Five Trends To Watch In State-Owned Banks Post Recapitalisation

Goldman Sachs upgraded State Bank of India and Punjab National Bank after analysing the longer-term implications of public sector banks cleaning up bad loans post government’s recapitalisation plan, and the impact on profitability and valuations.

But the global investment bank reiterated that private banks are likely to stay more profitable, while maintaining a ‘Buy’ rating on HDFC Bank Ltd. and ICICI Bank Ltd.

It expects Investors’ confidence on balance sheets of lenders to improve going forward, driven by availability of government capital, moderating new non-performing loans, and resolution of bad loans and an uptick in operating profits.

Five trends to watch out for in public sector banks post recapitalisation:

• Non-performing loan ratios to halve by financial year 2020: expects the average NPL ratio for state-owned banks to decline from 9.9 percent of loans in FY17 to 5 percent by FY20E, driven by lower slippages and an uptick in recoveries.
• Capital infusion could lead to accelerated clean-up of books.
• State-owned banks to arrest market share fall but shift to continue to private banks.
• Core return on asset differential between public and private banks to narrow: expects RoA gap between public banks and private banks to reduce to 87 basis points versus 123 bps currently.

• Valuation gap to narrow: Currently, 1 year forward price to book value differential with private banks is 65 percent (versus 39 percent average in FY03-07).

Earnings Revision

• Revised its estimates for public sector banks downwards by 6-59 percent in FY18/19E on higher near-term credit costs.
• Revised FY20 earnings per share estimates upwards by 9-16 percent on factoring in better operating profitability and normalisation of credit costs.

Preference For Private Banks Continues

The brokerage continues to weight toward private banks on expectations of continuation of market share gains, traction in under-penetrated retail/small and medium enterprises lending (which are key-drivers of profit pools) and focus on earnings post the narrowing of valuation gap.

Price Target Changes

For Public Sector Banks:

Goldman Sachs has raised target prices by 26-41 percent for public sector banks on expansion of valuation multiple, as they move valuations to FY20E basis and as they believe provisioning coverage at 65 percent on total impaired loans versus 70 percent earlier is adequate.

It upgraded State Bank of India to ‘Buy’ on expectations of book value of equity per share growth of 10 percent, normalising ROAs by FY20E and re-rating of subsidiaries. It has upgraded Punjab National Bank to ‘Neutral’ on balanced risk-reward.

FOR PRIVATE BANKS

For private banks, Goldman Sachs has revised price targets by -6 percent to +8 percent.