Prefer private sector banks over PSUs: Macquarie

The sharp rise in non-performing loans (NPLs) of banks in Q4 is a cause of worry, says Suresh Ganapathy, banking analyst of Macquarie. "The biggest issue has been the pace of restructuring," he adds.

He prefers private sector banks over PSUs."The only buy in the entire banking space currently is HDFC Bank," he asserts. He is neutral on ICICI Bank. "At this point in time, valuations are pretty compelling. More importantly, the management is actually guiding for a very benign credit cost environment even next year, closer to about 70-75 bps credit cost," he elaborates.  He advises investors to avoid banks where there is a management change in the making. "BoB and PNB would definitely be the avoids in PSUs," he adds. Below is the edited transcript of his interview with CNBC-TV18's Latha Venkatesh and Ekta Batra. Also watch the accompanying videos. Q: The sharp rise in non-performing loans (NPLs) has been the biggest highlight of the various banking results that have come out, especially the public sector banking numbers. As some fund managers were pointing out, for some of the banks, it’s almost coming to a point of eroding networth like an Oriental Bank of Commerce or to some extent even an Allahabad Bank. Even in Punjab National Bank, it’s almost as much as the capital adequacy of the company, especially the tier-1 capital adequacy, the restructured assets. Is this becoming a bigger worry than the market factored in? A: Clearly, the biggest issue has been the pace of restructuring. Note that, going ahead, perhaps the pace would reduce because you would not have assets like Air India and SEBs repeating again in the coming quarters. But this is indeed a cause of worry because if you look at the provisioning that these guys do on restructured assets, many of the restructuring have even happened on a zero NPV loss basis. So, they are pretty inadequately provided. If there is any regulatory dictate on increasing the provisioning on restructured assets, clearly there is further potential scope for eroding of profitability in PSU banks. So, the risk does remain in them. Q: How do you approach the banks hereon? Are all of them uniformly an ‘avoid’ for you or do some of them show some sense of turning a corner? In some of the previous laggards like Bank of India, we are actually seemed to be sensing some kind of an improvement in the position, even if it is per se still bad. A: You can never really take a call on these PSU banks based on a single quarter. This quarter could be good, next quarter could turn out to be pretty bad for them. We need to really see whether there is any sustainable trend in asset quality improvements. Unfortunately, we haven’t seen that happening in PSUs. I think the appropriate way to look at them would be you take a haircut on the book value based on what is your estimation of restructured assets. I personally believe that the book values of these banks are overstated to the extent of 15-20%. So, once you take the haircut of 15-20% on the book value and then look at valuations you would get a fair sense of where valuations are in the context of historical averages and then accordingly take a call. So, most of the PSUs are clearly pretty cheap on a reported basis. But if we were to adjust for the restructured assets, clearly they are not cheap compared to historical standards. Q: PNB, there was guidance from the management in terms of asset quality in particular and that’s what actually didn’t go down well with the street in Q4 as well. What is your call on PNB? A: If you look at PNB’s margins, they have been one of the highest in the sector, despite CASA actually having gone down quite sharply over the course of last 12-18 months. So, in our opinion, they have gone ahead and done high-risk lending. That is also reflective in their asset quality. I guess going ahead, in the next couple of quarters, you are going to see continued pain in asset quality. Management themselves are not very optimistic about the trends in asset quality and restructuring would also continue at higher pace. It would look lower compared to the previous quarter because Air India and SEBs would not recur. But still the general problem asset formation will continue to be pretty high in Punjab National Bank. That will be a continued source of worry. So, clearly we would avoid at these levels, despite the stock having corrected quite a bit. _PAGEBREAK_ Q: Do you have a buy in any of the banking stocks then? Would they be in the private banking space? A: The only buy in the entire banking space currently is HDFC Bank. In other private sector banks, we are a bit more neutral. PSUs, everybody is an underperformer at this point in time. But, yes, the preference continues to be relatively towards privates compared to the PSUs. Q: It’s probably brewing trouble in HDFC Bank as well, if the Nair Committee’s recommendations on priority sector lending actually becomes law. There could be of course many a slip between the cup and the lip by the time it becomes law. Would that be a worry because in that case, perhaps some of the transactions they have with HDFC could be in jeopardy? A: The Nair Committee is not very clear about whether housing finance companies are going to be what we call included in the 5% cap. So, the Nair Committee only specifies NBFCs. So, if the HFCs are exempted, I don’t think HDFC Bank will be in a soup. Nevertheless, if you look at HDFC Bank’s priority sector compliance, actually it has increased over the course of past two-three years. So, they are building up the priority sector peace very well into their entire business model and various asset segments. But all said and done, there is going to be pressure on margins coming from the Nair Committee Report. There can be easily 20 bps compression in margins. But that is well within the guided range. Management has always said that they would like to keep margins around 4%. Currently, it is 4.2%. So, there is downside to margins, but HDFC Bank would still be in a better position compared to others. Q: Going into FY13, we all know that restructuring and asset quality is going to be the biggest problem. But who or which bank do you think is more susceptible or is at highest risk at this point in time going into FY13, hence would be a complete ‘avoid’ for you? A: Punjab National Bank stands out in that term because of the large restructured assets portfolio. The other one where I would be a bit more worried about would be Bank of Baroda. This quarter numbers were really pretty bad and the pace of restructuring or for that matter NPL formation will be high. You really need to avoid banks where there is clearly a management change in the making. So, BOB and PNB would definitely be the avoids in PSUs. Q: We also have SBI coming out with numbers this week. Any sort of preview or any sort of estimates you are working with? A: On a YoY basis, the numbers are going to look extremely good, considering that they reported hardly any profits actually in the fourth quarter of last year. So, numbers, on a YoY basis, would look good. But critically the most important factor, which the market would be looking out, is slippages number. I think that number has been Rs 80-85 billion for the past two quarters, second and third. So, fourth quarter in my opinion the management guidance itself has been closer to about Rs 60 billion odd. That’s one very critical number. If the number comes out to be much higher than the Rs 60 billion guided by the management then there can be a correction in the stock. Q: The new securitisation rules have made bilateral sale and purchase of loans less attractive to banks and securitised route as perhaps the more viable route. Would that increase the cost of lending or cost of money for the NBFCs? Are you changing your opinion on any of the NBFCs, especially gold loans? A: That is true. You are going to see the volume of securitisation dipping down quite a bit next year. Not only that, the cost of funding will also go up. Note that they have banned credit enhancement of bilateral assignment. Most of these NBFCs actually add credit enhancement to risk weighted assets and inflate the capital adequacy ratio, whereas if you go through the securitisation route, you will have to deduct credit enhancement from tier I capital. Clearly, these guys are going to go more towards SPV route. It is going to actually act as a big burden on that tier I ratio and effectively leverage will come down. Net-net, the revised securitisation norms are tougher, it is going to act as a bigger drag on ROE for the entire NBFC sector, tougher times for the NBFCs. Q: Do you have a buy on any of them? A: None. Q: Any bank, at this point in time, which you are neutral on, hence you would be looking at some amount of fundamental change and hence there would be a potential for an uptrend? A: ICICI Bank, at this point in time, valuations are pretty compelling. More importantly, the management is actually guiding for a very benign credit cost environment even next year, closer to about 70-75 bps credit cost. I think the earnings upside definitely is there in ICICI to the extent of 15-20% because I don’t think consensus has stuttering in what the management is guiding. If the management is able to deliver what they are actually promising then clearly earnings upside do exist in ICICI. So, ICICI we are a bit more positive amongst the other private sector banks.