Don’t bank on returns :: Business Line

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Investors in public sector banks (PSBs) have not been laughing all the way to the bank.

Muted earnings growth and rising stock pile of bad loans and restructured assets have eroded PSBs’ capital. Many of them are just about meeting their capital requirement and a large amount of their restructured loans could turn bad and eat into their capital.

In the past, state-owned banks depended on the Government for their capital requirements. The Government has made capital infusion of ₹58,600 crore in the last four years (2011-14) with plans to infuse ₹11,200 crore in 2014-15. But Government’s backing has only increased the moral hazard and has left minority shareholders short-changed.

Most of the public sector banks are trading well below their book value. Capital infused at such abysmal valuations has eroded their book value by almost 50 per cent in the past.

Ensuring adequacy

The Government’s share in state-owned banks varies between 55 and 82 per cent. By diluting its stake, the Government can raise funds to take care of the needs of some of the larger banks. But what’s good for the banks may not be the best for investors. The implicit backing by the Government does not take away the risks. Most of these banks trade at a low valuation for a reason — operational inefficiency, bad asset quality and corporate governance issues.

Banks such as Central Bank, United Bank, Bank of Maharashtra and IDBI Bank, where the Government holds more than 75 per cent stake, are also the ones where the capital need is high. For instance, Central Bank has a tier I capital of 7.4 per cent (6.5 per cent norm) and very high stressed assets of 20 per cent. United Bank, which has a tier I capital of 7.2 per cent, has bad loans alone at 10.78 per cent of loans. These may be risky.

The scene for companies such as Power Finance Corporation and Rural Electrification Corporation that lend to the power sector is hazy as well. These companies are obvious beneficiaries of power sector reforms but there have not been many changes on the ground. Improvement in the financial health of State Electricity Boards and ensuring availability of raw material for power projects are all a big ‘if’ to re-rate these stocks.

Also, given the recent regulatory leeway that allows banks to raise infrastructure bonds, the competition is expected to intensify, which will likely impact the pricing power of these players.

Good picks

But banks such as Bank of Baroda, State Bank of India and Bank of India are better placed in terms of capital ratios and have also been able to contain slippages in bad loans better. These may be safer bets for investors who are keen on PSU banks.