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Wednesday, June 1, 2016

Banking sector: More bad news expected

Poor March quarter numbers indicate more bad news in the offing. Experts say prices not cheap. Is the worst over for banking stocks? Poor March quarter numbers indicate more bad news in the offing. Experts say prices not cheap. Is the worst over for banking stocks?

The RBI may be going soft on banks in its asset quality review for the March quarter, but there is no respite from burgeoning bad loans for the lenders. The current earning season shows that asset quality-related stress at banks remains very high. Lender after lender, particularly public sector ones, have reported massive losses. Most bank stocks have seen prices tanking. The PSU bank index has fallen 37% in the past year, and lost 11.6% per year for the past five years. Is the worst over for banking stocks ?? 

Last year was particularly bad for the banking sector. Loan book growth for 25 banks (the latest March quarter numbers were declared until 17 May), including private and public sector players, stood at 10.7% in 2015-16—the slowest in two decades. On top of that, these banks nearly doubled their gross non-performing assets (NPAs) to Rs 2.43 lakh crore over the last fiscal. 

This sharp ramp-up in NPA was mostly owing to the mandatory asset quality clean-up by the RBI that requires banks to recognise and provide for non-performing loans. Higher provisioning eats into the bank's profitability. Earlier, the banks maintained profitability by keeping certain stressed assets out of the NPA category. That way they did not have to set aside funds for them. However, the RBI mandated asset quality review has got the skeletons tumbling out of the cupboard. 

The quantum of provisioning and additional slippages in the March quarter has surprised analysts. Punjab National Bank posted the largest quarterly loss ever reported by an Indian lender at Rs 5,367 crore. Its provisioning cost rose three-fold to Rs 10,485 crore, eating away all profits. As a percentage of its loan book, PNB's gross NPAs now stand at a whopping 12.9%.

Another PSU lender, Bank of Baroda's continuing asset quality pangs shocked markets too. After reporting a loss of Rs 3,342 crore in the December quarter owing to 'one-off' provisioning for bad loans, the lender followed it up with another loss of Rs 3,230 crore in the March quarter. While announcing the numbers for the preceding quarter, the bank's management had indicated that the worst was over as it had taken the entire provisioning hit in a single quarter, unlike other banks which opted to spread it out over several quarters. 

Four other state-run lenders, UCO Bank , Dena Bank, Allahabad Bank and Central Bank of India , have reported a weakening balance sheet in the just concluded quarter. The extent of additional provisioning by these banks indicates higher than anticipated stress in balance sheets. Numbers from the country's largest lender State Bank of India are still awaited (due on 27 May) and could reveal more. Given how the situation across banks, the country's biggest lender is not likely to paint a different picture. 

Meanwhile, experts are not sure whether the worst is over for PSU banks. Vikas Gupta, CIO, ArthVeda Capital, says, "We are not comfortable with PSU banking stocks yet. More bad news could be in the offing and prices do not look cheap compared to fundamentals." Within the PSU banking space, mid-sized entities like Allahabad Bank, Dena Bank, Union Bank of India and Andhra Bank are in particularly bad shape.

Apart from high asset quality stress, they are hampered on the operational front too, points out a Edelweiss Securities report. "We perceive clear demarcation between large and mid-size PSU banks and expect pressure to continue in latter. Given increasing BASEL III (capital adequacy) requirement and limited capital support from the government, dilution risk is imminent at weak multiples, which will be detrimental to shareholders' returns," says the report.

Despite ongoing woes, prices of several PSU bank stocks surged around mid-February after the RBI announced that it would go easy in the asset quality review. The passage of the Bankruptcy Bill boosted stocks and the sharp decline in prices earlier also supported the rally. However, once the weak results were announced, prices of most banking stocks took a renewed hammering. Most PSU bank stocks are now trading at a discount to book value, leading some to argue that the downside for these stocks is limited and that they could be great value picks at current prices. 

"The valuations of PSU banks factor in the potential stressed loans and weak core operating performance for 2016-17," says Alpesh Mehta, Research Analyst, Motilal Oswal Securities. But he prefers private banks over state-owned banks. Ambareesh Baliga, an independent market expert, says the risk-reward is more in favour of PSU banking space now given that the market has mostly discounted continuing asset quality pangs. There is a belief that many of the banks' books are now cleaner after the hefty NPA provisioning, and that these lenders are now done with most of it. "Public sector banks are not likely to provide any further surprises. However, risks are more prominent in private banking stocks where negative results have come as a surprise," says Baliga.

Private lenders ICICI Bank and Axis Bank posted weaker than expected numbers in the March quarter and also came out with weak guidance for this fiscal. While ICICI Bank has indicated likely stress in Rs 44,000 crore worth of loans going forward, Axis Bank has put Rs 22,628 worth of loans on watch. A handful of private banking stocks like Yes Bank , IndusInd Bank, HDFC Bank and Kotak Mahindra Bank have displayed consistent resilience to the NPA issue. These are considered more retail-centric banks where asset quality issues are under control. Not surprisingly, these stocks have surged over the past few months even as others have stumbled. Most analysts have maintained 'buy' rating on these stocks.

Stay away from PSU banking funds 

EQUITY FUNDS focused on banking stocks continue to be weighed down by the gloom surrounding the sector. Over the past year, this fund category has tailed international funds as the worst performing category, clocking a negative return of 7.53%. The worst affected funds have been the ones purely focused on the PSU banking segment. Kotak PSU Bank ETF and Goldman Sachs PSU Bank BeES Fund have both seen a 36% drop in their NAV over the past year. 

Investors willing to bets on the banking sector should not restrict their exposure to PSU bank focused funds. If at all, opt for funds which invest across banking and financial services stocks. Here the fund manager has the freedom to pick from a basket of private banking as well as non-banking financial services players that boast of better quality loan books, apart from PSBs. These funds have done relatively better in recent times. 

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