The bank stands out because of its sheer size and relatively better operating performance among public sector banks, which are fast losing their relevance in the financial system.
State Bank of India (SBI) reported a Q4 FY18 loss of Rs 7,718 crore on account of a spike in provisions for bad assets and huge mark-to-market losses on its investment book. The bank has recognised a significant part of its stressed assets as non-performing. This comes on the back of Reserve Bank’s revised stressed asset recognition framework dated February 12, which resulted in greater slippages and provisioning. Consequently, the provision cover improved and remains healthy at 66 percent.
The bank is grappling with asset quality issues arising out of its corporate exposure since the past many quarters. While some asset quality pain might persist for a couple of quarters, the end seems certainly near.
The bank stands out because of its sheer size and relatively better operating performance among public sector banks, which are fast losing their relevance in the financial system. We expect a faster recovery for SBI in contrast to many small-sized public lenders. The management’s guidance of reduced credit cost for FY19 and improvement in return ratios in FY20 provides near-term direction to investors. While FY19 remains a year of consolidation, reported numbers should improve significantly from FY20.
Earnings at a glance
Despite a 5 percent YoY growth in advances, the bank reported flat net interest income (the difference between interest income and expense) due to a downtick in net interest margin (NIM) and significant interest reversal as a large quantum of assets slipped into the non-performing category. Non-interest income growth was subdued at 5 percent YoY as healthy growth in core fee income at 11 percent YoY was partly offset by lesser trading income from the investment book.
Growth in operating expenses were contained at 2.7 percent, though cost-to-income ratio inched up to 50.18 percent (64 bps YoY) due to lower net income. Despite providing for a wage hike and gratuity in Q3, staff expenses declined 2 percent in FY18 as staff strength reduced by 15,762 employees. Growth in the number of employees will be restrained in near future as new recruitments are expected to be lesser than retiring employees. However, employee cost might still be high as bank partly provided for revised gratuity ceiling in the quarter gone by. The balance would be provided in the next three quarters. Pre-provision operating profit (PPoP) was flat YoY.
There was significant increase in FY18 MTM provisioning to the tune of Rs 8,088 crore in the investment book, most of which was provided for in the last quarter. Investment depreciation was on the back of hardening bond yields. The bank has not availed of any benefits under RBI dispensation, which allows for amortisation of MTM losses, and instead provided fully on the same. This along with the spike in loan loss provisions by 28 percent YoY due to higher slippages, while keeping a decent provision cover of 66 percent, resulted in widening of FY18 losses.
Deposits increased to Rs 25,85,320 crore, a growth of 5 percent YoY, in line with advances growth. Current account-savings account (CASA) ratio remained healthy at 46 percent as at the end of March. Capital adequacy of the bank remained comfortably above the regulatory requirement at 12.6 percent as compared to 12.85 percent last year. Despite negative internal accruals, the bank’s Tier I ratio improved to 10.36 percent due to fund raising of Rs 15,000 crore via a qualified institutional placement (QIP), Rs 2,000 crore through AT1 bonds, and Rs 8,800 crore infusion by the government last year. Credit risk weighted assets (RWA) to advances declined 780 bps from 79 percent in FY17 to 71 percent in FY18, indicating improvement in the quality of incremental book and less capital consumption.
Asset quality: Large cleansing done
Slippages surged to Rs 33,670 crore last quarter, which is almost 7 percent of the loan book, pushing gross non-performing asset (NPA) ratio to 10.91 percent (180 bps YoY). Around 50 percent of slippages was from the watch-list which is comforting. There was one large telecom exposure from outside the watch-list that turned into an NPA. Moreover, all strategic debt restructuring (SDR) accounts were recognised as NPAs in line with RBI’s new directive on stressed assets.
In addition to GNPAs, the bank’s stressed asset loan pool, popularly known as watch-list, is key to its future asset quality. The watch-list encompasses all special mention accounts, with power sector loans constituting 41 percent of the list. The bank’s watch-list has declined to Rs 25,802 crore (1.3 percent of loans) as compared to Rs 50,500 crore (2.8 percent of loans) in 3Q FY18. While the watch-list puts upward pressure on GNPAs, the comforting factor is that the bulk of the bank’s power exposure is towards state-owned utilities and hence less likely to slip.
We are most enthused by SBI’s higher provision coverage ratio (PCR) of 66 percent. The bank’s total exposure to corporates undergoing resolution through National Companies Law Tribunal (NCLTL) stands at Rs 77,630 crore, and PCR on the same stands at 63%. If the haircut (difference between amount recovered and bank’s exposure) is less than the provided amount, then there will be write-back of provisions.
Guidance provides some direction
SBI’s management sounded very confident on asset quality, with bulk of the recognition in place. It expects FY19 and FY20 slippage ratio to reduce to around 2 percent and less than 1.3 percent, respectively. The management also clearly articulated the targets which it endeavours to achieve by FY20. It aims to deliver return on asset (RoA) of 0.9-1 percent while improving GNPA to below 6 percent and maintaining provision cover above 60 percent by March 2020. With much lower NPA formation in FY19 and FY20 and normalisation of credit cost, the target looks achievable.
Best positioned to play the asset cycle
While reported earnings were weak, we are encouraged by the improving outlook. We expect asset quality pain to persist for a couple of more quarters and credit cost to trend downwards over the next two years. Earnings will gain traction as provisioning reduces and bank levers the capital for loan book growth. A successful equity raising in the coming months will be an added trigger.
With a potential improvement in return ratios, the current valuation of 1.1 times FY20e price-to-adjusted book value looks undemanding. Moreover, SBI could benefit from the ongoing resolution of corporate cases through NCLT. A favourable resolution will be a positive trigger for the stock. The bank is also looking at unlocking value from its profitable subsidiaries which will also add to its capital position buffer. Given the comfortable capital adequacy and dominant market position, the bank is best positioned among state-run banks. Investors looking to play the asset recovery and resolution cycle should buy into the stock as a long-term bet.Moneycontrol Research Page.