Suresh Ganapathy of Macquarie believes SBI is likely to report fourth quarter numbers in-line with the performance of other PSU banks. "Slippages would be relatively lower compared to the previous quarters, but restructuring would be higher," he told CNBC-TV18.
Overall, he expects the recoveries to be strong in fourth quarter.
In terms of bets in the private space, his top picks are ICICI Bank and Yes Bank. Among the PSU banks, Ganapathy prefers sticking with the larger names like SBI and PNB. However, he thinks that in the NBFC space valuations are too expensive, so he does not recommend any of them.
Below is the verbatim transcription of his interview to CNBC-TV18
Q: The Bank Nifty’s rally yesterday was largely attributed to the big rally in the bond markets as well, Rs 2 rise in bond prices over 24 hours. What percentage of their profits could come from bond prices in the current quarter or in FY14 more importantly? Who would be the winning candidates?
A: It is going to be very difficult to estimate the exact quantum of treasury profits. In 2003-04 when treasury profits used to be 40-45 percent of the overall profits, the bond book today is actually much smaller in relative terms compared to what it was in 2003-04. To that extent perhaps 15 percent of the profits could be contributed through treasury gains, which is going to be relatively better than what we had seen over the past three to four years.
Q: The estimate according to bond dealers and economist is that the 10-year could go all the way to even 6.75 percent over FY14. In that case do you think it would still be gains of only 15 percent or would that be higher then?
A: A substantial proportion of bond book today is in Held-To-Maturity (HTM). We had done an analysis and we found that nearly 80 percent of the bond book is in HTM. So, the available portfolio to sell down and book gains is only the Available-For-Sale (AFS). It is a different issue that banks also tend to sell out of HTM and book it in P&L, which can be done if it is required.
However, RBI generally takes it well if you sell-out of HTM and book gains. It is all going to be dependent upon how well banks try to manipulate the HTM portfolio and book gains. If one is looking only at the AFS portfolio then the amount of gains is going to be pretty limited in my view.
Q: Treasury profits are better this time around in FY13 vis-à-vis FY12. In that case how much of a boost has it actually given the bottom-line? Would the bottom-line for possibly a lot of the PSU banking stocks have looked worse if it was not for this bit of cushioning from treasury income then?
A: Without treasury profits their numbers would have looked much worse in FY13. What is happening is that as and when treasury profits are going up you are in a cycle when asset quality is also turning exceptionally bad. So, much of the treasury profits, which were booked this year were used to provide for bad loans. In my opinion that could also happen again in FY14.
It is not necessary that bad loans come to the extent that we have seen in FY13, but the provisioning guidelines are likely to change, the dynamic provisioning guidelines which are expected in June. That in general seeks to increase the provisioning requirements. So, unfortunately whatever gains you will end up making, you will have to provide for a better coverage ratio or in general improving a provisioning buffer and that takes away much of your profits.
Q: Who would be the best beneficiaries in the PSU space because of the quality of their bond holdings, the length or tenure of their bond holdings? Give us an idea whether you think the worst is over? Whether FY13 first two quarters will start to show receding, declining asset quality problem?
A: Coming to the bond book both PNB and Canara Bank do have high duration AFS book and to that extent they can have relatively better amount of treasury gains. One can actually see that having happened in FY13 itself where these two banks reported much amount of higher treasury profits.
So, one can extrapolate that and expect FY14 also to be a good year for them when it comes to treasury profits. When it comes to asset quality I am a bit cynical out here, because slippages would have come down this quarter, maybe in some cases flat on a Q-o-Q basis. However, unfortunately restructuring has picked up to a great extent.
More importantly, the right way to look at the asset quality metric in the banking sector is the stressed asset formation, which is basically slippages plus new addition to the restructured assets. If we were to combine these two numbers there has been no trend which indicates that these numbers are coming down.
For example, PNB stressed asset formation that was the highest this quarter over the past four quarters. It is pointless that banks are just using the RBI regulatory framework to report higher restructured assets. However, that is an indicative of the asset quality issue that these guys are facing.
Q: Would that restructured assets problem at least stabilise or do you think there could be some big problems with some power plants or power companies declaring themselves Non-Performing Loans (NPL)?
A: Your question is full of maybes and that itself is an indication that a lot is riding on hope than anything else. Currently based on hope I would say that perhaps the second half should be better compared to the first half.
However, with several maybes in the question there is no indication that there is going to be anything improving in the next few quarters. So, I do not think asset quality is likely to improve for the next few quarters.
