Home Undervalued Bank Stocks in India – Asset Quality Concerns

Undervalued Bank Stocks in India – Asset Quality Concerns

15th April 2013; (Re-looked on 20th January 2014 – position reiterated)

Many investors buy shares in underperforming companies purely due to the strength of their reserves. Is that such a good thing? Especially with respect to PSU banks which have accumulated huge reserves over the years?

Weak economic growth, high interest rates, uncontainable inflation along with subdued consumption and investment demand have  all played a part in denting the performance of the India’s banking sector.  Are we close to recovery? No clear sign yet but one thing is for sure, no economy can start improving without an improvement in its banking system and in the absence of liquidity. It may be the most difficult question to answer as to whether it is a good time to buy some of the undervalued bank stocks in India? After all, even those who say “it’s good to buy now, if you have a long term investing horizon” have been proved completely wrong over the last 5 years or so. Depending of course on how one defines long term. That said, over the last 3 years or 4 years or 5 years, whatever period you look at, some banks have performed extremely well.  In Particular, private sector banks (Private Banks) have outshone their public sector peers.

Private banks command premium valuation as historically their credit growth rates have been higher with steady margins and better asset quality (i.e. lower NPAs). On the other hand, in the last few years, the performance of Public Sector Banks (PSBs) has declined considerably. Recently, PSB stocks were weighed down by asset quality concerns, intensified by a long period of economic slowdown. PSBs are facing issues like lower credit growth, rising Non-Performing Asset (NPA) levels and are consistently losing market share to private banks which offer better service quality. Many of the PSBs such as State Bank of India(SBI) sit on a pile of real estate assets,  the present value of which no doubt will be huge but one wonders whether the value of their running business is as good? 

Asset Quality Concerns

Asset quality has been a major concern for the banking sector as a whole ever since the start of the economic slowdown and the global financial crisis in late 2008.

Gross NPAs (GNPA) for the banking sector increased from 2.4 % in 2008 to 2.9 % in FY12. For PSBs, GNPAs increased from 2.3 % in FY 2008 to 3.2 % in FY 2012. For private banks, GNPAs declined from 2.7 % in FY 2008 to 2.1 % in FY 2012. The gross and net NPA additions in case of PSBs have been higher largely due to relatively high exposure to sectors like telecom, power, airlines and agriculture which have largely performed poorly over the last few year. Private Banks are more focused on the retail segment, with close to 35-50 % of exposure towards retail whereas PSB have less than a 20 % retail exposure.

Undervalued bank stocks in indiaFor the nine months period ended 31st December 2012 the GNPAs for most private banks stood at ~ 1 %. For PSBs this came at 3-5 % However, within the PSBs, Bank of Baroda is comparatively better placed than its peers. Its GNPAs stood at 2.4 %. SBI, on the other hand, witnessed a high GNPA of 5.3 %.

Pressure on NIMs

Net interest income grew by just 16 % in FY 2012 for the banking industry as a whole. Private Banks managed a 20 % growth while the PSBs were able to register only a 3 % growth. The net interest margins (NIMs) for PSBs stood at 2.76 % in FY 2012 as compared to 2.33 % in FY 2008 while the same for private banks stood at 3.07 % in FY 2012 as compared to 2.69 %. Private Banks have been able to maintain margins due to a more stable Current Account-Saving Account (CASA) ratio. PSBs had not focused on customers who were maintaining valuable relationships with them for years. The PSBs were slow in offering better services and tailored solutions to customers which resulted in many retail clients switching to private banks. Consequently, private banks have moved far ahead and captured a substantial retail market share which has given them an inherent advantage over PSBs. This will help private banks to sustain and improve NIMs in coming years. The switch in favour of private banks may well be permanent in the absence of some drastic incentivising measures by the Governement of India.

Undervalued bank stocks in indiaLower Loan/Deposit Growth

The nine month period ending 31st December 2012 was subdued for lending and showed a credit growth of only 15.2 % over the last year. Deposit growth continues to be slower, with low inflows and banks consciously reducing high-cost bulk deposits[1]. For the nine month period ending 31st December 2012 deposits grew by 11.1 % over the last year.

The loan growth in the coming quarters will remain sluggish as the retail segment is deferring their purchase decision because of the slowdown in the economy, coupled with higher interest rates and high inflation. We believe that investors should be selective in buying banking shares and focus on high quality names. The expectation of a rate cut in coming months could trigger growth for the banking sector. But lower credit growth, higher margin pressure and persisting asset quality concerns may not allow a significant turnaround for some of these undervalued bank stocks in India, specially in PSU’s.

[1] The Finance Ministry defines high-cost deposits, also called bulk deposits, as ‘any amount of deposits solicited at rates higher than card rates’. Card rates are those published by banks for various kinds of deposits.