Bond rally signals improving fundamentals: upgrade BOB, PNB to OW :: JPMorgan

We upgrade BOB and PNB to OW on the back of a sharp rally in bond
markets. We see the benefits extending beyond mere treasury gains – we
think the imminent deposit and base rate cuts will be incrementally
positive for loan growth and asset quality. The bond rally also creates
conducive conditions for a quick margin-accretive switch from excess
SLR to loans. Elevated delinquencies remain a risk, but recoveries should
improve given the more aggressive intent shown in recent weeks. We
retain our ratings on SBI (OW) and BOI (UW) with raised price targets.
 Interest rates headed down. We think the bond market rally (yields

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 Interest rates headed down. We think the bond market rally (yields
down 60bp since early April) heralds a significant decline in lending and
deposit rates. CD rates have now slipped below retail deposit rates,
which is positive for loan growth and asset quality. Also, PSU banks
have a significant cushion on excess SLR which they can now liquidate
in favor of loans to protect themselves against the margin pressures from
base rate cuts.
 Asset quality pressure continues. We see a continued increase in
delinquency on both NPLs and restructuring, and that is a worry.
However, the recent efforts by PSU banks in cases such as Kingfisher
Airlines (covered by Princy Singh) point to some acceleration in bad
loan recoveries. We are not convinced that asset quality has turned the
corner, but believe it is unlikely to get much worse.
 Valuations appear undemanding. Our upgrade is significantly led by
valuations. Both stocks are trading at <1sd and="" on="" p="" thus="">the incremental good news on interest rates is likely to trigger a rerating,
in our view. Some negatives persist for PSUs – the steady erosion of
deposit franchises (most acute for BOB), and the weakness in capital and
pension hits. However, the potential upside from falling rates is
significant, given where valuations are.
 BOI – low coverage and CAR. We stay UW on BOI as we are worried
about the low CAR and provision coverage (32%). We do see some signs
of improved performance but believe these two factors will continue to
be a significant drag on the stock price. Structurally falling ROEs are our
primary worry.