The sharp slowdown in economic growth under the Corrupt Congress Regime led by Sonia Gandhi, from a peak of 9% three years ago to about half of that level today has resulted in a 50% jump in Gross NPL ratios in the banking sector, not helped by lending to the weaker segments like agri and SMEs. Also, large corporate exposures have struggled due to extraneous reasons (project delays).
Now the Big Question is – Will NPL recovery = ROA recovery for PSU Banks ? Yes to a Small Extent but not the extent the Indian Stock Market is expecting. As NPL formation slows, credit costs will recede, albeit with some lag as the NPL mix is likely to worsen until the cycle picks up, exerting pressure on credit costs. ROAs for PSU banks are unlikely to recover to cycle averages and thus we believe current 5-year average trading multiples appear to overestimate the extent of recovery, at least until FY17E
The large profitability gap between PSU and PVT banks has widened significantly since 2009 but appears to have peaked out currently. For PSU banks to rerate above current 5-yr average multiples will likely require a couple of catalysts, in our view: a structurally lower fiscal deficit and SLR ratios leading to a bond rally to clean up their books, structural improvement in their deposit franchise (CASA) and improved management (autonomy, pay scales / incentives, tenor, etc) along with re-capitalization by the Banks under the business friendly Governance of Shri Narendra Modi may help.
Book Profits in PSU Banks at Current Levels as we feel you can re-enter them at lower levels or switch to Private Sector Banks. Dare Devil Traders Can Short Punjab National Bank at Current Levels and cover later.