Not just falling g-sec yields, but reforms too to aid banks: SBI

The 10-year G-Sec yield falling off a recent peak of 7.5 percent to 7.05 percent has resulted in immediate treasury gains for the banks that hold a lot of these bonds on their books in their available-for-sale (AFS) category.However, bond yields and prices have an inverse correlation.To talk about what is going so right for the sector that have had an extended rally, CNBC-TV18 spoke to Dinesh Khara, MD, State Bank of India and MB Mahesh of Kotak Institutional Equities.According to Khara, even more than the benefit of falling yields, government's focuses on structural reforms will help the recovery process for the sector. Second is the risk evaluation system put up by banks has had a positive impact and, thirdly, it has been the macro-economic situation where the rural economy is likely to pick up post better monsoons, 7th Pay Commission etc. “All these ensure a better landscape for the banking sector,” he said.Talking about the benefits of the new Arbitration Act, Mahesh expects most of the PSU banks to gain from this and amongst private sector he expects ICICI Bank to benefit. However, one must remember that construction is not a big portion of the overall loan book for PSUs; it is only around one percent, he said.Mahesh said if one wants to play the banking space through PSUs then SBI is the best to own because they are very strong on the liability side. The house has a target price of Rs 280 on the stock and further gains too are possible. He said there is a need to factor in much more treasury gains for PSUs.Below is the verbatim transcript of Dinesh Kumar Khara and MB Mahesh’s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18. Latha: What is going so right? Is this just a liquidity rush that is pushing an under owned sector like public sector banks (PSBs) or has business gotten easier in some fashion. Are steel companies paying back and infra companies paying back, is business any better? Khara: First and foremost is of course there are certain things, more coming from the ecosystem the kind of structural reforms which are being pushed by the government, they are something which are going to eventually help banking sector in ensuring the recovery process. The second piece which has really taken firm root in the banking system is the kind of risk evaluations which they have put in place. When the going is difficult naturally banks have really put their act together and also have come to the risk evaluation system which takes care of the potential risk which are there in any kind of underwriting. Third of course the kind of macroeconomic situation in terms of the rural economy looking up better monsoons ensuring rural economy to be better and also the seventh pay commission which will probably give a boost to the consumption demand and also in turn it will have a lag effect on the remaining part of the industry. So, these are some of the things which are ensuring a better landscape for the banking sector and probably the market is also reading the signs well and have started really responding well to the banking stocks. Overall if I can put it like this it is a macro plus the kind of strengthening of the system within the banking system which has augured well and it has also inspired the confidence of the investors. Sonia: I also wanted to talk about the new arbitration act to get the stalled projects moving and that has really been a big positive for many infrastructure companies. So, what kind of an impact do you think this will have on the banking sector, the new arbitration act and which are the banks that could benefit the most? Mahesh: If you look at that particular comfort which the government has given on the arbitration procedure by and large you will see most of the public sector banks being key beneficiaries and in privates we are looking at probably ICICI Bank being one of them. But you must understand that constructions as a space is not a very big proportion of the overall loan book. It is just about one percent. But directionally you are looking at something which is positive because roughly about 25-30 percent of that particular sector has seen a fair bit of stress over the last 3-4 years for lack of cash being received by many of these construction companies. So, directionally it is a very positive move but it doesn't change the entire direction of the gross non-performing asset (NPAs) because of this one specific act. Anuj: What about public sector undertaking (PSU) banks in particular? You think there are more levels now, the stocks have rallied a lot, the under ownership has got corrected, somewhat but there is still a lot of under ownership. Of course treasury gains that we are talking about for this quarter, do you see more gains for PSU banks? Mahesh: Yes, in the sense that do we have to factor more treasury gains, the answer is yes because the initial expectation was not that the ten year will fall below seven percent or closer to seven percent out there but there are still issues on the ground. The good part of it is that on the steel side we have seen a fair bit of resolution but power still there are question marks out there. And if you look at the entire provisions of the back book of non-performing loans (NPLs) which is out there we are still looking at a fairly weak set of numbers but fairly much better than what we were initially anticipating at the start of the year. So, that is how we are looking at these numbers but our broad way of looking at the stocks is probably we are lot more comfortable kind of playing the entire PSU rally through the State Bank of India (SBI) and also to some extent through the private banks who have fairly dominant corporate book which is ICICI Bank out there. That is how we are kind of positioning the sector rather than playing purely through only PSU banks. Latha: You are one of the top buy for most of the brokerages when they want to take exposure to PSBs or even banks in general. But if you can guide us a bit there is this 60 bps fall in government of India securities and maybe more will come as the new ten year becomes the dominant bond as well. There must have been a lot of rise even in AAA paper. What is the investment gain likely to be? Just give us a ballpark idea and will you book some of it. As well what is your exposure to construction and how does the government's payment order benefit you? Khara: As a bank we are very optimistic in terms of the recent guidelines relating to arbitration proceedings and 75 percent of the arbitral amount to be paid off to the contractors. We pursue that it is going to really help the construction sector in a big way and more than the construction sector which are dependent upon the construction sector will also have an impact on it. So, overall though it amounts to not a very big number in terms of the total book size but considering the fact that it will give the kind of a push which will be required by the various other sectors like cement and steel those are the kind of sectors which will also have a smooth flow of cash coming in which will really improve the market sentiments and also improve the activity level in these industries. So, this is a very positive and as regard the book size is concerned about AAA I would not have the numbers readily available with me but yes of course, we are going to have the benefit in terms of the government securities being on our book and also the AAA papers which are there on our book. It is quite a significant number which we have on our books. Latha: At least if you can tell us what is your total Statutory liquidity ratio (SLR) and what is the available for sale (AFS) book? Khara: Off hand I don't recall the number. Maybe I will get back to you separately. Latha: You would be tracking this very closely, are they big gainers of the yields falling, what would the numbers be? Mahesh: Well they are but even I too don't have the numbers off hand. Latha: What is your view on the stock though on SBI particularly? From these levels what kind of an upside do you see over the next 6-12 months? Mahesh: I have said before if you want to play through the PSU banks it is probably the best idea to own simply because they are very strong from a liability side. They can kind of position their branches quite aggressively to originate retail assets as well. They are one of the leading players on the retail side. So, irrespective of where the growth is likely to emerge you will always see SBI acting as one of the key beneficiaries out there and if the economy sees the gradual recovery as most of us are predicting then you should see the credit cost declining as well. So, you should see the gross NPAs falling over a period in time and that is why SBI kind of stands out amongst all PSU banks out there. In terms of upside we have a target price of Rs 280 on the stock but we could see further upside setting in the stock if the gains turn out to be much better than what was initially anticipated. Latha: Is the hump over in terms of recognition of stressed loans, as well should we see something better in terms of upgradation of recoveries in the current or the coming quarters? Khara: As far as the hump is concerned yes for all purposes. Since AQR we had already implemented in total as on March itself and whatever our associate banks also have recognised a good amount of AQR already. Only some bit of it is left out which is likely to get over in this quarter as far as associate banks are concerned. On the resolution piece of course partly it is a function of how the economy will fare and partly it is a function of the efforts which have been put in and also the kind of resolution mechanisms which have been made available by the eco-system. So, we are trying to leverage al the resolution mechanisms. We are hopeful that we are in a position to see better days going forward.