Friday, January 15, 2016

What is causing PSU banks to fall ?

Banking stocks, especially the public sector banks, are being hammered in the markets. In fact, banks have led the recent fall in the indices and continue to do so even today. The NSE PSU Bank index has fallen from 3,235.35 to the present level of 2,312, a drop of nearly 28.5% since November 30, 2015. In comparison, the Nifty Bank index, which also has private sector banks in it, has fallen by only 12.8%, highlighting the growing diversion in valuation between the two sectors.

For example, SBI is trading at Rs 184, a level last seen in March 2014; PNB is trading close to its two-year low at Rs 91.65. Same is the case of almost every public sector bank.

While it was a known fact that these banks have been saddled with high level of NPAs and analysts have generally been bearish on the sector for over a year, what is the new provocation for the sell-off?

There are two main reasons. First is the change in the base rate calculations for the bank, which was announced in early December 2015. In the guidelines, which will be effective from April 1, 2016, RBI has now introduced a more complex MCLR (Marginal Cost of Funds Lending Rate) replacing the base rate earlier. With this, RBI is now introducing a tenor-premium-linked term structure of MCLR, which will serve as the basis to arrive at the lending rate.

Analysts expect margins of banks to contract as they will now have to pass on the changes RBI makes by cutting their interest rates. In the past, banks have not transmitted the interest rate cuts announced by the central bank but have reduced deposit rates, thus pocketing incremental profits. But with the new norms, the banks will have to cut interest rates in line with the deposit rates, which will impact their margin. 

The second reason is that RBI is now acting tough with the banks in terms of their disclosures. The central bank has identified around 150 corporates, which are currently classified as standard assets to be declared non-performing assets (NPAs).  According to CNBC, these 150 accounts are nearly 2% of total NPA and are worth Rs 1.5 lakh crore. As a result, provisioning is expected to increase by Rs 30,000 crore across the sector. But this is not enough; RBI wants banks to provide for another 6-7% of NPA resulting in provisioning to increase by around Rs 1 lakh crore.  

Deutsche Bank in a report on the banking sector has said that RBI's drive to build-up contingencies will result in higher credit costs at times when NIMs are declining.  Deutsche adds that they believe that RBI will call for higher provisions on stressed assets to guard the banks against any future risks. Unrecognised stress levels are high at 12-14%. As per their estimates, banks will build about 10% provision on such exposures – likely increase of 1% of loans as provision cost spread over FY16/FY17. Deutsche expects banks’ earnings to be impacted by 5-18% for FY17.

While some might be tempted to look at valuations which look attractive, the uncertainty element is too high which is resulting in higher selling. Price to adjusted book value (P/ABV), which is the valuation parameter that is widely followed, has one element which is causing the prices to fall. No one knows how much to adjust a bank’s book. What is the mess that is there in the books of these banks.

RBI calling for providing for these assets is a good step in the long run but investors will have to go through the pains in the interim.

According to a Macquarie report titled "Indian Banks Apocalypse Now', the balance sheets of banks have become very opaque as banks try to camouflage by resorting to 5:25 refinancing, restructuring, SDR, NPL sales, ever-greening, etc, and thus looking at reported earnings has become futile in many cases. In their view, close to 16-18% of the loans which are currently shown as standard (normal or restructured) remain potential sources of stress.  

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