Anil Agarwal, Head of Research-Banks, Asia ex Japan, is more bullish on private sector banks as he expects earnings growth to be stronger in that space
The pace of formation of bad loans has begun to slow down, Anil Agarwal, Head of Research-Banks, Asia ex Japan, Morgan Stanley tells CNBC-TV18.
He sees return on equity (RoE) of state-owned banks between 5-10 percent.
Agarwal is more bullish on private sector banks as he expects earnings growth to be stronger in that space.
On the impact of payment banks on the sector, he feels some of the weaker traditional banks could lose market share.
Below is the transcript of Anil Agarwal's interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18.
Sonia: I was going through your report on public sector undertaking (PSU) banks where you expect to see a 30 percent downside in PSU banks going ahead and you mentioned that the recent upmove is an opportunity to sell. What is your biggest fear when it comes to PSU banks? Does it continue to be asset quality pressures and which are the banks that you are referring to?
A: That is a three day old report and stocks have moved down quite a bit since then. The reason why we have had a relatively cautious view on the PSU banks or state owned banks for the last few years is essentially that we struggle to see how they will make a return on equity (ROE) which is anywhere close to cost of equity, even if I look at next couple of years. If you break down the factors, the profit and loss (P&L) of these banks, as you move ahead, loan growth is likely to remain very weak. So, we expect loan growth from PSU banks between 5 and 10 percent depending on the bank we are talking about. Margins have already been under pressure in the last few years because of non-performing loans (NPL), etc. But I think margins can fall a bit more given that banks have cut deposit rates, but till now they have not touch base rates. But, it is just mathematical because it is formulaic, base rate is formulaic.
So, as you move ahead, base rates will come down and that will pressurise margins. However, from provisioning perspective, while the banks have reported a lot of bad loans, I mean in the last four years, all the Indian banks have reported almost USD 170 billion of new bad loans, the provisioning has been very low because the way provisioning schedule works in India is actually, it is very lax.
So, credit cost will remain high as you move ahead. Our view is that profitability will be weak and then you need to keep putting in more capital which leverage goes down. So, return on equity (RoEs) of these banks in our view would be, depending on the bank we are talking about, would be between 5 and 10 percent. Cost of equity has to be much higher than that. So, I do not see why these stocks should be trading anywhere close to book and obviously they are also losing market share to the private banks. So, it is not even that there is a growth element in here.
Latha: If you looked at the numbers right now and factored in the NPLs and the cost of equity, there would not be any reasons to buy. But are there any intangible reasons why you would buy them? One of the banks has gotten two private sector heads, Managing Director (MD) and Chairman – Bank of Baroda. You have also got refreshing set of Chairman for other banks like Bank of India where an ex-Reserve Bank of India's Executive Director (ED) is taking over as Chairman. Will these intangibles be a reason to buy any of the stocks?
A: We have an overweight on one of the stocks because they got in private sector Chairman and CEO. Our view would be that investors will look at owning these banks if they think that the banks are getting ahead of the problem rather than just carrying forward what we have seen the last two-three years which is that asset quality keeps creeping up, provisioning keeps creeping up, profitability remains weak. If somebody from outside comes in and if they take a fresh look at the banks, that is a big caveat here, and they start getting ahead of the problem, in the sense that they recognise bad loans, they raise enough capital to ensure that bad loan book is taken care of, then you can start thinking of these banks as a entities which can start meeting cost of equity. Because ultimately, if we take a step a back and look at the state owned banks, one of the toughest thing that is for a bank to create its deposit franchise, then most of these banks have very strong deposit franchises. So, if somebody is willing to take that harsh step of taking bad loans, providing for that adequately, raise a lot of capital, you can actually have a fresh start because they have the deposit franchise.
Sonia: In your assessment, in many of the stressed sectors that the banks are exposed to whether it is power, metals or infrastructure, have you noticed any respite as far as stressed assets are concerned? Or has the situation gotten worse?
A: If you look at the bad loan formation number - that had started slowing down, but now you have this whole 5:25 scheme, because we look at 5:25 as another form of restructuring. So, if you start adding 5:25 into the bad loan formation numbers, there has been a pick up recently and probably will keep picking up given what is happening to the commodity price complex and if you look at the media, the kind of numbers which are being talked about for 5:25. So, I would say that our view is, if I go back 12 months, our view was that financial year 2015, will be the worst year in terms of bad loans formation and that will e the peak, but it looks like financial year 2016 can also be as high as FY15 if we add 5:25. So, as of now, no.
Latha: The bigger destabilising or disruptive factor that we are seeing the financial space is the issue of payment bank licences. Now, some like State Bank of India (SBI) have very creatively tied up with a very big telecom player. ICICI Bank would be of course participating through Financial Information Network and Operations (FINO). The banks, some of the big banks are participating, but what does this do to the entire banking space, weaken it or strengthen it?
A: You can look at it from two different perspectives. One is that, these will obviously big competitors for the existing banks. My view again for the better banks is that it is a growing pie; it is not a pie which is not growing. I mean if you look at deposits even now when nominal gross domestic product (GDP) growth is reasonably slow, deposits are still growing at 11-11.5 percent in the system. So, it is a growing pie. So, any good bank, I do not think they will lose share.
So, payment banks, they will take away market share from relatively weaker bank and there are quite a few of those. For the good players, I do not think they are going to lose share. Obviously these guys are going to be predators in terms of market share gain.
But second point, if we look at it from a holistic perspective is that ultimately this will hopefully bring in a significant chunk of unbanked population into the economy. So, in that sense the cash flow in the economy itself goes up and the biggest beneficiary of cash flows going up is the banking system. So, we will only know in hindsight after three or four years or maybe even longer, it is a great step because it will bring in a more of the cash kind of economy into the proper banking system. And for the good players, I do not think they will lose share, in fact they benefit if the banking system as a whole increases.
Latha: I assume you have buys in the private banking space?
A: Yes, we like the private banks. They are just, whichever way we cut it, their earnings per share (EPS) growth depending on the bank we are talking about will be between 15-25 percent for the next couple of years compounded. I look at regional banks but when we look at global banks also, I do not think there is any banking sector which is giving that kind of an earnings growth. So, these stocks are trading at mid cycle or lower in terms of average multiples. I would own them, just buy them and forget about them for a couple of years.