Public Sector Banks Are Performing Well. 10 Facts To Bring You Up To Speed

The government is employing capital expenditure programs to boost demand.(Representational)
The government is employing capital expenditure programs to boost demand.(Representational)

Finance minister Nirmala Sitharaman tweeted a month back, that the continuous efforts of the government to reduce bad loans and strengthen the health of public sector (PSU) banks are now showing tangible results.

This tweet came around when the banks were announcing their quarterly results. India's public sector banks may be out of the woods and fiercely competing with their private sector peers. Both large and small PSU banks put up a healthy performance in the quarter ending September 2022, reporting stellar profitability.

State Bank of India reported a 74% rise in net profit from a year ago. Along with improved asset quality, it is hopeful of disbursing 15% more loans in the financial year 2023 than the last year.

Bank of Baroda (BoB) posted a 59% growth in net profit and a 19% increase in domestic loans and is also hopeful of strong growth going forward.

The stocks also soared, with BoB nearly doubling and SBI up 29% from the beginning of the year. But before you go around analysing the exhaustive list of PSU stocks, lets understand a few things better.

The privatisation of the PSU banks is still far away but what has led to this stellar performance? And why are PSU banks the talk of the town?

Let's find out.

#1 Government capex plans to boost loan book growth

The government is employing capital expenditure programs to boost demand. The key is to stimulate growth via a long-term capex measure.

In the Union Budget for this year, Finance Minister Nirmala Sitharaman announced a capital expenditure target of Rs 7.5 tn for the financial year 2023, up from Rs 5.6 trillion announced in the financial year 2022.

The private sector is also expanding its capacities to support the anticipated growth in demand and benefit from it.

According to Goldman Sachs, private sector manufacturers in India raised their fresh investment announcements in the financial year 2022 by more than three-fold over the last year to Rs 8 trillion.

This massive capital outlay bodes well for banks in general. However, the PSU banks are at a slight advantage.

When it comes to government spending, public sector banks (PSUs) are obliged to lend to them. Therefore, they do most of the capex-led loan disbursements. After all, these are government-held banks' lending money to the government for its capital spending.

This kind of large expenditure will help PSU banks boost their loan book in the coming years. In the latest quarterly results, banks are already talking about growth from these segments.

#2 Drastic improvement in asset quality

In comparison to private banks, PSU banks have often been saddled with poor asset quality, represented by the Net Performing Assets (NPAs) ratio. However, the tide has been turning in the past few years.

The asset quality across segments; corporate, retail, and SMEs, has improved from the past, and the outlook remains positive.

State Bank of India (SBI), the country's largest state-owned bank, has improved its asset quality dramatically. The bank reported a net NPA level of 0.8% for the quarter ended June 2022. This is a dramatic improvement, falling from 5.7% in the financial year ending 2018 to 0.8% now.

However, it's still below HDFC Bank's NPA, which has never crossed 0.5% in the past five years.

Bank of Baroda's Net NPAs has also fallen one-third, now at 1.7%, over the last five years. And so has Canara Bank's NPA's, falling from a whopping 7.5% in the financial year 2018 to 2.7% in 2022.

These advancements come on the back of various strict measures and underwriting guidelines implemented by the banks. Apart from this, they have also de-risked themselves by lending to better-rated clients and by providing for stressed loans.

All of this in tandem with a strong credit cycle growth has resulted in robust growth. This brings us to our next point.

#3 Robust margins led by strong loan book growth

The overall credit offtake in the country has increased in 2022 by Rs 10.5 tn, implying 8.9% growth. This growth is nearly the highest in over a decade.

While a large part for this growth comes from the revival in the corporate credit cycle, retails loans have also contributed. Moreover, a lot of it comes from the banks' lending to the NBFC sector in the country.

These high levels of credit growth should hold up as demand for corporate credit is inching up with recovery in capital outlay.

Apart from this the lower levels of NPAs bodes well for the banks. Not only have they grown their loan books, but also expanded margins in the past few years.

These expanded marings are the result of a gradual rise in deposit rates, despite a rapid change in lending rates. This disparity propelled their yields while the cost of deposits moved only by a fraction.

While Bank of Baroda (BoB) and Canara Bank have reported margins improvement, SBI has been on top of its game.

It has reported a net profit of Rs 132 bn for the quarter that ended September 2022, an increase of 74% over the Rs 76 bn in the corresponding quarter last year. This is the highest-ever quarterly net profit reported by the banking giant.

An expanding margin allows banks to write off the provisions made for loans. And when provisions are written off the balance sheet, the bank's financial condition strengthens.

#4 The public sector banks are a lot more financially sound than before

The Capital Adequacy Ratio (CAR) is calculated as a percentage of a bank's capital to its risk-weighted assets and current liabilities. Much like debt-to-equity in a manufacturing company, it measures a bank's financial strength.

This number is set by the central banks, in this case, the RBI. The aim is to prevent banks from taking on excess leverage and eventually declaring insolvency. It ensures the banks have enough capital to redeem deposits.

