Shares of PSU banks have been on a tear over the last year, with the Nifty PSU bank index rallying 88 percent. In comparison, the Nifty Bank index, which comprises largely private sector banks, has risen just 13 percent.
Through this explainer, we look at the reasons for this divergence and whether the trend can be sustained.
First up, why the sudden fancy for PSU bank shares?
This has partly to do with the upbeat outlook on the PSU universe as a whole. Once viewed as wealth destructors, PSUs have turned out to be the biggest wealth creators over the last year.
So is the rally purely due to reasons of a change in sentiment for the better?
Not really, PSU banks have reported a good financial performance for the last couple of quarters. The numbers look even better because the previous year’s base was low.
What is driving the improvement in performance?
Till a couple of years ago, PSU banks had a lot of bad loans on their books because of which they were unable to make loans. This led to their losing market share to private banks. The PSU banks have now written off most of their bad loans and their asset quality is much better.
Private sector banks were supposed to be better run and more efficient. Then why is the market chasing PSU banks instead?
Because investors were buying private sector bank stocks for a long time, their valuations had become expensive.
In comparison, public sector banks started looking cheap. Also, when too many institutional investors get into a stock, the performance suffers after a while because anybody who is bullish on the stock already has it in their portfolio. This is what happened with private-sector banks.
Are there other issues with private-sector banks?
Yes, they have been struggling to raise low-cost deposits through savings accounts and current accounts. This has forced them to turn to wholesale borrowing, which comes at a higher cost. This has begun to hurt profit margins. If you don’t grow deposits fast enough, it restricts your ability to make loans. Also, because of intense competition, many banks are finding it tough to charge a higher rate of interest to clients.
But doesn’t the same problem apply to public sector banks?
In a way yes. But PSU banks have a much wider network compared to private sector banks, and hence they have better access to low-cost deposits, compared to most private sector banks other than ICICI Bank and HDFC Bank.
What is the outlook for the banking sector as a whole?
Corporate lending has not picked up in a big way because companies are not expanding their capacities aggressively.
Also, because many large and mid-sized companies now have surplus cash on books because of strong earnings, they are funding a good part of their capex with that.
Besides, the curbs on unsecured lending are expected to hurt private sector banks more than PSU banks.
What makes PSU banks different?
Investors are betting that because the government is spending on capex in a big way, PSU banks will be the beneficiaries. That is also because traditionally, PSU banks have been better at project loans compared to private sector banks, which mostly focus on retail lending. Also, when private capex picks up, it will benefit PSU banks as well.
What about valuations? Are PSU banks cheap?
Compared to historical averages, PSU banks are beginning to look expensive. Traditionally, PSU books used to quote less than one time (stock) price to book value. Most of them are now quoting more than one time the book value.
The valuation gap with private sector banks has narrowed considerably.
Can the high valuations for PSU banks be sustained?
A lot depends on how well PSU banks can grow their earnings. If they manage that, the high valuations can be sustained. At the same time, not all PSU bank stocks can repeat the performance of last year. Investors will prefer to stick with the large ones.
Also, if private sector banks, too, see a sharp uptick in earnings, their stocks will compete for incremental investments into bank shares.
For two reasons: one, private sector banks have been underperforming for a while and so valuations look attractive. Two, investors are willing to pay a premium for private sector banks because of the perception that they are better run and more efficient.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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