Has the time come to look at state-run banks seriously?

The key question that investors should be asking now: has public sector banks (PSBs) done much better job in Q1 FY19? They indeed have, with much lower slippage compared to the previous quarter and lower credit cost leading to lesser reported loss. But is it time to go out and buy any PSB stock? The answer is no, as we have often reiterated, be selective.

In Q1, 21 listed PSBs reported an aggregate net loss of Rs 16,615 crore as compared to an aggregate net loss of Rs 62,681 crore in the preceding quarter. It is pertinent to note that in Q4 FY18 only two banks had reported profits, while in Q1 seven banks (almost one-third of the universe) have reported a profit. The change is squarely on account of lower incremental slippage as a large part of the bad assets were recognised in the previous quarter after the Reserve Bank of India’s February 12 circular.

In contrast to a provision of Rs 128,699 crore in Q4 FY18, total provisions declined to Rs 63,010 crore in the June quarter. What is heartening to note here is that nearly all banks barring a handful have now seen provision coverage in excess of 60 percent, which means that if fresh toxic asset formation cycle ends soon, the requirement of incremental provision would wane in coming quarters, thereby resulting in the return of the much awaited virtuous cycle of profitability.

Q1 also saw some improvement in core performance led by net interest income (NII, the difference between interest income and expenses) as resolution of few insolvency cases led to some write-back and lesser interest reversals on account of lower slippage. Consequently, NII grew 16 percent sequentially to Rs 59,930 crore.

All that sounds straightforward and a tad too rosy. Investors need to remember that 11 out of the 21 PSBs are in RBI’s prompt and corrective action list (PCA) and their improvement needs to be monitored closely. Of the 11 banks under PCA, while the sequential performance was better, only two were profitable in the quarter under review.

Although the lower provision might provide a kicker to earnings in the medium term, banks have to profitably grow their balance sheet, have the requisite capital to be able to do the same and have the right liability profile to compete in the market for growth to sustain in the long term.

In terms of business, banks under PCA framework have been faring poorly. Only three out of the 11 banks have grown their deposits in the past one year. On an aggregate basis, deposits have de-grown Rs 89,302 crore. In advances, the picture is bleaker with only two out of 11 banks reporting year-on-year (YoY) growth in advances. The aggregate decline for the 11 is to the tune of Rs 122,119 crore.

In the system, incremental growth in deposits and advances from June last year to June 2018 has been to the order of Rs 9.8 lakh crore and Rs 8.8 lakh crore, respectively, which was grabbed by private banks and non-PCA PSBs. PCA banks have lost share in aggregate deposits from 23.3 percent in June last year to 20.8 percent in June 2018. Their loss in aggregate advances is higher from 22.1 percent to 18.2 percent.

The data point brings to the fore that 10 non-PCA banks and private sector entities have clearly gained at the expense of PCA banks. For 10 non-PCA PSBs, their aggregate share in total deposits and advances have fallen by close to 100 basis points in the past one year, which is the share they have lost to their private counterparts. However, their absolute share in deposits at 50.8 percent and advances at 51.8 percent is still meaningful.

Source: Company

Banks like State Bank of India, Canara Bank, Union Bank of India and Vijaya Bank have seen meaningful incremental market share in deposits, whereas Bank of Baroda, Canara Bank, Indian Bank, Punjab National Bank, SBI and Vijaya Bank have seen a strong growth in incremental advances.

Source: Company

Most banks have a large and decent sized balance sheet to take part in the economic recovery. However, with everyone in the system chasing quality credit in order to de-risk their book, it makes sense to look at banks that have a strong liability profile in terms of low-cost deposits.

Source: Company

Finally, availability of capital will be a key differentiator as only the well capitalised entities will be able to grab market share vacated by banks under the PCA framework.

Source: Company

We do not expect large scale capitalisation of PSBs ahead of any significant restructuring in that space. In the interim, banks without capital buffer wouldn’t be in a position to grow. Hence, we would stick to relative quality in the PSB universe.