Is it time to exit PSU banks or would you stay invested?

Similarly, I see and that is a bit of hope, it is not number, that the kind of issues which are being faced or they are being surfaced, the policy reference or the structural changes to that will be the key driver to gradually re-rate the sector apart from the fundamentals which are also improving both for the economy and also in terms of asset quality for PSU banks. So, I wouldn’t say for a medium-term investment it is time to quit.

Menaka: Would you agree?

Deewan: I would agree to that. I think one needs to stay invested in PSU banks. Of course one needs to select which ones to stay invested in but even as far as the restructured assets are concerned the ferocity with which they were going up has come down now. We saw that in the last quarter results also. So, as far as the gross NPAs are concerned the way they were getting added has become less now. With the economy picking up there will be more and more high yielding loans like the SME, the retail segment which can even improve the profitability of the bank going ahead.

As far as the problems are concerned whether it is capital, whether it is the management of banks the government is very well aware of this and with whatever issues which have come right now regarding some of the scams or some of the problems because of that reforms can be much faster. They even talk about having a separate Chairman and Managing Director for the bank. So, there will be a lot of reforms which will happen.

A lot of cleaning up has already happened and will follow now. It will be very good for the next two or three years for the banks when the economy is picking up and the banks are getting cleaned up, coming out of a very bad couple of years. I think this is the time one needs to stay invested and next couple of years would be very good as far as investment in banks is concerned specifically PSU banks because a lot of negatives are already priced in.

Menaka: Let me play devils advocate here. If we look at the price to book value of let us say the top three PSU banks whether that is State Bank of India (SBI), Punjab National Bank (PNB) or Bank of Baroda (BoB) that has gone up considerably since the beginning of this year. However, the bad news doesn’t seem to end so whether it is the NPA cycle which is as yet showing not that clear signs of bottoming out or it is the corruption newsflow or it is the mismanagement newsflow, none of this is ebbing. So, while you say over three to five years these are good buys, over the next year or so would they be sells?Vora: No, when I say medium-term I typically mean 1-1.5 year also. While some of these problems which you mentioned are true but what has changed is the ability of Indian corporates a) to raise funds overseas markets through QIPs which lightens their balance sheet which some of these very heavily indebted companies have done for example GMR Infra, Jaiprakash or the ability to sell some of their assets the way Unitech has done; sell their Rs 5000 crore worth of block of some buildings in the commercial side or the way things are shaping up, ability to sell some of their infrastructure assets or get partnership in that. All these when it will happen in corporate India the repercussions will definitely be on to the balance sheet of the banks where their borrowers balance sheets will start getting repaired. So, as we move forward the intensity of assets going bad will certainly come down.Also last year, all these issues of policy paralysis and so on and so forth were compounded by two important things. One was the volatility in the currency market which also got some of the SMEs and mid corporates unaware and they also landed up in big trouble. As we are seeing a slightly stable currency regime also and slightly improving GDP outlook, all this augurs well for banks balance sheet.

Senthil: What look most attractive to you?Vora: In the PSU segment?Senthil: Yes.Vora: We would say that there are two way to probably look at it. One is from the FII perspective always the largest remains the darling, also in terms of; I would say the ROE that gradually SBI’s ROE from the current level will expand. One of the reasons is that they have raised the capital. So the ROE was little subdued because of increased capital as also their credit cost will gradually keep coming down. So we expect rising ROE and at current price to book we would still think there is scope for improvement.The next best in the sector we still are betting on Bank of Baroda. There is still going to be some top management change but now we are more confident about most appropriate candidate to come. So we are saying otherwise than that the second best in the sector we are looking at is Bank of Baroda in the two large cap names that we were mentioning.Anuj: Again just to extend the point about the asset quality and the earnings quality, surprisingly the biggest rally has come in the two most volatile stocks; Union Bank and Indian Bank this week. Does that worry you because it is fine to see rally in index stocks but in the rank underperformers or banks which had history of volatile earnings we have seen the biggest rally. Would that worry you?Deewan: Stock specific if you go definitely that is a cause of worry. We don’t really like banks which have these volatile earnings where you get some surprises coming any time. Two quarters are good then one quarter can have a surprise for you. That is why it is very important to select which bank you want to invest in. That is what I said in the beginning also, suppose there are banks like Canara Bank, this bank has grown in the last three-four years at 20 percent or it is above the bank average that you have seen in the PSU banking but they have still been able to maintain their gross NPA at 2 percent or below and even that NPAs are quite low at 1.5 or 1.7 percent. So if you have a good asset quality in spite of having the growth and most of the banks which are aware, which are having the provision coverage ratio going up like even Canara Bank for that matter will have the provision coverage ratio going up to 40 percent this year.So you have to see specific things. Everyone is aware of the problems; everyone knows that there has to be a decent provision coverage ratio. If a bank has grown and has been able to maintain and has been steady there you have to be selective as far as PSU banks are also concerned and you can’t put everyone in one basket and you have to be selective there.Menaka: Tell us stocks that you would stay away from given that you have already listed stocks that you like, besides Syndicate Bank what would you stay away from in the PSU bank space?Deewan: There are so many PSU banks. It is difficult to name everything that we will stay away from but I can give you the top picks that we have. We have stocks like Canara Bank, Bank of Baroda which we feel are amongst the larger banks. Even the smaller banks there are very good banks like Vijaya Bank for that matter. If you see Vijaya Banks that is among the best asset quality. The growth is also 20 percent and the management is saying that they will grow by 20 percent loan growth this year also.So it is better to take your picks rather than select out of a big list of the number of stocks which you might not like to keep in the portfolio.Menaka: You have already told us you like the biggest one the best, any PSU bank stocks that you would stay away from?Vora: Stocks like Central Bank. Our opinions are slightly different, so I would like to not answer this question at this juncture but I would say that PSU banks still has lot of challenges also in terms of A: capital raising, B: in terms of their pension provisioning and of course C: in terms of the talent that they will need as a big amount of talent pool is retiring. So these are three issues that they have to face and also like we qualify the real trigger in this sector will not be just the credit growth or slightly improving asset quality but the real trigger if at all could be for rerating some structural changes or policy initiatives which can unshackle the issues like PSU chairmen come for one and half years, two years, there have been talk for very long time that they should have a reasonable tenure.Senthil: How much of additional money into banks would you put into PSU versus private sector?Vora: The typical debate always has been why not put all the money in private sector because there is continuity, growth, they are much better placed to target the upcoming growth in the economy. There is where we differ. We say yes, the private sector banks are structurally good stories but at current juncture and valuation PSUs should be part of the portfolio.