Public Sector Banks Struggle for Growth Despite Better Valuations

Why are the shares of public sector banks, barring the largest lender State Bank of India (SBI), still trading at a discount to their book value despite a phenomenal rise in stocks in the last one year?

The Nifty PSU Bank Index has gained 83% during the period as against a marginal rise of 28% in the Nifty Bank Index. The private sector index gained just 18%. Against the broader Nifty 50’s 35%, it is clear that public sector banks (PSBs) have been the drivers of gains in financial sector stocks.

To begin with, shares of PSU Bank were among the worst hit even before the pandemic. For perspective, in February 2020, eight months before the market turmoil of the Covid-19 pandemic, shares of PSU banks had fallen by nearly 30%. Shares of PSU Bank fell 45% till April. The subsequent sharp rally made up for this loss, though not completely. Indeed, some analysts believe the valuation does not reflect complete optimism.

“We believe that the corporate NPL (non-performing loan) cycle has come down, and we expect gradual moderation in credit cost, thereby improving profitability… Thus, PSU banks ( Current valuation of SBI (excluding SBI) is at 0.5-0.7. x FY23E P/ABV (Price Adjusted Book Value) is not fully priced in the upcoming RoE (Return on Equity) recovery as we expect to see earnings manifold in the coming years expects to increase,” analysts at Motilal Oswal Financial Services Ltd wrote in a 21. November note.

Compared to their private sector peers, state-owned lenders have been successful in reducing their bad debt pile. For the September quarter, the gross bad debt stock of PSU banks was down 5% compared to a year ago, while private sector lenders grew by about 8%. National Asset Reconstruction Company Limited (NARCL) is expected to further reduce this burden, thereby boosting earnings per share for lenders to public sector banks. With already high provisioning levels, chances of drawing out a large chunk of profit for bad loans in the coming quarters are slim. As a result, PSU banks can show decent growth in quarterly profits.

However, perhaps there is a more sensible reason for public sector lenders to still fall out of favor in terms of valuations. Despite the decline in bad loans, about 9% of the total loan book of public sector banks remains non-performing as of September.

More importantly, PSU banks are still hungry for balance sheet growth. For the September quarter, public sector lenders excluding SBI reported contraction in their loan book at an aggregate level. On the other hand, private sector banks saw their advances grow at a faster rate of 10%. While management’s remarks suggest that credit growth may jump in the second half of FY22, it would be a stretch to expect double-digit growth.

In the last decade, the picture of development is more uncertain. Public sector lenders have lost debt market share to their private sector peers. Their stake (including SBI) has come down to 56% in FY11 from 56% in FY11. Much of this can be attributed to the bad debt cycle which is now on a downward trajectory. Although the merger has strengthened their balance sheet to lending, their capital ratio is nowhere close to that of private sector peers.

Now with NPLs coming down, analysts expect growth to pick up. However, it depends on how fast the demand for credit from companies grows. Here, the signs are not as good as they are portrayed. Analysts at Emkay Global Financial Services Ltd expect credit growth to remain sluggish.

In a November 17 note, he said, “We reduce our systemic credit growth projections for FY22 from 9% to 8%, taking into account the impact of the continued slowdown in corporate credit on PSBs and some large banks. ” Unless balance sheet growth is close. PSU banks may find it difficult to demand their book value.