As Safe as a Bank

By Sudershan Mittsl

Public sector banks have been seen as safe harbours for your money. Now, it appears, these stocks could also help you weather the meltdown

While banks have traditionally been seen as safe avenues to store money, the past few months have shown that banking scrips could also be safe investments.

In the past three months, the banking index has lost only 30 per cent compared with a loss of 41 per cent in the Nifty.

The difference in returns is starker when we look at the Public Sector Unit ( PSU) banking space. During the same period, the PSU banking index lost only 18 per cent.

Individual PSU bank stocks also performed better than their private sector counterparts. In the past six months, the HDFC Bank lost 32 per cent, while the ICICI Bank fell 56 per cent. Compare this with the 7- 10 per cent positive returns generated by PSU banks like the Bank of India and the Union Bank of India.

Investors seem to prefer banks that are not aggressive in their operations.

“ Clearly, the fact that PSU banks are more conservative in their operations has played on the investors’ confidence,” says Anita Gandhi, head of institutional business, Arihant Capital Markets. After the sub- prime crisis, a lot of people think that private banks are risky investments because they deal in exotic derivatives.

This risk perception has also resulted in a flight of deposits from private banks to PSU entities, adds Gandhi.

This is, however, a recent phenomenon.

Till a couple of years ago, private banks were the darlings of investors because they were seen as aggressive go- getters. But during a downturn, the trend reverses.

“ Due to their aggression, which could have led them to take riskier bets, these banks are now facing major concerns about Non Performing Assets ( NPAs),” says Gandhi. The ICICI Bank’s NPAs have risen 48 per cent in this quarter.

Compared with this, the NPAs of PSU banks declined by an average 60 basis points over the past year.

Analysts say that PSU banks are in a better position today because stricter controls are imposed on them. But, says Abhishek Agarwal, Research Analyst, Religare Capital Markets: “ The regulations governing investments or exposure limits are the same for all scheduled commercial banks.” What PSU banks face is an increased amount of government intervention, including participation in schemes like the farm loan waiver, which are likely to lower their flexibility and put pressure on growth. But this has also helped cushion their fall in the sell- off by the Foreign Institutional Investors ( FIIs). “ When the FIIs pulled out money from the markets, the private banks were the worst hit as the FII holding was higher in these banks,” says Gandhi. According to current regulations, foreign holding in private banks can be up to 74 per cent against the 20 per cent in PSU banks. The government holding in PSU banks ranges from 51 per cent to 80 per cent, leaving limited room for FII participation. This has paid off now, but things may change when the government offloads its stake in PSU banks.

PSU banks are also strong on various financial parameters. Their capital adequacy ratio is 12- 13 per cent, against the minimum stipulated nine per cent. The average return on equity for 2009- 10 is pegged at 20 per cent for PSU banks and 15 per cent for private banks.

All these factors make PSU bank stocks very attractive. Yet, most of them are available at a price to book value of less than one compared with a range of 1.2- 1.8 for private banks. If you consider their Private Equity ( PE), the HDFC Bank and the Axis Bank are trading at 13 and 7.5 times the 2009- 10 earnings, compared with 3- 5 times for PSU banks.

Given the fierce competition in the banking sector, it is likely that private banks will gain marketshare at the cost of PSUs. But large PSU banks will be unperturbed by this, given their strong balance sheets and huge customer bases. The possible increase in FDI limit for insurance firms and increasing business from public sector enterprises will add to their attractiveness.

And after the silver lining, the cloud. The next quarter may not be easy for banks.

The sector moves in tandem with the economy, and though most of the negative is priced in, a further downfall cannot be ruled out considering that the economy is slowing down.

However, given the strong fundamentals of some PSU stocks and their attractive valuations, Gandhi expects these to generate good returns over the next two years and recommends buying at every dip. For those who do not wish to track each stock, there are PSU bank exchange traded funds offered by Benchmark and Kotak Mutual Fund. These funds are traded on the NSE and invest in more than 15 PSU banking scrips.

PSU Banks positively Falling interest rates: PSU banks will benefit because they hold long- term bonds of higher coupon rates. These bonds appreciate in value when interest rates come down.

Diversified portfolio: Low exposure to sensitive sectors like real estate and retail loans lowers risk of defaults.

Low valuations: PSU banks are trading at price to book values of less than 1 compared to 1.2- 1.8 of private sector banks.

Low- cost funds: Large base of current account and savings account ( CASA) deposits gives access to cheaper funds.

Investor confidence: PSU banks are seen as a proxy to sovereign investment.

Beneficiaries of government business: The government has asked public sector enterprises to park 60% of their surplus funds with PSU banks.