In India, the Reserve Bank of India (RBI) mandates the CAR for scheduled commercial banks to be 9% and for public sector banks, 12%.

The top PSU banks have all maintained their capital adequacy ratios well above the norms. SBI and BoB have upped their CAR game in the past few years to 13.9% and 15.8% in the financial year 2022. The smaller peers like Canara and Union bank have also maintained healthy levels at around 14.5%.

Private bigwigs like HDFC bank and ICICI bank have built the highest CAR in the industry, at 18.9% and 19.2%, respectively, in the financial year 2022. This is well above the 9% government mandate.

#5 Trading at high valuations

The stellar financial performance reported by the larger PSU banks like SBI and BoB has led investors to assign higher valuations to their stocks.

SBI and BoB both, are trading at a premium to their historical price-to-book value multiples. SBI is trading at 1.8 times, a 47% premium to its 5 year average of 1.2, and BoB is at 0.96 times, a 57% premium to its 5 year average of 0.61.

Canara Bank is trading at 0.82 times, a 64% premium to its 5 year average of 0.5, and Union Bank is trading at 0.78 times, a whopping 95% premium to its 5 year average of 0.4 times.

While they are trading at a premium to their historical averages, they are lagging behind the banking sector's P/E. The S&P BSE BANKEX, which includes both, private and public banks, is trading at a P/BV of 2.55 times.

#6 PSU bank stocks have rewarded their shareholders well

Investors have not been oblivious to the strong growth and improving asset quality. This is well-reflected in the skyrocketing stock prices.

The stock prices of SBI and BoB have nearly tripled since January 2021. Union Bank and Canara Bank have more than doubled in value. The S&P BSE Bankex has risen 36% in the same period.

While this outperformance is visible across the PSU sector, the private banks don't mirror the same.

Among the top banks in the private sector, only ICICI Bank has doubled in value since January 2021. HDFC Bank and Kotak have underperformed their peers massively, growing by 12% and 1%, respectively.

#7 India currently enjoys a low level of corporate debt to GDP

According to Morgan Stanley, India's corporate debt to GDP ratio is at about 46%, significantly lower than the global average of 145%. While China is at 139%, the UK and US are at 80% and 84%, respectively.

This ratio has gone from 62% in the financial year 2015 to 46% in 2022.

This low level of corporate debt indicates that the companies and the banks have a clean balance sheet. They are financially sound and are well-poised to borrow if need be.

Moreover, this also means that banks will be lending to financially-sound companies. Companies who are a lot more competent to borrow and pay back. This lowers the risk in lending.

#8 PSU Banks can now offer loans at competitive rates

One of the primary reasons a bank can offer a competitive rate on loans is the higher CASA ratio.

The CASA ratio of a bank is the ratio of deposits in current and saving accounts to total deposits. A higher CASA ratio indicates a lower cost of funds for the bank.

Banks do not usually give any interest on current account deposits from their customers. And the interest on saving accounts is usually low, ranging from 3-4%.

Therefore, higher CASA deposits, allow the banks to offer competitive rate on their loans. The low cost of funds allows the bank to offer competitive rates to the borrowers, encouraging loan growth.

SBIs CASA ratios have been at desirable levels of 40-45% for some time now. However, its smaller public sector peers have shown marked improvement in CASA ratios. BoB, Canara Bank and Union Bank have all reported a 3-4% increase in their CASA ratios in the past 5 years.

#9 Investors need to be selective in buying PSU banks and keep their exposure to a minimum

PSU banks in India have suffered poor valuations for decades. So, it is no surprise that before this stellar performance, these stocks languished for years.

They traded at steep discounts to their private sector peers, wreaking havoc on their shareholder's wealth.

This usually happens at the turn of every economic cycle. These government entities are forced to lend vigorously. Usually, it is never about the quality of lending but the quantity.

So, they even lend to corporates with poor balance sheets. Corporates that may not make for good borrowers. Thus, every few years, a fresh wave of NPA cloud the profits of these entities.

This time around, the banks are in better financial health. However, it would be foolish to assume that it cannot happen again. Therefore, investors are safer with limited exposure to PSU banks. They must be extremely selective and not compromise on fundamental research for excessive growth.

#10 PSU Banks technology remains behind the curve

PSU lenders have been losing market share in deposits, especially for the preeminent current and savings account deposits (CASA).

It is safe to assume that a younger generation is more technologically savvy. They may not want to bank with them. This is because, in terms of technology, most PSU banks, barring SBI, are still big laggards.

With digitisation becoming the new norm in the post-Covid era, PSU banks need to amp up their game. However, they lack the resources or the product lines to offer the same.

In conclusion

SBI and its PSU peers are not in as much at peril as they were back in 2018. And their potential to keep lending at healthy rates is real.

However, it would be naive to assume that the government will keep bailing out the banks every few years. Or that the NPAs will be soon forgotten.

There is a good chance you can see it all coming back, especially now when the economy is preparing to soak in a capex boom.

(Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.)

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