Q: State Bank of India (SBI) comes out with numbers next week. It is the only big bank which is left and the biggest of them all in terms of reporting. What is your expectation on SBI?
A: It is going to be similar to what other PSU banks have reported. Slippages would be relatively lower compared to the previous quarters. However, restructuring would be higher. If one looks at the reported gross NPL numbers, which have been reported by all these other PSUs, they have actually been flat or declined a bit more this quarter.
One can expect something similar in case of SBI because recoveries have been very strong in fourth quarter. The headline gross NPL number may not necessarily go up. Maybe decline, but the stressed asset formation that is slippages plus new restructuring that should be in my opinion closer to about Rs 9,000-10,000 crore for SBI. That is more or less the levels that you have seen in past few quarters.
Q: How do you look at the three big private sectors banks? Do you think that there could be some regulatory penalties after those sting operations and the RBI investigation report itself indicating fairly serious lapses in some cases? Will that have some kind of a P&L impact because of maybe fresh licenses not given in branches, in tier-1 cities or some other financial penalties?
A: Valuation-wise these private sector banks look a bit more expensive at this point in time, but the underlying fundamentals are very good. In an environment when there is so much of uncertainty involved it is pretty obvious markets or the investors are going to stick to quality and visibility of earnings growth, which is very high in these private sector banks.
Though there can be some short-term upmove or tactical strategy where you can position yourself towards PSU for a falling bond yields, but still from a longer term perspective say a 6-12 months privates will continue to do well because of the better earnings growth trajectory. As far as the Know Your Customer (KYC) allegations are concerned these violations are nothing new. It is not that these private sector banks have indulged. There are a host of PSUs which have indulged in these KYC violations.
During the IPO scam in 2005 many private sector banks were involved and then ultimately the penalties imposed by RBI are quite negligible. So, I do not think the financial impact coming from penalties would be big. There could be other impact for example licenses could be restricted a bit. Perhaps they could toughen up the guidelines when it comes to third party distribution of products, which is already talked about in the monetary policy review.
So, our estimates are that about roughly 3-4 percent of overall total income comes from third party distribution of products for the private sector banks. So that is that risk I would say because of the toughening up of guidelines. Whether there would be any serious financial impact, it all depends upon what exactly the RBI does to branch licensing in case they restrict to a great extent.
Q: Do you look at the gold NBFC space? What is your opinion on Manappuram? There is now an opinion emerging amongst a lot of analysts that maybe there could be a switch to Muthoot which released a good set of numbers as opposed to Manappuram this quarter?
A: Numbers alone do not convey much. The business model is more important when you take a decision of investing in these names. Unfortunately the business model has been put into question. It is very heavily reliant on gold prices moving up in one direction that is up. If the gold prices correct there is a serious issue with the kind of business model that they are running. So, we would be very skeptical.
Note that the churn in the portfolio is very high. So, even if you want to show a 20 percent kind of loan growth your disbursement have to grow at some ridiculous 70-80 percent every year, because the average tenure including of prepayment is only of three four months.
So to achieve that kind of a growth rate when gold prices may be relatively weak becomes very tough. Plus of course the bullet payment of interest itself raises lot of concerns about the kind of effective LTVs that these guys are running in their books. So, I would be very wary of gold financing companies.
Q: What are your buys in banking space PSU, private and even NBFCs?
A: In the private space I would go for ICICI Bank and Yes Bank which are my top picks. In the PSU banks it is better to stick with the large names and therefore I would prefer SBI and PNB. If there is any cyclical recovery these two stocks would definitely benefit. They also have a good franchise so the returns would also be relatively higher.
In the NBFC space valuations are too expensive. I will not recommend any of them. Perhaps considering where the valuations are and the effective power reforms which one is expecting Power Finance Corporation (PFC) would be relatively better.
Q: I thought you would be playing the bank licenses theme. There was a semantic change in the way RBI spoke with the Governor speaking of sufficiently large number of licenses. Would you play that theme now?
A: Certainly not. Look at which banks in India report Return on Equity (ROE) of more than 20 percent. HDFC bank with a Current Account Savings Account (CASA) of 45 percent gets an ROE of 21-22 percent. So, you can imagine that getting a bank license does not necessarily mean it is ROE accretive.
It could be bad for ROE because some of these NBFCs are generating 21-22 percent. ROE today and the cost of statutory appropriations, priority sector lending obligations and stuff and too much of regulatory scrutiny itself can suppress your returns. So, I am not very gung-ho on these NBFCs going for a banking license.