Morgan Stanley Upgrades PNB, BoB; Says SBI Top Pick Among PSU Banks

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.

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 per share estimates for PSU banks, excluding SBI, to factor in lower impairments, lower dilution and higher pre-provisioning operating profit.

Still, challenges remain.

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:

Bank of Baroda

• Balance sheet has improved over the last few quarters.

• Capital ratios and underwriting practices have improved.

• Expects lower slippages, higher rates and lower opex to drive recovery in pre-provisioning operating profit margins.

• Covid-related impairments and elevated exposure to stressed segments can keep credit costs elevated in the near term.

• Valuations against this backdrop are fair.

Punjab National Bank

• Seen strong improvement in its balance sheet over the last few quarters.

• Coverage on impaired loans has gone up.

• Asset quality challenges remain given weak underwriting and elevated share of MSME and BBB-and-below corporate portfolio.

• PPoP margins will improve gradually, helped by lower slippages and lower opex.

• Normalisation of credit costs will not happen before FY23.

• Lower book per share estimates by 9%, 8%, 8% for FY21, FY22 and FY23, respectively.