The counters in the banking hall of a state-owned bank in India. (Photographer: Sondeep Shankar/Bloomberg News.)

Macquarie Prefers Private Banks, Says PSU Bank Rally Unwarranted. Here’s Why

The recent rally in Indian public sector banks, driven by the government’s proposed recapitalisation, may not be justified as the funds infused will be insufficient for any tangible growth.

That’s what global investment bank Macquarie said as it continues to bet on private sector players. HDFC Bank Ltd. and ICICI Bank Ltd. are its top picks in the banking space.

The proposed Rs 2.1 lakh crore recapitalisation barely meets provisioning and solvency requirements of state-owned lenders, and the chances of big-bang structural reforms in public sector banks ahead of the May 2019 general elections look remote, it said in report.

We expect credit demand to remain anaemic, as capacity utilisation still hovers at a sub-optimal level of 70 percent. We are close to the end of the non-performing loan cycle and NPLs should peak in FY19, but provisioning on stressed assets is meagre at nearly 30 percent and provisioning requirements under IBC as well as IFRS accounting standard will remain very high.
Macquarie Report

State-owned banks will, in fact, need close to Rs 2.6 lakh crore just to meet their provisioning and solvency requirements, Macquarie said.

Outperformance Of State-Owned Banks

The Nifty PSU Bank index has gained 14.55 percent since Oct. 24, 2017, when the recapitalisation plan was announced, outperforming the broader Nifty Bank index and the Nifty Private Bank index, which have risen a little over 7 percent during that time.

Macquarie Prefers Private Banks, Says PSU Bank Rally Unwarranted. Here’s Why

Key Events To Watch Out

The two critical events to watch out for this year will be the resolution of stressed assets under the Insolvency and Bankruptcy Code, and implementation of the new accounting guidelines-International Financial Reporting Standards, the report added.

The IBC proceedings will decide on the quantum of haircuts that banks have to take, while IFRS implementation beginning April 1 could also pose significant challenges to capital requirements, as it would require upfront provisioning.

There is an added risk for state-owned banks in the form of rising bond yields for which banks will have to take mark-to-market losses on their bond portfolios, impacting earnings negatively. Bond yields on 10-year government bonds have risen 67 basis points in the October-December quarter. However, Macquarie believes the correlation between bond yields and stock performance has been getting considerably weaker over the past few years.

Rating Changes

Macquarie has raised price targets for all banks but expects private banks to continue to gain market share and see little risk to their growth projections.

It has upgraded Axis Bank from ‘Underperform’ to ‘Outperform’ and upgraded State Bank of India from ‘Underperform’ to ‘Neutral’. Yes Bank has been upgraded from ‘Neutral’ to ‘Outperform’ after its recent underperformance.

HDFC Bank and ICICI Bank are Macquarie’s top picks. “We see little risk to their retail loan growth, as they both are well capitalised to capture market share,” the report said.

Macquarie Prefers Private Banks, Says PSU Bank Rally Unwarranted. Here’s Why