See weakness in credit growth for PSU banks in FY18; sell SBI: Macquarie Cap Sec

Stock specific he prefers Yes Bank over ICICI Bank. He is neutral on Kotak Mahindra Bank with target price close to the current market price.

He recommends a sell on State Bank of India on the back of single-digit return on equity over the next two years.

However, he is positive on housing finance companies in the non-banking financial company space. In that space, he like LIC Housing and Indiabulls Housing.

Below is the verbatim transcript of the interview.

Latha: What are you expecting to hear from this package what will it make, some kind of a reasonable package to resolve non-performing assets (NPAs)?

A: The clear challenge at this point in time is how banks are going to take care of the haircuts in case there is going to be big nonperforming loan (NPL) package and clearly the capitalisation levels in banks are so poor that their ability to take haircuts at this point in time is pretty limited. So, a package mechanism whereby the government decides to put in a certain amount of money in the form of banks taking a haircut itself would be something beneficial in my opinion for the banking sector.

Clearly, the problem also has been the fact that banks have been reluctant to take specific company related haircuts because of Central Bureau of Investigation (CBI), Central Vigilance Commission (CVC) investigation issues. So, we are hearing that Reserve Banks of India (RBI) will also be involved in deciding haircuts and I think that is something which we are looking forward going ahead.

Anuj: For PSU banks right now we have already seen a big rally play out. Do you think this has legs to go I mean if these mechanisms are worked out and if some resolution does take place?

A: Any resolution mechanism where the hits to the public sector banks are minimised that is the NPL or the provisioning related hits if the government can come out with some good incentives in that sense then definitely this rally has more legs to go. But then any mechanism where by at the end of the day the public sector banks have to take a large haircuts on the profit and loss or balance sheets definitely there can be some weakness in many of these stocks which have rallied in anticipation of a favourable NPL resolution package.

Sonia: I will come to your picks in a bit, but before that I just wanted to understand from you is there any pick up at all that your channel checks are suggesting in terms of capex demand and what should we prepare ourselves for in terms of credit growth for the next couple of quarters. Will it be as muted as what we have seen earlier?

A: Credit growth is going to be very weak. I mean the problem is not only of supply that is the ability of the public sector banks to give money the problem is also of demand. Working capital demand is okay but then the capex demand is completely absent. There are no new projects coming and so credit growth will continue to remain very disappointing. You have also already seen a sharp decline in retail loan growth also coming from 17-18 percent down to 13 percent. There can be some marginal uptick there but then overall brace yourself a disappointment when it comes to credit growth not only for the next couple of quarters but for the entire next financial year.

Latha: We want your views on Kotak Mahindra Bank, Uday Kotak seem to emphasise Kotak Bank's interest in that space what were your key takeaways from yesterday?

A: What is happening is that there is a change in the assets reconstruction companies (ARC) rules effective April 1, 2017 whereby clearly the loophole which used to exist between the banks and the ARCs, when it comes to transactions and the accounting for those ARCs transactions have been plucked significantly. Going ahead if any big ARC transaction has to take place it definitely requires a lot of capital commitment from the asset reconstruction companies. We have already seen global players like KKR’s of the world entering the market, so any local ARC if it wants to be a bit more active in the market, requires a reasonable amount of capital. We have not really worked out with the estimates when it comes to what would be the total capital requirements for the ARC industry but part of a capital requirement would also be the fact that Kotak has its own ARC which is Phoenix ARC which will require capital in due course of time considering that there is a change in rule effective April 1, 2017. So it could be in that regard.

Anuj: I wanted your thoughts on two stocks which have been at the opposite end ICICI Bank and Yes Bank. Yes Bank has of course made new life time highs. It is almost on periodic bases and ICICI Bank has been the perennial underperformer. How would you rate these two stocks now?

A: We have an outperformed recommendation on both the stocks. Our clear preference is for Yes Bank over ICICI Bank. The reason is that at the end of the day it is still a small banks in an environment where the larger banks are finding it difficult to grow and of course PSU banks are going to lose market share. The smaller banks are the ones which can continue to grow a bit more profitably and also deliver a very strong earnings growth. So, the power of compounding in case of Yes Bank is far higher compared to that of ICICI Bank or for that matter any of the large corporate banks or PSUs. We are positive on Yes Bank.

We are also positive on ICICI Bank mainly because at this valuation I think most of the concerns are significantly priced in. So there is a downside support at the current valuation, of course the challenge clearly is what could be the catalyst and I think that would be some time away before the stock actually starts performing but we definitely see downside protection in ICICI at this point in time.

Latha: What was your view on Kotak, what kind of a price target and what would you expect. Would there not be limits to growth organically?

A: My view on Kotak has always been a bit more cautious because of valuations and so we have a neutral rating on this stock and our target price is closer to the current market price. Having said that the biggest challenge has been Kotak has always been an extra conservative banker and even if you look at the last quarter, the loan growth was 13 percent whereas the likes of Yes Bank and IndusInd Bank were still growing at 25 percent.

So as far as organic growth is concerned I think he will always be a bit more cautious. The real challenge is whether he will try to go ahead and pursue inorganic opportunities and that is where the challenge lies in because any other stocks which have been speculated in the market be it Axis Bank or Mahindra or Bharat Financial all of them trade at pretty expensive valuations and any acquisitions for any of these candidates will be treated pretty negatively for Kotak shareholders in my view.

Sonia: You did mention that any further rally in State Bank of India (SBI) or other PSU banks is contingent on the NPA resolution mechanism that the government announces but what is your particular view on SBI what kind of upside you do you see from these levels over the medium to long term?

A: We have a structurally underperform rating on this stock. One has to understand that if the chairperson says that it takes two-two-and-a-half years post consolidation even to actually generate a double digit return on equity (RoE), I think it becomes very difficult to pay more than 1 time price to book to the stock. Our estimate itself is 8-9 percent kind of RoE over the course of next couple of years. So, fundamentally I think the stock is a sell at this point in time.

Latha: What about NBFC space. What is the pick of the pack; even they are trading expensive, aren’t they?

A: Most of the NBFCs are expensive and they are quite price to perfection, but then if there is one pack of NBFC which I would be bit more favourable it would be housing finance companies because there are two things which are going in favour of them. First of all I am reasonably a bit more confident about their ability to deliver growth compared to any of the other segments in the NBFCs space because of the various incentives which the government is coming out on the housing sector and still there is some demand from tier II tier II cities, so therefore loan growth should still be reasonably okay at about 14-15 percent odd for the system and then there isn’t any issue of balance sheet quality or soundness in case of housing finance companies. So, the multiple that you are paying is actual a fair multiple that you paying because the book is clean and therefore my top picks there are LIC Housing Finance and Indiabulls Housing Finance in the NBFC space.

Latha: What about asset reconstruction we have seen Edelweiss Financial Services go up a goodish bit after especially Uday Kotak spoke about asset reconstruction, as well I think JM Financial is doing very well today anything in that space?

A: As I said it depends upon the kind of schemes that the government will try to come out with. In case there is not much of a support coming from the government and in case this scheme actually doesn’t turn out to be pretty attractive the real problem is post April 1st 2017 I see a very significant dip in the number of ARCs transactions in the country because banks will completely not be willing to sell to asset reconstruction companies as per the new rule because there is no incentive for them to do that. So, clearly a lot depends upon what the reforms the government comes up with the NPL resolution mechanism barring which the outlook for the ARC industry is definitely negative for the near term because of the new RBI rule and regulations.