, there are PSU bank exchange traded funds offered by Benchmark and Kotak Mutual Fund. These funds are traded on the NSE and invest in more than 15 PSU banking scrips.
TOP PICKS PSU BANKS
PSU banks are trading at very attractive valuations, with some priced below even their book values. Here are five stocks with the highest potential:
|Stock||Current price||Target price||% Upside||Rationale|
|State Bank of India||1,210||1,772||46%||Largest PSU bank with very large low-cost deposits. Hike in FDI limit good for insurance JV. Advances growing at 31%.|
|Bank of India||257||351||37%||2009-10E RoE at 21.2% and RoA at 1.1%. Diversified loan portfolio, with corporates constituting 40% of advances.|
|PNB||458||650||42%||Fastest growing PSU bank. RoE of ~18% in 2008-10. CASA of over 40%, NIM of ~3.4% and growing provision coverage.|
|Bank of Baroda||254||425||67%||Strong growth in advances. Sustained earnings momentum with 17% CAGR in profits and RoE of ~15% over 2008-10.|
|Union Bank of India||144||200||39%||Net NPA of 0.14% among best in industry. Strong operating profit growth of 57.6%. Fee income to grow by over 20%.|
|Source: Brokerage houses|
THE MACRO FACTORS AFFECTING PSU BANKS POSITIVELY
• Falling interest rates: PSU banks will benefit because they hold long-term bonds of higher coupon rates. These bonds appreciate in value when interest rates come down.
• Diversified portfolio: Low exposure to sensitive sectors like real estate and retail loans lowers risk of defaults.
• Low valuations: PSU banks are trading at price to book values of less than 1 compared to 1.2-1.8 of private sector banks.
• Low-cost funds: Large base of current account and savings account (CASA) deposits gives access to cheaper funds.
• Investor confidence: PSU banks are seen as a proxy to sovereign investment.
• Beneficiaries of government business: The government has asked public sector enterprises to park 60% of their surplus funds with PSU banks.