As balance sheets and capital ratios of public sector lenders improve, Morgan Stanley prefers State Bank of India to play the economic recovery cycle.
“SBI is our top pick. At others, we see structural challenges which will keep return ratios muted, limiting any significant rerating potential beyond the short cyclical upswing,” the global investment bank said in a note. “Valuations, however, are cheap, and hence we upgrade Bank of Baroda and Punjab National Bank to ‘equal-weight' from ‘underweight'.”
Excluding SBI, the Common Equity Tier-1 ratio—core measure of a bank's financial strength—for Morgan Stanley's coverage universe of state-owned banks is now at 9.6% versus 9.1% in FY20 and 6.8% in FY18. “Over the last few years, state-owned banks have seen a significant capital infusion by the government, lower RWA (risk weighted asset) density, higher provisioning and some large recoveries,” the research firm said.
As slippages moderate, [we] expect gradual moderation in credit costs over the next few years.Morgan Stanley Note
The gross non-performing loan ratio, too, has moderated and GNPL coverage has improved at state-owned banks over the past few quarters. Excluding SBI, GNPL coverage at such lenders has improved 20 percentage points since FY18 to 67%, and is about 55% on overall impaired loans, Morgan Stanley said.
The research firm even raised its book value per share estimates for PSU banks, excluding SBI, to factor in lower impairments, lower dilution and higher pre-provisioning operating profit.
Still, challenges remain.
A higher share of moratorium customers/stressed corporate exposure, and a materially lower collection efficiency than private banks imply continued elevated slippages/restructuring in upcoming quarters, Morgan Stanley said.
Besides, “state-owned banks have been aggressively growing their lending in retail, agri and MSME segments over the past few years where their underwriting practices have been suboptimal”.
These segments, according to Morgan Stanley, have formed 50-60% of loan books of many lenders. “Even the share of BBB-and-below rated corporate loans is much higher at these banks,” the note said. “This, coupled with a relatively lower coverage, will limit any sharp downtick in credit costs.”
Morgan Stanley also highlighted that these lenders will continue to lose loan market share, given the technology changes, strong competition and a weak internal rate of capital generation. “Incremental market share for state-owned banks in overall deposits has also been weakening in recent years.”
Here's Morgan Stanley's rationale behind its upgrade of Bank of Baroda and Punjab National Bank:
