Govt lax on PSU banks, avoid until capitalised: Macquarie

Latha: Let me start with the PSU banks since your scathing notes also have a lot of deep sense of humour and comedy when you analyse these banks. There have been some incremental efforts, the CMD post has been split, some eminent guys have been shortlisted as Chairman; we don’t know, the final clearance hasn’t come. MD interviews are underway and then banks have got some ability to take over promoters who are not behaving themselves. Isn’t all this adding up to something in favour of the PSU banks?

A: I agree these are definitely some steps in the right direction. However, government has delayed all these things. If you look at it, six to seven large public sector banks have been running without proper executive managing directors for the past 6-12 months. Some of them were also retiring. So, the government was very well aware of the kind of attrition issues in public sector banks and it has taken a lot of amount of time for them to act upon.

The government doesn’t have time at this point in time considering the way the public sectors banks are. So, that is where the problem has been that there has been a lot of delay.

Secondly, it is too naive to assume that one guy coming at the top can change the system. So, there are going to be a lot of structural challenges in trying to turnaround these public sector banks and that is where I remain a bit more sceptical at this point in time.

Sonia: You have a couple of private sector banks that you are advising a buy on and out of that ICICI Bank is one stock that has lost almost 20 percent from its highs. There is that continuous worry about the exposure that ICICI has to JP Associates and the fear of it turning NPA, etc but do you think this is a good level to invest into ICICI Bank?

A: The risk reward is very favourable at this point in time. If you look at it, the core business itself for ICICI is at about 1.4-1.5 times on an FY17 basis. People are forgetting the fact that despite the stress which ICICI has faced on their books, they have had the ability to provide for their bad assets. So, they have managed to improve their margins and it is a very smart thing that ICICI has done.

It is very surprising that the stock has lost 20-25 percent but then earnings have not been cut even by 0.5 percent by the street. So, there is some kind of a mismatch between what the bank is delivering versus what people are thinking it could turn out to be and that is where the opportunity lies at this point in time.

So, we are positive on ICICI, there could be some near-term pressures in the stock. The stock does get traded as proxy for the economy as well as the banking sector and the macroeconomic stuff is a bit more negative be it inflation or rate cycle. However, nevertheless, longer term ICICI is still a good pick to own at this point in time.

Latha: If you looked at the restructured plus NPL numbers as of March 2015, the total for the system comes at 4.45 percent for gross NPLs and if you add the restructured it comes to 10.9 percent. Yet we had an IMF report almost around the same month, May, saying that 36 percent of Indian debt is under strain. What could they be referring to; this is a huge difference, where is 10.9 percent and where is 36 percent?

A: 10.9 and 11 percent would be the right number to look at it and for the public sector banks the number is closer to about 13 percent odd. 36 percent I think they are trying to include some SMA2 advances – whether they have got an access to that kind of portfolio; I am not pretty sure.

However, if you look at it the informal channel checks, it actually reveals a number that the SMA2 advances are very large; almost twice or thrice the size of gross NPLs of the banks. So, if you were to take that into account, you are possibly taking about an additional 10 percent getting added to the overall 10 percent number. So, numbers could look large if I were to add SMA2. Otherwise you have to go by the 13 percent number for public sector banks.

Latha: Is there no valuation argument at all for some public sector banks?

A: The valuation argument could have been given at 0.8 times price to book, 0.7, 0.6 – the stocks today are at 0.5 and 0.4. These guys can go to 0.2. The valuation argument is pretty senseless at this point in time because the book itself is in question. In banks if you lose 2 percent of the loan book you are literally losing 30 percent of the networth.

So, the point here is, valuation at this point in time doesn’t necessarily make sense to look at considering the kind of stress these public sector banks are facing. More importantly, the issue of capitalisation is a very big issue which the government has just failed to address completely. Till that time, that issue is addressed properly by the government there is absolutely no sense in owning any of the public sector banks at any level.

Sonia: Let us talk about one of your private sector banking picks which is Yes Bank. That stock has not moved anywhere in the last five to six months and the exposure that Yes Bank has to a couple of risky sectors like power has in fact gone up over the last three to six months. Would that not worry you and would you still recommend it at these levels?

A: They have of course always been very judicious in their selection of assets. Most of the exposures that they have entered into have been post 2009 and 2010 when the problems for the power sector as well as several of the sectors were clear. So, they have been very choosy in their project selection. Look at it this way that they have zero restructuring on their book or very little, so, clearly they don’t have any legacy issue to deal with compared to say that of an ICICI or an Axis which do have some restructured assets and of course all the public sector banks.

So, we still prefer YES Bank and more importantly the story in private sector bank is that they will gain market share from public sector banks who are not doing well at this point in time. If that is the case it is better to take exposure to a bank which has the least amount of market share and can grow faster than others. The visibility is also pretty high when it comes to earnings and growth. So, Yes Bank remains a top pick at this point in time.

Latha: Your note after your last interaction with your investors indicated a fondness for housing finance companies especially Indiabulls. Give us a word on NBFCs in general and housing finance in particular your picks?

A: In case of housing finance companies, the biggest advantage is the fact that the growth is somewhat secular in the sense that you can still have an 18-20 percent kind of a loan growth; there is still quite a bit amount of demand there. Secondly unlike the other banks in the country they don’t have any issue of NPLs as well as capital at this point of time. So, that is the reason the earnings visibility is very high and we do recommend going overweight in housing finance companies.

The problem is in some cases the valuations are pretty uncomfortable or very high and therefore it is very difficult to recommend them. However, considering the risk reward at this point in time, we would be a bit more favourable towards LIC Housing Finance which could be the preferred way to play the housing finance companies. We don’t cover Indiabulls Housing Finance.