Dalal Street Investments

Which is the Best PSU Bank worth Investment Grade in India ?

March 10, 2015

Best PSU Bank in IndiaWeak balance sheet growth and elevated credit costs would keep the profitability of PSU banks subdued. Furthermore, visibility on structural reforms remains poor. Whilst the Government has taken some initiatives, the process appears to be too gradual and it side-steps some of the key objectives of removing the Government’s direct control on PSU banks.

PSU banks’ 3QFY15 results highlighted continued stress on their loan book growth and credit quality. Slowing NII growth (5% YoY) and elevated credit costs (provisions at 1.1% of assets) led to RoA compressing to 0.3% in 3QFY15.

Focus on Structural Reforms
PSU banks, on an average, have lagged their private sector peers significantly over the last decade in terms of profitability and earnings growth. This weak profitability has led to frequent capital infusion by the Government in these banks, putting pressure on government finances.

Capitalization Issues
The large capital requirements for PSU banks remain as much as an issue as it was a year ago. Based on various calculations, the total tier-1 capital requirement for all the PSU banks combined could be anywhere between US$40bn and US$55n (excluding retained earnings) over the next five years.

Return Over Equity
Historical data suggests that even in the best of times, most PSU banks have struggled to generate RoAs of more than 1%. However, higher leverage has helped PSU banks to generate RoEs north of their cost of capital. Historically, PSU banks have levered anywhere between 18x and 19x, which has helped PSU banks to generate RoEs of 15-22%.

Narendra Mod Only Vocal about Professionalism in PSU Banking, No Actions
The Government has taken some steps such as splitting the post of CMD and proposing – during the Union Budget speech – an autonomous Bank Board Bureau, as an interim solution to a banks holding company in 2-3 years. The theme has been that of reducing political interference in the day-to-day functioning of PSU banks and of professionalising PSU banks. However, the Government has retained its option of political interference, as it will not cut its holding in PSU banks below 52%.

Which is the Best in our Research ? – Bank of Baroda – And Why ?
BOB’s stressed assets are at 9.7% of loans vs an average of 14% for its PSU peers. Also, relatively better provisioning coverage (22% vs peer average of 18%) and tier-1 capital (9.1% vs peer average of 8.1%) mean that stressed assets (net of provisions), at 77% of net worth, are the second lowest among PSU banks, after SBI. On the underlying strength of its franchise as well, BOB is relatively better placed, with a better share of retail (18%) on the assets front and higher branch productivity

At a valuation of 0.8x FY17E BV, the risk-reward is favourable. We turn BUYers in the Stock of Bank of Baroda with a target price of Rs 210 (implied P/B of 1.0x Dec-16).


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